For the best part of two centuries, the British postal service was the wonder of the world. No other country delivered letters so cheaply, reliably and quickly. Most of the credit belongs to Rowland Hill, but even before he remade the institution in the 1840s, Britain's dedication to the speedy delivery of letters drew admiration at home and abroad. Purpose-built mail coaches pulled by relays of horses (four to every coach) had tightened British geography by the end of the 18th century, shrinking the five-day journey from London to Edinburgh to 60 hours and London-Bristol to an overnight gallop. Inside cities and towns, speedy "penny posts" flourished. John Keats finished "On first looking into Chapman's Homer" at dawn one October morning in 1816, put a copy in the post at Southwark, and the recipient was able to enjoy the sonnet an hour or two later over his 10 o'clock breakfast in Clerkenwell.

The public revered the post for its military dash. Mail coach guards swore loyal oaths, wore scarlet tunics and had the right to shoot anyone they suspected of being an escaped French prisoner-of-war, with a £5 reward. In 1829, the Post Office opened its magnificent new headquarters in St Martin's le Grand, close to St Paul's and a must-see for foreign dignitaries after the cathedral's Whispering Gallery had been tested. The architect, Robert Smirke, was already working on designs for the British Museum when he got the commission and the General Post Office was equipped with similar Ionic columns and a Portland stone façade  illuminated at night with 1,000 gas flares, as a procession of mail coaches clip-clopped from the courtyard to begin their night-rides across Britain. Anthony Trollope, a junior clerk, once guided the queen of a German state around the building, walking every step backwards in front of her, which included the tricky negotiation of many stairs, and received half a crown for his courtesy. ("A bad moment," as Trollope remembered.)

Still, the Post Office of that age was far from perfect. It was smug and conservative and operated a bewildering system of charges that varied according to how far a letter had to travel and how many sheets it contained, with the receiver and not the sender paying the costs; an important incentive, it was thought, to the post boys who had to deliver them. Hill, who came to the Post Office as a Treasury adviser, revolutionised every aspect of the business when he introduced the uniform penny post and commissioned the first adhesive stamps. None of his reforms was easily achieved. The political establishment thought he was crazy: the Treasury worked out that the current average price of sending a letter was sixpence, which meant that the Post Office would need to multiply its mail volumes six times simply to maintain its revenue. Government ministers saw this as impossibly ambitious (rightly so; decades passed before mail volumes rose so much), but the simplicity and cheapness of Hill's plans caught the public imagination and the penny post became a mass movement that, in Duncan Campbell-Smith's words, "equalled anything seen on behalf of the abolition of slavery or even the reform of the parliamentary franchise". And so the government gave in.

Campbell-Smith sums up Hill as "a workaholic autocrat". But his sweeping postal reforms were vital to Britain's success as the world's leading industrial nation. It was so easy to be in touch. By the 1840s, the railways' travelling post offices were sorting letters en route. A north country manufacturer could have a reply from a London bank "by return of post" as the Royal Mail became a pulsing channel of business negotiation. Prices no longer excluded the working class, who might find themselves hundreds of miles from their relatives in a new industrial town. In the words of the social historian GM Trevelyan, Hill had "enabled the poor, for the first time in the history of man, to communicate with the loved ones from whom they were separated".

Consequently, and unusually, the nation fell in love with a government department: "It was universally seen as unique, not just as a flourishing business enterprise run by the state but as an organisation of unparalleled efficiency and trustworthiness." For most people in Britain, the Post Office became "the most familiar manifestation of the state in ordinary daily life". And it grew and grew, changing the nation's habits and landscape. Hill and one of his associates invented the Christmas card. Trollope, by now working in the Channel Islands, heard reports about new-fangled post boxes in France and imported the idea. (After a standard colour was adopted in 1874, their splash of red gave the humblest village the glamour of distant communication.) The Post Office invented the postal order, set up a savings bank, hired thousands of boys to deliver telegrams, and built offices in provincial towns that in their elegance and importance rivalled France's hotels de ville. By 1914, it employed more people than the army, the navy and the royal dockyards combined.

What went wrong? Digital communication has left every postal service in the world struggling to cope with a loss of trade, but long before that happened the British Post Office found its own peculiar difficulties, created in part by its Victorian success. Like much of British industry, it found modern inventions a nuisance. The government persuaded the PO before the first world war to take over a ramshackle telephone system, owned by a dozen different companies, but throughout the 1920s the PO did almost nothing to extract more money from what was a monopoly asset. Britain ranked 12th in the world in the number of telephones per 1,000 people in 1929. Among cities, London came as low as 27th. Marketing was an anathema. A small revolution occurred in the 30s  when the PO snapped awake to the potential of telephones and in Night Mail commissioned one of the most brilliant publicity films ever made  but it went on thinking of itself primarily as a deliverer of letters; not unreasonably, because letters still accounted for 90% of its income.

By the 70s, the main problems were size and torpor. A head-count of 430,000 employees made it the biggest business in Britain, and though by now it was a public corporation rather than a government department, its upper management still ran along civil service grooves. Down below, trade unions ran the shop floor, planned the overtime rotas, and, particularly in the London sorting offices, grew solid in their opposition to productivity agreements and mechanised sorting: the postal section of the London District Council (LDC3) made its initials notorious as "a kind of workers' Soviet". Losses mounted. The inflation-adjusted cost of posting a half-ounce letter had never been lower, not even in Hill's day, but mail volumes (unlike labour costs) began to fall. Even in this melancholy atmosphere, the PO managed to go on innovating  where would a satnav be without postcodes?  and then in the 1980s a surge in mail volumes suddenly overturned the prevailing wisdom of "managed decline".

The number of letters posted rose by more than a quarter between 1982 and 1987. Mail shots poured out of personal computers, ink-jet printers and high-speed copiers  new office technologies that gave the Royal Mail an unexpected Indian summer. Social correspondence  letters between individuals needing a stamp and a walk to the pillarbox  now accounted for only 15% of letters. Everything else was "business" mail. In the 1840s, William Wordsworth had complained that all cheap postage had done was increase the number of time-wasting letters from strangers. Now we were all Wordsworths, but to the Post Office's great advantage.

What was a government to do with such success? The telecoms division had already been successfully privatised in 1984, but Mrs Thatcher revealed a surprisingly sentimental streak when it came to the mail and insisted the Post Office remain in public ownership. (Why? Because of stamps with the Queen's head? The friendly postmen of her childhood? Nobody knew.) If the PO had been allowed commercial freedom as a public corporation, this might have been good news. Instead the Treasury used it as a milch-cow, creaming off profits that were badly needed for investment so that sometimes the PO kept staff on because it couldn't afford their redundancy payments. Meanwhile the Department of Trade and Industry set up a zealous regulator, Postcomm, which on the one hand could curb rises in the postage rate and on the other could demand that the PO's monopoly be opened to private competition. Postcomm insisted it was simply following EU directives, but its puritanical dedication to the free market ideal amazed the Royal Mail's counterparts elsewhere in Europe.

The pressures drove the Post Office into successive waves of corporate reorganisation, or what Campbell-Smith calls "death by a thousand plans". For a mercifully brief time it even gave itself a new name, Consignia. Managers spent more time trying to implement change than they did looking after the business. By 2002, "Blair and his ministers were faced with a Post Office in total financial disarray. Five years of frenetic reorganisations had reduced it to a state of virtual collapse."

This is a majestic account of a great institution's rise and fall. It doesn't close without hope: the author thinks the British postal service may have a modest, privatised future as a kind of co-op where users and staff hold the shares, trading on the British public's "abundant good will" towards the Royal Mail. It's hard to read his closing chapters, however, without being angered at the spectacular muddle and carelessness of recent British governments, which first bled a national asset dry and then poked the carcass with sticks.

 Ian Jack's The Country Formerly Known as Great Britain is published by Vintage.