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Credibility now

Labour’s new leadership intends to reset its economic policy. However, Labour needs to do much more than find the right policies. It needs to fundamentally rethink the basis for its economic platform, making sure it is relevant to today’s economy...


Labour’s new leadership intends to reset its economic policy. However, Labour needs to do much more than find the right policies. It needs to fundamentally rethink the basis for its economic platform, making sure it is relevant to today’s economy and reflects progressive values. The economic approach of the New Labour years no longer applies but a politics of simple anti-austerity misses the point.


A changed economy


Labour has a mountain to climb to restore public trust in its economic management. By the end of 2015, the party, its new leader, Jeremy Corbyn, and shadow chancellor, John McDonnell lagged far behind the Conservatives on the issue, as did Ed Balls and Ed Miliband. Labour are also expected to borrow more and is regarded as running a higher risk of economic disaster, even if people are not convinced that more spending cuts is the right policy. Labour has still to work out what being credible on the economy actually means, as the confusion over whether or not to support George Osborne’s ‘fiscal charter’ and Labour’s current low level of engagement with business has shown.

Credibility should not be the primary aim of economic policy but a consequence of doing the right thing. And here, both Conservative and Labour economic policies have failed. This is because they have assumed the economy would return quickly to a pre-crisis ‘normality’ after the Great Recession – despite the fact it was that normality which set up the conditions for the financial crisis.

Politics needs to adjust to a changed economy. Before the crisis, the economy was in an apparently stable state, which became known as the Great Moderation, with growth, low inflation, and, compared with previous decades, low unemployment. The crisis awoke us to the reality of a high debt global economy, and we now have interest rates at rock bottom, continuing asset price increases, and occasional dances with deflation. In both periods, the push has been towards greater inequality.

We are now in the midst of a long financial cycle. As the Bank for International Settlements has noted: “Financial fluctuations (“financial cycles”) that can end in banking crises such as the recent one last much longer than business cycles. Irregular as they may be, they tend to play out over perhaps 15 to 20 years on average.” They have called for a move “away from debt as the main engine of growth”, which is a challenge given global indebtedness. Growth in global debt is now being driven higher by emerging markets where, overall, debt has risen to 195 per cent of GDP from 150 per cent in 2009, with limited deleveraging in developed economies. High levels of debt carry risks, especially from rising interest rates. Without sustainable growth, debt is like an addictive drug. It puts off the day of reckoning, but not forever. Restructuring and economic growth are two fundamental requirements for dealing with the problem.

Yet Conservative economic policy relies on household borrowing increasing further. Although household debt to GDP reached over 160 per cent, at 140 per cent it is still high and the Office for Budget Responsibility (OBR) predicts that under current government policy it will rise once again, driven in part by higher house prices. That is the flip side of the government’s spending cuts. Despite the current GDP growth rate, the trend rate of growth could be much lower than pre-crisis.

Interest rates are very close to zero. Together with quantitative easing, this has helped push up asset prices, including housing. Central banks are determined to ‘normalise’ rates but are finding this difficult with inflation at such low levels (more or less zero in the UK in October 2015). A normal interest rate in the UK is now regarded to be 2 per cent.

This presents a problem. As Bank of England chief economist Andrew Haldane has noted, ideally interest rates should be at or above ‘normal’ levels in time to be cut into the next recession. The probability of a recession in any 10 year period is very high and increases. The last recession was in 2009 and based on history some sort of slowdown might be expected in the next few years. Even if the Bank has managed to raise rates towards 2 per cent, it might then have to cut them soon afterwards, if inflation remains low.

Meanwhile, investment is relatively subdued, despite low interest rates. Businesses are experiencing a high degree of uncertainty as they plan for the future and in many cases are holding back expansion plans. They were also bitten hard by the near collapse of the banks and are content to hold extra cash on balance sheets. It is likely too that executive pay schemes are incentivising executives to buy back shares to boost earnings per share, and hence bonuses, rather than make longer term investments. The corporate sector is lacking sufficient and sustained confidence to increase investment substantially.

Interest rates have been falling for at least a decade before the crisis. Real (after inflation) wages have been falling too. The longer term factors have probably been the financial integration of China into the global economy and the large increase in the global labour force from China and Eastern Europe. Low interest rates have driven up asset prices, while real wages have been driven down. Inequality has grown as those with capital saw their wealth increase. QE has exacerbated this.

Central banks are now focused on preventing Japan-style deflation and are mindful of the risks of speculative booms and busts encouraged by low interest rates and QE, as the most recent Geneva Report on the World Economy highlights. Governments are faced with rising inequality, the risk of another crisis, and, unless they tackle the debt and growth challenge head on, lower rates of growth.


A new hope?


These longer term trends towards greater inequality may reverse, according to the Geneva Report, as “the bulge of high saving middle-aged households moves through into retirement” and stop saving. What’s more, the pace of China’s financial integration should slow as its economy becomes more domestically focused. With little prospect of another large increase in the global labour force, real wages could rise. Higher wages could prompt companies to boost capital spending, raising productivity, while transferring money to the less well off, improving living standards and reducing inequality. This is good news and the trend may be on the turn already.

However, the Geneva Report says “the time scale … is highly uncertain and will be influenced by longer term fiscal and structural policy choices.” The values behind these policy choices will be highly significant. The outcomes above are not guaranteed and could take a long time to become evident. Waiting for them to occur could lose a generation to further inequality and so action is required now, but in a way which can encourage any future trends towards a more equal economy.


Policy that suits the times


If interest rates, inflation, and growth are to remain low for some time, it will also take time for the tax base to grow to support past levels of spending. The Conservative answer, ideologically and practically, is to pare back spending to match, shrinking the state. Yet debt levels are still high, and markets may limit the government’s ability to ramp up borrowing during the next slowdown. This is the old model.

One alternative is to raise tax further, reducing the burden of deficit reduction from spending. While this is never popular, it should be pursued but as part of wider tax reform. This should probably include the controversial step of reducing the concentration of income taxation on those with higher incomes. That seems counter to Labour values but the concentration is a risk. It would be more economically sensible to tax significant increases in wealth brought about by government policies such as QE. Such reform should probably include a land tax. A financial transactions tax would also assist here and might dampen some QE-related volatility in asset prices, together with banking reform. However, taxation as a proportion of GDP has never sustainably risen much beyond 36 per cent, which limits what government can do beyond temporary increases. So even higher taxation has limits.

Ultimately, therefore, we need higher and better growth.

Labour should adopt a genuine Keynesian approach by acknowledging the role of financial markets and uncertainty. To get out of the current liquidity trap, when cutting interest rates has little effect, government has to be proactive. That means stepping into the gap and significantly boosting investment, for example in infrastructure, climate change prevention and mitigation, and education. This should be accompanied by measures to promote an environment for business, with clear and stable taxation and regulation. Extra government investment should be funded by borrowing, combined with a clear plan for balancing the current budget.

Balancing the current budget over time of course means some hard choices, even though higher growth should eventually make the task easier.

There is another option. The Bank of England owns £375bn of assets, mainly government bonds, which it bought via QE. It created money out of nowhere to purchase the bonds. In theory, the process will be reversed when the Bank believes conditions have normalised. However, the Bank could in effect write off some of the purchases. This would reduce the government’s debt, and so make the task of fiscal consolidation easier. Moreover, if there was another financial crisis or recession in the near future, the Bank could print more money but this time use it to stimulate the economy more directly

This seems like cheating but it is possible. The problem is that it carries risk, that governments will use the technique on a regular basis to boost demand, creating hyper-inflation and a loss of confidence in the UK economy. Ultimately this is a question of control and degree. While it seems controversial, it has been proposed regularly, for example by Milton Friedman, Ben Bernanke, Martin Wolf, and most recently in the UK, Adair Turner. At the very least, a one-off reset of debt linked to the financial crisis could help boost growth and avoid unnecessary hardship. It would merely be continuing an approach adopted since the Jubilee laws found in the Bible, where debt was written off every seven years, and assets redistributed every generation. However, it would need to be implemented at the right time by a party that people and markets believed was highly economically credible.

We need to be wary of conventional wisdom. Fabians should recall a lesson from history. Labour lost power in 1931 when it could not agree to implement harsh spending cuts to balance the budget and support the pound. It then looked on as the National government simply left the gold standard and avoided the problem, with Sidney Webb remarking that “no one told us we could do that.” If there is another slowdown soon, we should expect more rules to be broken. We have to be proactive.

However, even such radical measures are insufficient. A great deal of work is required to show Labour can be trusted to manage the economy and that it understands how a modern dynamic economy works.


Applying our values today


The values held by government matter, particularly during fundamental changes of the sort we are experiencing now. The challenge is to integrate the principle of equality with economic policy, in particular to ensure each person gets opportunities to fulfil their potential and has a fair stake in the economy. This was the vision of RH Tawney and others, who saw economic freedom as part of a more equal society, focusing on distribution of opportunities and power.

This ethical socialism is an appealing vision because it treats people as individuals acting within society. It is a rich seam on the left that is consistent with liberal values, and has always contrasted with impersonal ideologies which have little appreciation of human character. It is a vision that can only be achieved if we shake off statist policies and think about how to do this in a dynamic modern economy.

People and companies respond to economic incentives and they make their own decisions, usually much better than government attempts to do so for them. Business is an expression of human creativity and good business is something to be celebrated and more than as a means to an end. It is often a challenge for the left to appreciate this, but it should not be. It will mean doing basic things such as turning up to business conferences and engaging with business people.

The state plays an important role to ensure economic power does not become concentrated, something it failed to do in the run up to the financial crisis when banks became too powerful, and to ensure everyone has proper stake in the economy. One important future role should be additional reform of executive pay. Another should be more vigorous promotion of competition.

The character of the economy and the equality principle should lead us to increase access to and ownership of capital. This is why the Child Trust Fund was such a good, if limited, idea. Something similar should be attempted again. However, capital is more than an investment fund. It can be seen in the range of opportunities a person has and there should be a better distribution here too, particularly in educational opportunity. Technology brings new challenges. Increasing automation needs to work for everyone, rather than provide another reason to drive down wages and risk unemployment for the many, which has concerned even the Bank of England. The policy of investment should be applied across the economy, with government declaring it will invest in everyone’s future and give them the capacity to do so too.


Towards a ‘progressive synthesis’?


While Labour is a long way from having a comprehensive economic policy, some emerging features can be observed. In his leadership campaign, Jeremy Corbyn set out some policy ambitions in an attempt to move Labour in a new direction. These have included borrowing to invest and not to pay for current spending from 2020. The emphasis has been on promoting growth as the primary means of reducing the deficit rather than spending cuts, focusing Labour as a clear ‘anti-austerity’ party. It is assumed, however, that by the time of the next election government spending cuts will be finished, neutralising this as a dividing line. Corbyn also advocated a ‘People’s QE’, whereby money is created and used to fund infrastructure.

Other measures that have emerged include: a national investment bank, a greater role for employees in the running of businesses, the promotion of technology, taxation of retained company profits, firm encouragement of financial institutions to promote long term investment, and spending of an apparently large amount of avoided tax once recovered.

It is apparent, particularly in the light of the above discussion, that in isolation these ideas are not particularly radical. However, some contain hints of a threat of legislation to control company behaviour and there is little demonstration that the role of business and markets is understood.

Labour’s economic policy is indeed in need of a fundamental overhaul. The world has changed. The financial crisis changed the economy but there have been longer term trends evident too, which may begin to reverse. Labour needs to regain its reputation for fiscal prudence and guarantee spending growth will be controlled and effective. But it has to be clear about what happened in the financial crisis and what kind of economy we have at present. It cannot rely on the old economic assumptions. Neither going back to business as usual before the financial crisis or a more fervent anti-austerity stance meet the challenge. Either choice will look as if Labour is burying its head in the sand, because that is what it will be doing. A new framework is required, which unites progressive values with an economic policy that meets the challenges of our time.



Stephen Beer

Stephen Beer

Stephen Beer writes on economic policy based on an investment career spanning over two decades, most recently as a chief investment officer and head of ESG for pension and charity funds. He is the author of a Fabian pamphlet on the economy.


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