Getting back to normal?

This might sound odd given their obvious mutual dislike but it is possible that Ed Balls and George Osborne have more in common that you think; something pretty fundamental in fact. What binds them is their shared faith that, sooner or later, the British economy will return to its pre-crisis growth path.

Of course, they disagree intensely about appropriate policy in the interim and one has to admit that Balls’ Keynesian arguments are making mincemeat of the remains of Osborne’s Plan A. However, underlying that disagreement is a consensus on long-term prospects. Indeed, the private-sector bounce-back would provide the financing for Balls’ fiscal stimulus. The consensus that we will get back to normal is widely shared and each successive official projection, perhaps for political reasons, just seems to push the return to the old trend slightly further into the future – but it’s a risky assumption.

These are highly uncertain times and economic forecasting is always an imprecise art. An economics tutor, who had worked as a statistician in the Treasury, once summed up the lesson of post-war economic forecasting as: “you’re doing well if you can explain the past, let alone predict the future.” Given this degree of uncertainty it makes sense, I would argue, to consider a range of possible economic futures rather than pinning all our hopes on just one.

Why, then, might the ‘new normal’ differ from the ‘old normal’? One reason that has received relatively little attention in the context of the ongoing macroeconomic crisis is the shift eastwards in the centre of global economic gravity. For example, China has displayed a remarkable economic dynamism over the last 25 years with very high rates of economic growth and capital accumulation and so it retains enormous potential for future development.

Economic development is nothing new, of course. Think, for example, of the development of Japan and the Asian tigers during the post-war period and how its potential impact on the west has often been overstated. However, what perhaps sets the latest phase apart is size. For example, the integration of China and India into the world economy will eventually add two billion people to the global marketplace.

We may reach a stage in the future where business investment in the west remains chronically sluggish as economic activity shifts to more profitable sites in the east and elsewhere. This is an idea that is being somewhat neglected. For economies like Britain this suggests a long-term outlook that is anything but rosy: depressed capital accumulation and overall economic growth, virtually stagnant levels of productivity and real wages, and high unemployment for a prolonged period. It is possible that we’ve already been on this low-growth trajectory for some time but did not realise because living standards did not decline at a commensurate rate. There is now widespread recognition, for example, that our pre-crisis prosperity was built, in part, on unsustainable borrowing by consumers and perhaps governments. However, before getting too carried away, we should note that the total flow of foreign direct investment from developed to developing countries within the global economy is currently but a small fraction of total capital accumulation within the developed world.

In a nutshell: we should, for prudential reasons, give more consideration to the possibility that the integration of the so-called BRICs – Brazil, Russia, India, China – into the world economy might have significant macroeconomic consequences for western nations. One channel through which these effects might operate is the reorientation of worldwide capital accumulation from west to east. Another is the impact of eastern development on global commodity prices, like oil.

Interestingly, there is a growing recognition within the economics profession that east-west trade has microeconomic impacts on the distribution of income within advanced economies – it tends to favour capital over labour and skilled workers over unskilled ones. For example, Paul Krugman has recently “reconsidered” the position he took in the 1990s’ trade and wages debate. He argued that the great majority of the rise in income inequality between skilled and unskilled workers in developed countries was due to “skill-biased” technical change rather than shifting international trade patterns. Now he believes that trade with large developing countries, like China, is “probably” affecting the western income distribution substantively. We should generalise this recognition of the impact of eastern economic development within a globalised economy to the macroeconomic level.

Recognition at the academic level is one thing; positive action at the policy level is quite another. What positive action could a future Labour government take if faced with the grim (and admittedly extreme) scenario outlined here? There are no easy answers, nor are the lessons of history terribly reassuring. For example, the cause of the British economic crisis of the 1970s has often been located in a ‘profits squeeze’ that was itself the result of reduced productivity growth, commodity (oil) price shocks, and international monetary disarray (the collapse of the Bretton Woods system of fixed exchange rates). This sounds similar to the picture painted here although, of course, the parallel isn’t exact – for example, today we are not facing a re-run of the inflationary spiral of the 70s. Some argue that the Thatcherite programme of deregulation restored the profitability of British capitalism but, for social democrats, the human cost of that brand of reform programme is repellently high.

Before getting too despondent we should recognise, as Gordon Brown has rightly emphasised, that economic development abroad has the potential to create jobs at home, as the expanding foreign middle class consumes our exports. Perhaps the central lesson of the economic analysis of international trade is that trade integration is not a zero-sum game –  it has the potential to create gains for all trading partners simultaneously.

However, this optimistic message assumes a smooth transition from autarky – being self-sufficient – to free trade. In reality, increased international policy co-operation, especially in the monetary arena, is likely to be required if we are to hope to reproduce the ‘soft landing’ of the economics textbooks.

There are two broad types of measures that would further Labour values. Firstly, even in a low-growth environment, policy can try to improve material economic outcomes. For example, long-term investment could be encouraged by the establishment of a National Investment Bank with responsibility for financing public infrastructure (beyond the political cycle) and perhaps also the ability to pump-prime investment in physical and human capital more widely. Short-termism could be addressed by tougher rules on hostile take-overs, and banking reforms, such as the promotion of mutuals, would give voice to a wider range of interests in finance. At the same time, greater equity in the distribution of rewards could be achieved through corporate governance reforms (e.g. more influence for shareholders in the setting of executive pay, and a stronger voice for workers in running firms) and through fiscally-neutral tax/benefit changes coupled with a determined assault on tax avoidance/evasion.

The second broad class of reforms focuses on improving the quality of life within the ruling economic constraints. The point here is that the standard of living means more than just pay. For example, stakeholding corporate governance reforms would give people more control over their work and thus improve the quality of the employment relationship. Likewise, decentralising reforms within the state could give local people more control over their lives. Within any given economic context, action should also be considered to improve the work/life balance and to address green concerns.

These types of reforms fit with the developing ‘responsible capitalism’ agenda of Labour politicians like Ed Miliband, Stewart Wood and Jon Cruddas. Of course, a key question remains: Is our democratic system, with its widespread lack of faith in both politicians and the power of government, fit to deliver these big changes? Doubtless some will say that it’s easier to bank on a return to normal in both economics and politics, but that would be a mistake