Credibility Deficit

Even if Labour is proved right on the dangers of a double-dip recession, it will not be enough to win the economic arguments of five years hence

If Labour had won the general election, by June we might have been giving an emergency budget statement.  Until we realise this, we are not going to get very far in renewing our economic policy.  The rhetoric we are using about investment versus spending cuts will have no traction unless we have a credible economic policy not for the next year but for the next ten years.  A new Labour economic policy worth having would acknowledge that some spending cuts are necessary.  It would also look beyond this year’s political battles to the long term challenges.

While the election campaign was underway, the rest of Europe was in the midst of a new financial crisis.  Investors were worried that would default on its debt.  Market attention moved to other countries believed to be vulnerable.  The Treasury and the Bank of England worried that the could come under market pressure.  If this had happened, government bond (gilt) prices would have fallen, so raising the interest rate the government had to pay for new debt.  Some believed the ’s AAA credit rating was at risk.  These worries were despite the economy’s different characteristics.

The ‘cult of austerity’ was in full swing and the Conservatives planned to take the opportunity to roll back the state.  Concerns about international markets gave the Liberals a fig leaf to cover their total change of position.  The ground was prepared for a stringent budget with ­­­­­­­­­ public spending cuts £40bn more than Labour planned.  Some spending areas could see 40% cuts.  Despite the austerity, credit rating agencies remain concerned.  They want to see signs of real commitment to cuts in the autumn spending review.  This is why Labour might have needed budget statement: not about cutting further but to put some flesh on our existing, already stringent, plans.

government debt rose because of the banking crisis and subsequent economic slowdown.  The Tory/Liberal government focuses on the annual deficits the crisis created (blaming Labour).  However, while these are large (£154.7bn last fiscal year) the impact has not been as great as originally feared because we took action.  Moreover before the crisis the UK had, compared to some other rich countries, a relatively low net debt position at around 40% of GDP (forecast to peak at 70%, compared to 150% for Greece), and much of this debt was long term.  The crisis is estimated to have created a structural hole of around 5.8% of GDP which has to be addressed to keep public finances sustainable.  Labour planned to do so, but over a longer time scale than the Coalition to avoid damaging the recovery.

The scale of the cuts Labour planned was significant.  Alistair Darling declared they would be more severe than experienced under Margaret Thatcher.  Ed Balls, in a speech in the City in August, pointed out that Labour under Clement Atlee had coped with a worse debt position in 1945 but had still achieved great social reform, such as the foundation of the NHS.  He is right to suggest that, in economic terms, the financial crisis is of a similar scale to a war.  Therefore we should not set unrealistic goals to cut annual deficits but should have a medium term plan to reduce them.  Balls was also right to argue that economic policy should not be dictated by the short term concerns of financial markets (though it cannot ignore them).  Investors have the luxury of being able to change their minds in an instant.  Concerns over deficits in May gave way in August to concerns about growth with gilt prices rising further along with US government bonds (a country showing little immediate sign of cutting its debt).

However, we cannot postpone spending cuts indefinitely and Labour in opposition needs to build up economic credibility.  There are at least £40bn of cuts that we believe are not necessary but if we oppose every spending cut going we will not get very far with the public.  At some point we will need to say what spending we would reduce.  Tax rises will not suffice.  That may lead us to some surprising commitments, even though we do not need to go through every cut proposed.  It should lead us to further public sector reform in a way which works with people and promotes a public service ethic rather than slashing jobs and leaning on charities.  We should shift some spending to a proactive employment policy that keeps people in work and means spending falls as growth picks up.  That is the right policy but it means some difficult choices for shadow cabinet members.

There is a real risk that austerity measures will reduce economic growth.  The austerity hits in future years, raising the prospect that the growth rate could dip next year (despite its rhetoric, the Coalition only plans to reduce the deficit by an extra £8bn this tax year compared to Labour’s last budget).  George Osborne is relying on a rapid increase in investment and exports to compensate for the withdrawal of government spending.  The Financial Times has expressed concern at this and even proposed that he keeps some emergency stimulus measures up his sleeve.

Labour cannot pin its electoral hopes on a double-dip recession since we need an economic policy that will speak to voters’ concerns in 2014 and beyond.  Imagine our fears are realised and the economy does slow down in a year or two.  What will be our message in four or five years?  Even if growth remains sluggish and unemployment high, at the next election we will be saying ‘you can’t trust the Tories on the economy, look at how they managed it’.  That only takes us so far.  The Tories will claim sunny uplands lie ahead.  Labour’s economic policy must speak to the future.

A Labour economic vision should be for an economy in which anyone can prosper.  We will focus on more jobs and better jobs, even cutting spending elsewhere to ensure people are in work (so we would reinstate the Future Jobs Fund).  We should promote a stable environment for business, with a simple tax system.  We should keep a lid on taxes for most people, while using tax incentives to reduce carbon emissions.  A Labour government should invest in our common future, focusing capital expenditure on infrastructure (a point emphasised by David Miliband).  That way, we raise the country’s productivity which of course leads to more jobs, higher tax revenues, and therefore fully funded public services.

Labour achieved much in office so we should not be depressed.  As the economist Keynes pointed out during the 1930s recession, despite straitened times we are wealthier as a country than we were a few years ago.  Our education and health and other public services are much improved, with new schools and hospitals and much-needed equipment.  New technology makes our lives today much changed since 1997.  Of course Labour was not directly responsible for the millions of business and consumer decisions made, but we managed an economy that was open to innovation and investment and we did it while supporting the poor and vulnerable.  When the banking crisis struck, we prevented another Great Depression.  Now, we have to plan for much reduced spending as the economy recovers.  Labour needs to be clear about this to improve its economic credibility.  It must also develop an economic policy that meets people’s needs and aspirations for the future.