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Credibility on debt and growth go together

Ed Miliband's speech and lessons for Labour from the European crisis

The turmoil in European financial markets continues and it is directly affecting the lives of millions. Technocratic governments now run two eurozone countries but it is really the bond market that is in charge. If ever proof was needed that economic credibility matters it is surely here.

The uncertainty and the prospect of new austerity measures on the continent are damaging growth prospects in the UK too. The Bank of England this week downgraded its GDP growth forecast to around 0.9per cent for 2012 from the 2.2per cent previously expected. That probably means more quarters of negative growth as well as slight increases in GDP. The Office for Budget Responsibility is expected to lower its forecasts later this month too. With the private sector struggling and public sector job cuts in progress, that points to a grim outlook for unemployment levels.

Labour leader Ed Miliband spoke yesterday about the challenges facing the economy. He called for action from a government which seems stunned at events. It was a well-argued speech which enlarged on his theme of responsible capitalism, first outlined in his Labour conference speech. He spoke of how companies had told him they were being held back by City short termism and talked about the need for more responsibility on matters of executive pay.

Labour is not alone in thinking the relationship between finance and the rest of the economy needs refreshing. In a pamphlet published by corporate governance specialists PIRC last week, politicians and City practitioners addressed the need for change.

That companies struggle to get longer term finance is an important problem. For small businesses, the blame mostly lies with banks and, in some cases, their own poor management of working capital and existing borrowing. That is why we need a national investment bank (as I argued in a recent Fabian pamphlet) because it can stand behind loans to business and can also provide them with advice. Traditional pension investment funds are not usually short termist. Besides, the key issue here is trust. Since financial forecasts have little value beyond a couple of years, investors need to trust company managements know what they are doing. Experienced fund managers will recall mistakes they made when they believed some long term growth stories that seemed convincing at the time. This points to the need for better relationships between businesses and its stakeholders, a point made by another recent contribution to the debate (Transforming Capitalism from Within, by Jonathan Rushworth and Michael Schluter).

The role of trading funds needs to be looked at when we worry about companies being unduly vulnerable to opportunistic takeovers. As far as executive remuneration is concerned shareholders should be able to vote on future remuneration policies rather than cast an advisory vote on what the company is already doing (see my comments in PIRC’s pamphlet). Labour’s 2010 manifesto contained a similar proposal for bank pay. Indeed, Ed wouldn’t have needed to go much further in his speech to remind us of Labour’s election pledges. Some are still relevant – perhaps the responsible capitalism theme can provide the narrative they so sorely lacked.

What cannot be ignored is the need to be credible on economic policy. Being credible does not simply mean having a reasonable plan. It means people and markets must be convinced of a party’s motives. Italy, for example, has more austerity measures planned than six months ago when investors seemed relatively unfazed with its debt. Now they are struggling to believe it can control its debt levels and the poor growth outlook adds to the worries. Before Europe lies the path of deep recession/depression, or a grand exercise in leadership to promote growth across the continent. Credibility on debt and growth go together. That lesson applies to the UK too.

This article was first published by Progress on 18 November 2011.
Progress, 18 November 2011, 20/11/2011

Not an easy task given uncertainties, especially if energy and commodity prices do fall later in the year. Ultimately, radical economic reform required.
Central banks are struggling to head off general inflation while dealing with price shocks that will be negative for growth. They waited too long, which has made their tasks more difficult.
The Bank of England has raised interest rates, but that does not mean it has been most effectively managing inflation risks.
The Bank should signal it will act if higher prices look likely to translate to higher inflation rate.
The IMF's Fiscal Monitor is actually quite radical.
Spare a thought for finance ministers, and the opposition counterparts who aspire to replace them. The conventional wisdom was that they should at least make an attempt to follow fiscal rules. Now, there are no rules.
My letter in the Financial Times on the need for a framework for economic policy decision-making.
Responding to Brian Griffiths' article in The Article on the risks of inflation.