You can't fool all the people all the time...

The great icon of Rastafarianism, Bob Marley, used to sing - "You can fool some of the people some of the time, but you can't fool all the people all the time". Now Bob used to smoke a lot of fairly potent and illegal substances, but he was still capable of coming up with these sorts of reality bites amidst the purple haze. The esteemed Prime Minister, Gordon Brown, on the other hand apparently doesn't dabble with that sort of stuff, yet he and his band of cohorts are the living representation of Marley's sentiment. As his right hand man, Alistair Darling, delivered his Budget this week you would have sworn that he too had been "puffing the magic dragon", when coming up with the statistics that he claimed as his version of financial reality. This was not a one-off - we have passed through a long period of mass delusion of gross proportions, but with the tide now fully out economically you might have expected a bit more honesty.

There are two parts to this gross delusion. Firstly, the government doesn't seem to grasp where the money comes from, and secondly, it doesn't seem to want to understand where it goes. Both would appear to be fairly important. The sense has been for a long time that we could go on borrowing heavily to fund the creation of make-believe jobs in the public sector. This delusion was multi-faceted - that the private economy as strong enough to bear the burden of the bloated public sector; that the economy would never experience a severe downturn which would undermine tax revenues; that the tax-take could go on rising, even though it rested to a large extent on two of the most vulnerable bits of the economy, namely the housing market and the financial sector; and that all the extra jobs in the public sector were real.

Last week's Budget should have been the moment when it became clear that these are desperate times. On the contrary, there was an ongoing surreal delusion about the impending doom: most people are still employed and public spending continues to accelerate. The budget presented a statistical snapshot of the ugly shape in which Britain now finds itself, yet provided little genuine understanding of how bad things could get. With the financial heart shot out of the economy, tax revenues have fallen dramatically just as social spending has increased. The same situation exists in many countries, and is largely unavoidable - but the government's heavy borrowing even before the recession hit, was entirely avoidable. If this government was running a public company, the inefficiency of its spending would have seen the leadership sacked and replaced long ago. Yet they still stealthily try to delude the public.

As with all financial operations, the national balance sheet has to balance. Assets (the individuals and corporations) that generate the revenue need to be fostered in a way that the liabilities (government borrowing and public service commitments) can be afforded. GDP growth increases the revenue that comes from the assets side of balance sheet, and diminished public spending reduces the liabilities side of the balance sheet. In that context if tax revenues fall because of falls in GDP growth, then the liabilities side has to be reduced at some stage to balance the books, with borrowing filling that gap over some defined period of time.

The government plans to borrow £175bn through gilt auctions in the current fiscal year and the same the year after. In last year's budget, public net debt was expected to be 39% of GDP this year, now it is at 59% and is going to be close to 80% by 2013-14. In theory such borrowing should be sustainable if the assets side of the national balance sheet are likely to produce the tax revenues to pay these debts, or if the other part of the liabilities side - public sector spending promises - are reduced, or both. As Alistair Darling stood at the despatch box he had to reassure potential creditors that the government had a plan for tightening fiscal policy, and for creating the economic growth that will generate the required tax revenues. A tough gig, but one where you would have hoped for a degree of honesty.

Instead he continued the mass delusion with a string of over-optimistic economic assumptions and political gamesmanship. The raising of the top rate of income tax to 50% threw petrol on the fire that suggests that "the rich" are responsible for this mess and that taxing them a bit more would remove the need for a Reckoning that will come to the remainder of the population. Nonsense, but politically sound short-termist thinking.

As the Economist pointed out: "The fiscal plans are like one of those childish excuses that begin with a little exaggeration and morph into outright falsehood". The theoretical commitment to cut the growth of current spending to 0.7% a year from 2011-12 (after the election) is insignificant. In these circumstances, the squeeze on public spending doesn't go anywhere near far enough. There needs to be a complete freeze on public spending in nominal terms, implying cuts in real terms, to take effect over a multiyear period. It would be out of this world to expect this government to be so explicit about its intended cuts with an election due before next summer.

Where the biggest delusions lie in the projections for the size of the forthcoming budget deficits, however, is on the assets side of the national balance sheet - the assumptions about economic growth are truly "pie in the sky".

In order to "fix the numbers", the Treasury assumes that the economy will start growing at the end of this year and expand by 3.5% in 2011. The rest of the world outside the drug takers in government, such as the World Bank and the IMF, expect further declines in GDP next year and only moderate recovery when it comes. No self confessed "prudent" prime minister would have allowed these aggressively positive assumptions - too much is at stake if they are overoptimistic. The Treasury also forecasts that next year consumers' expenditure will rise by 0.25%, despite what will probably be high and rising unemployment and average earnings growth that is unlikely to be positive. Similarly the savings rate will still be at very low levels and people are likely to want to rebuild their financial strength before starting to increase their spending again.

In this context, what is the government actually doing, or proposing to do, to foster these proposed levels of economic growth that will sure-up the assets side of the national balance sheet?

Sterling's relative weakness should help bolster exports, which should help economic growth and tax revenues as a consequence. In this regard, I suppose the government did its bit by devaluing sterling when they mismanaged the economy for long periods, so we'll give them indirect credit for that one. Aside from that there is little else that the government can do quickly. The real contribution they can make is by boosting confidence - which wasn't helped by the Budget. The Chancellor did manage to retain his predecessor's tendency to see the UK as leading the world in a variety of fields, including green technology and digital media. He talked of developing offshore wind, though perhaps with the amount of wind coming from himself and his boss, the onshore market should be the best place to start. As Roger Bootle commented: "We seem more likely to be leaders in red technology, with the Debt Management Office issuing umpteen squillion of gilts in the morning and the Bank of England buying them in for more in the afternoon. Talk of recycling."

What is fundamentally missing is any sort of long term game plan for truly adjusting the British economy to the new world order where significantly lower tax revenues from financial services will permanently diminish the assets side of the national balance sheet, and where inefficient public services will become an even bigger drain. The long term health of this economy is down to the capacity of it to produce truly world class businesses in high margin fields. Sadly it seems that the government is determined to foster a resentment of those who aspire to such endeavour, the 50% top income tax rate a fitting case in point.

Where are the Silicon Valleys of the UK, and what is being done to create global leadership in the fields like green technology and digital media that the government falsely claims leadership in?

A simple example of how this government and their predecessors have got the process wrong is in their attitude to third level education - which has rapidly become "a right of passage" in this country as opposed to a well thought out privilege. In February this year, after a 18 year experiment, the universities secretary John Denham began to acknowledge that the turning of the polytechnics into "new universities" has backfired. Instead of providing hands-on vocational skills training for the less academically inclined, this switch created the opportunity for those with lower grades at A-level to go on and study "academic" degrees, and in doing so burden both themselves and the taxpayer with high debts and impractical skills. "The truth is that a classics degree at a traditional university is not the same as a degree in mining and engineering at another." Mr. Denham is clearly no Sherlock Holmes.

The old polytechnics should be brought back and strengthened in their approach to teaching practical, vocational courses that allow their students to have a fighting chance of a job upon completion. The elite academic universities should take to the forefront of Britain PLC's attempt to become leaders in the fields that the government aspires to. A point which Mr. Denham did acknowledge - which would signal a move away from the Labour attacks on so-called Oxbridge "elitism". "We aim to encourage the advancement of a handful of academically excellent institutions. They will receive the lion's share of research funding, £1.5bn this year, although 'pockets of excellence' in the new universities group would also get some funds." he said.

By comparison to our global competitors the £1.5bn investment is an absolute pittance. It represents a fraction of what is available for research and development at individual US universities, and is almost laughable in the context and size of the British economy, particularly when you consider the scale of spending within the inefficient public services.

When all is said and done, without dramatically addressing the competitiveness of the UK economy with serious investment in the efficient parts of the system, the level of borrowing predicted over the coming years is completely unsustainable. The consequences will mean higher taxes all round, further weakened public services and potentially a decision for entrepreneurs to take their ambitions and the jobs that they will create elsewhere. The Chancellor talked warmly this week, of grandparents caring for their grandchildren. In the circumstances this was appropriate, for it seems that the grandchildren will still have to live with the consequences of what had to be endured by their grandparents.