Labour’s Economic Policy Debate – Kalecki, Clinton, Dalton and David Miliband

Don Paskini has rightly asked for the five contenders to set out their economic policy proposals.
He has also identified what he sees as the four current strands of opinion in the Party:

1. The Blairite one set out by Pat McFadden. Continuing the economic policies set out by Alastair Darling and prioritising increased investment to increase economic growth while halving the deficit by cutting spending on public services, public sector pensions and welfare benefits by around £60 billion.

2. The Gordon Brown/Ed Balls strategy of maintaining higher levels of public spending on current priorities and reducing the deficit more slowly, aiming to stabilise levels of debt at c. 90% of GDP rather than 70%.

3. The leftie approach of massive cuts to targeted areas of spending such as defence and prisons, maintaining or expanding other areas of public spending, and raising income tax, corporation tax, capital gains tax, council tax, introducing new taxes such as a graduate tax and a mansion tax, while creating jobs through a Green New Deal.

4. Reject orthodox economics and the idea that the deficit is a problem entirely, and argue for an alternative based on an entirely new kind of political economy such as Modern Monetary Theory.

What is striking is that none of the five contenders are going for the first approach.

I think he’s correctly identified where Ed Balls fits into the spectrum and Dianne Abbott seems broadly to be arguing for the third approach (not to be confused with the Third Way). I haven’t seen much in the way from Andy Burnham and I’m not exactly sure where to place him in terms of economic policy (I saw the higher tax stuff, and would welcome pointers to anything more detailed).

Ed Miliband has made a few interesting speeches (this one in particular) and made some appealing noises in terms of the living wage, banking reform and the general balance between states and markets but he hasn’t yet fully fleshed out an alternative political economy (yet) to what came before. Currently I’d place him somewhere in between the second and third approaches as outlined by Don.

Speaking as someone broadly on the soft left of the Party (I’d have voted for Gould in 1992), this might sound unusual but…the most interesting and detailed economic policy development so far, has come from David Miliband.

But before discussing this, its worth pointing out why the Blairite argument described by Don and articulated by Pat McFadden is wrong. Now, focusing on increasing investment is certainly the right thing to do, the fall in investment has driven the current recession and it is the biggest threat to our long run growth. Ken Livingstone’s 17 page, detailed economic policy document provides a very clear statement to this effect.

The question becomes, how should we increase investment?  My problem with the Blairite model, as argued by Pat McFadden, is that it is, in some regards, little different from the New Economic Model, proposed by George Osborne.

Both essentially can be boiled down to a programme of increasing private investment, increasing exports and cutting the deficit. The only two major differences are that McFadden would cut the deficit a bit slower and that whilst Osborne aims to increase private investment by cutting corporation tax and keeping interest rates low, McFadden argues that we should increase it by more government support (in the form of loans, targeted tax breaks and an active regional policy).

Both are wrong. As the best argument why they are wrong was made by Michal Kalecki in 1943. (All emphasis from me).

In current discussions of these problems there emerges time and again the conception of counteracting the slump by stimulating private investment.  This may be done by lowering the rate of interest, by the reduction of income tax, [George Osborne’s way] or by subsidizing private investment directly in this or another form [Pat McFadden’s way].  That such a scheme should be attractive to business is not surprising.  The entrepreneur remains the medium through which the intervention is conducted.  If he does not feel confidence in the political situation, he will not be bribed into investment.  And the intervention does not involve the government either in ‘playing with’ (public) investment or ‘wasting money’ on subsidizing consumption.
It may be shown, however, that the stimulation of private investment does not provide an adequate method for preventing mass unemployment.  There are two alternatives to be considered here.  (i) The rate of interest or income tax (or both) is reduced sharply in the slump and increased in the boom.  In this case, both the period and the amplitude of the business cycle will be reduced, but employment not only in the slump but even in the boom may be far from full, i.e. the average unemployment may be considerable, although its fluctuations will be less marked.  (ii) The rate of interest or income tax is reduced in a slump but not increased in the subsequent boom.  In this case the boom will last longer, but it must end in a new slump: one reduction in the rate of interest or income tax does not, of course, eliminate the forces which cause cyclical fluctuations in a capitalist economy.  In the new slump it will be necessary to reduce the rate of interest or income tax again and so on.  Thus in the not too remote future, the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy.  The same would arise if it were attempted to maintain full employment by stimulating private investment: the rate of interest and income tax would have to be reduced continuously.
In addition to this fundamental weakness of combating unemployment by stimulating private investment, there is a practical difficulty.  The reaction of the entrepreneurs to the measures described is uncertain.  If the downswing is sharp, they may take a very pessimistic view of the future, and the reduction of the rate of interest or income tax may then for a long time have little or no effect upon investment, and thus upon the level of output and employment.

Thankfully this policy option, of relying on stimulating private investment though either tax or interest rate cuts or subsidy of one form or another is not being outlined by any leadership contender.  

David Miliband, easily caricatured as the ‘Blairite’ contender, is different in two important regards.

First, in his recent FT article he put the creation of jobs, rather than halving the deficit, at the centre of his policy. He also made the case for increased public sector investment.

Instead, it should focus on the jobs deficit: the 2.5m people looking for work. Sweden made halving unemployment its priority during its 1990s fiscal consolidation. But Britain is repeating Japan’s response to its crisis: pulling stimulus too early, raising value added tax and relying too heavily on monetary policy – leading to unemployment and stagnation.
…deploy the public sector to invigorate local economies by maximising the multiplier effect of public services. Cutting Building Schools for the Future is not just bad for education, it will hit construction jobs.

Now, he still wants to halve the deficit, but he is making a case that the creation of jobs is the key purpose of economic policy and that public sector investment has a role to play. If this was David’s entire policy proposition, it would be tempting to describe as Clinton-esque circa 1992 – a focus on jobs and productivity as a means to cutting the deficit.

And people might ask, what is wrong with that?

Clinton, after all, not only won two elections, he also had a strong record on job creation (unemployment down from 6.9% to 4.0% and 22 million jobs created) and moved the budget to surplus.  

However Clinton had two advantages the next Labour Prime Minister is unlikely to have – a very benign global economy for much of his term and the good fortune to rule in the decade after the fall of the Wall but before the fall of the Towers, when the peace dividend came into effect (defence spending was cut from near 30% of Federal expenditure in 1992 to closer to 20% by 2000).

What has moved David beyond a simple Clintonian agenda, was first mentioned in his Kier Hardie lecture last month (and, of course, ignored by a media more interested in a perceived attack on Gordon Brown).

In the last twenty years Labour has gone from the prawn cocktail offensive under John Smith to a love in with financial markets to an election campaign in which not a single business would support our tax policy.  Our lack of distinction between the proceeds of financial capital, which was often concerned with its short term multiplication not its long term investment, and manufacturing capital, which was embedded in the real economy, led to a real lack in private sector growth throughout the country.  A lack of innovation and initiative, a lack of partnerships and prosperity. We did not sufficiently recapitalise the regions.  We did not intensify the redistribution of power.  We saved the City of London but we did not reform it. (My emphasis)

A leadership contender talking about the distinction between financial and manufacturing capital and the need for financial reform, not just to prevent the next crisis but to help the economy grow, seizes my attention. It’s something I’ve banged on about for the past 18 months (for example here).

If David had left it at this, I’d have been tempted to dismiss this as an interesting aside but one with no real agenda behind it. Last week’s Durham speech from David though, fleshed this out in considerably more details – notably this section (my emphasis):

Before the crash, too much money was sucked into an inflated property market or dodgy financial products – or was siphoned off for bloated fees and bonuses. The short term, speculative gains offered by the City of London deprived areas like this of the capital they needed to grow.
We do need to reform the banks to prevent another financial crisis. But we also need to take this opportunity to reform the banking system to help rebuild and rebalance our economy in the years ahead.
We need to get money flowing to the people, the companies and the workers with the best ideas and the best strategies to seize the opportunities of the modern economy.

Over many decades, our European neighbours have had a much better record on productive investment. This has created a weight around the ankles of the British economy.
To crack this problem, the government’s Banking Commission needs to address the question of how the British banking sector should be reformed to ensure it serves its proper role in allocating capital to drive growth and jobs – not just seek the quickest, speculative gain.
One option I think it should consider is the case for establishing a British Investment Bank to facilitate investment for vital infrastructure, to support good small businesses and to accelerate our transition to a low carbon economy.
As an example, a bank along these lines – owned by the public but controlled by an independent, commercially-orientated board tasked with delivering long term returns – would be ideally placed to provide loans to companies like Sheffield Forgemasters.

So, here we have David Miliband – the ‘Blairite’ candidate – giving the most detailed proposals for financial reform and coupling it with rhetoric which places the “jobs deficit” over the “fiscal deficit”. And talking about the need for a publicly owned bank (!).  

In some ways, he’s moved beyond Clinton in 1992  and more towards Dalton in 1944 (and yes, I’ve used this quote before):

‘Blame for unemployment lies more with finance than with industry. Mass unemployment is never the fault of the worker; often it is not the fault of the employers. All widespread trade depressions in modern times have financial causes; successive inflation and deflation, obstinate adherence to the gold standard, reckless speculation, and over investment in particular industries …
Finance must be the servant, and the intelligent servant, of the community and productive industry; not their stupid master.’ (Labour Party 1944)

I’m not sure how I’m going to vote yet. But I must say, and much to my surprise, the agenda catching my attention at the moment is his. I’d welcome similarly detailed proposal from the other four.

The World Economy in One Picture

I’d highly recommend Danny Quah’s short (7 page) note on the world’s centre of economic gravity. I think it is the clearest, and certainly the most vivid, demonstration of the key trends in the global economy I’ve seen. Because one trend is key – economic power is moving east.

The key map is below (black points are historic ones from 1980 until 2008, red are projections):

 

As Danny explains:

This note describes the dynamics of the global economy’s centre of gravity. Such dynamics form part of more general ongoing research on the world’s shifting distribution of economic activity (Quah 2010). By economic centre of gravity, I mean the average location of the planet’s economic activity measured by GDP generated across nearly 700 identifiable locations on the Earth’s surface. The calculations in this note take into account all the GDP produced on this planet.

I report below that the world’s economic centre of gravity located in 1980 at a point in the middle of the Atlantic Ocean. By 2008, however, that centre of gravity had drifted to a location at about the same longitude as Izmir and Minsk, and thus east of Helsinki and Bucharest. This change occurred not due of course to the emergence of Turkey or Belarus, but instead from the continuing rise of China and the rest of East Asia.

Extrapolating growth in the 700 locations across Earth, the world’s economic centre of gravity is projected by 2050 to locate, literally, between India and China. Observed from the Earth’s surface, that centre of gravity will move a distance of 9300 km, or 1.5 times the radius of the Earth, from its 1980 location.

There we have it, thirty years ago the world’s centre of economic activity was in the mid Atlantic, today it is around Turkey, in thirty years time it will have reached India and China. This is the new globalization and I’d like to hear how Western politicians plan on dealing with it.

Industrial Policy: We’ve been here before

I commented last week that the five contenders might be wise to start looking at the Wilson era, especially in light of the wide spread agreement in the Party that some form of industrial policy/growth policy will be both necessary for the economy and a crucial dividing line with the coalition.

Ed Miliband has argued that:

Reshaping our economy is not a project for one year or one term but is a long-term effort that we have to make.
It begins by deepening – not abandoning as the coalition is doing – the active industrial policy that Peter Mandelson led at the end of our time in government.
It is scandalous that the government have announced the abolition of Regional Development Agencies today, when it is clear that in many regions they have led the way in building the growth economies of the future.
I saw that in my time as climate change secretary working with One North East to bring jobs in offshore wind manufacturing to Tyneside, for example.
Our country should be building on the success of the RDAs and a more active industrial policy with a new approach to finance.
Business as usual says let’s sell our stake in the banks back to the private sector as quickly as possible.
But I would take the opportunity of the rationalisation of these stakes to create a new banking system which works to invest in the industries of the future and the small businesses that can be the centre of our communities.
This means creating a stronger regional dimension to our banking system, potentially keeping a public stake or remutualising part of the sector.

Whilst his brother has stated:

Creating an economy driven by innovation and imagination will not happen by chance. It needs serious investment.
New ideas need capital to generate jobs and wealth. I’ve said before in this leadership campaign, we need markets and capitalism to work far better for the people of my constituency in South Shields.
We have to address something that has been a problem for the UK economy for decades. This is the failure of our banks and businesses to consistently put money behind the most productive ideas and the most innovative practices.
Before the crash, too much money was sucked into an inflated property market or dodgy financial products – or was siphoned off for bloated fees and bonuses. The short term, speculative gains offered by the City of London deprived areas like this of the capital they needed to grow.
We do need to reform the banks to prevent another financial crisis. But we also need to take this opportunity to reform the banking system to help rebuild and rebalance our economy in the years ahead.
We need to get money flowing to the people, the companies and the workers with the best ideas and the best strategies to seize the opportunities of the modern economy.
Over many decades, our European neighbours have had a much better record on productive investment. This has created a weight around the ankles of the British economy.
To crack this problem, the government’s Banking Commission needs to address the question of how the British banking sector should be reformed to ensure it serves its proper role in allocating capital to drive growth and jobs – not just seek the quickest, speculative gain.
One option I think it should consider is the case for establishing a British Investment Bank to facilitate investment for vital infrastructure, to support good small businesses and to accelerate our transition to a low carbon economy.
As an example, a bank along these lines – owned by the public but controlled by an independent, commercially-orientated board tasked with delivering long term returns – would be ideally placed to provide loans to companies like Sheffield Forgemasters.

There is a strong Wilsonian overtone to all of this:

Thus by 1964 Labour had developed a large reformist agenda, which may be characterized as predominantly ‘quantitative’, in which the performance of industry would be transformed by greater inputs of investment and R and D, and these in turn facilitated by expansion in the size of enterprises. The DEA and the National Plan would provide the framework of stability to encourage investment, which would also be heavily subsidized; government would pay for much more R and D and switch much of it from military and ‘big science’ to commercially related projects: in addition, more labour would be trained and more of it diverted into productive industry. Total government spending on industry, particularly manufacturing, rose very sharply from 0.4 to 9.0 per cent of net output in that sector between 1964 and 1967.

Tomlinson, J (2004) ‘’The Labour party and the capitalist firm, c.1950-1970′, Historical Journal 47

The question is – why didn’t Wilson’s industrial modernisation agenda work? It’s one I’ll be returning to on this blog.But I would say that one major failing of industrial policy in the 1960s/70s was a focus on industry whilst the financial sector was  broadly left alone. Both Milibands appear to be taking financial reform seriously.

Whilst I’m on historical matters, this passage (from 1982) struck me as strangely accurate.

Thus, a pattern is emerging. Depressions in twentieth-century Britain have  typically appeared at the end of an extended period of sustained expansion. The  economic pressures are perceived first in the City which reacts by calling for  cuts in public spending and other measures to restore confidence in sterling.
Industry is also faced with the need to respond to market forces. The experience  of this century suggests that British industry will also press for retrenchment  by government even if the cost is the loss of some measure of State support for  industry and the weakening of the corporatist structures in which business  leaders had a considerable stake. Thus, by the time that depression begins to  hit employment (and changes in unemployment always follow changes in the  national income), there is a considerable climate of opinion which blames the  level of government spending and the level of wages (maintained in part by the  closeness of the unions to the centre of government) for many of the economic  problems. These opinions are exposed to an electorate which had become  accustomed to annual rises in real living standards. The frustrated expectations  among the mass of the population, which in other circumstances can be a  pre-condition to revolution, are channelled in the British case towards economic
liberalism and orthodox finance. During the three depressions of this century,  organized labour has been in no position to offer a challenge to this movement.  In the British context, therefore, ‘orthodoxy’ or ‘monetarism’ are the natural  policies of depression
Booth, A (1982) ‘Corporatism, capitalism and depression in twentieth-century
Britain’, The British Journal of Sociology 33 (2)

GDP Reaction and Warning from the US Data

First off the good news – 1.1% quarter on quarter growth is certainly excellent news. The FT money supply blog has some good, detailed analysis. This surprisingly fast growth helps explain the higher than expected tax receipts over the past few months, the stabilisation in the jobs market and the stubbornly high inflation numbers.

The TUC have pointed out that much of the, very large, contribution from construction may well be related to the public sector.

But…

I’d add one major cautionary note, taken from the US experience.

USA GDP grew at an even faster quarterly rate in Q4 2009, 6 months ago (+5.5% annualised), it then slowed to 2.7% (annualised) the following quarter.

Residential investment in the US (construction) grew at an annualised rate of +18.9%(!) in Q3 2009, it fell by an annualised  10.3% in the first quarter of 2010. Construction can be very volatile.

Most importantly, since the end of Q3 2009 (when the US began experiencing even faster growth) the unemployment rate has only fallen from 9.8% to 9.5%. 9 months of strong growth and unemployment has barely budged. And this is a context of continuing stimulus.

So let’s not get carried and start arguing that now is safe time to be cutting or raising interest rates.

Growth Plans

I have a niggling worry about much of Labour’s current talk on the deficit. Whilst all the leadership contenders, and the Party at large, seem to agree that the coalition is cutting the deficit too fast and thereby risking the recovery, there is little agree (currently) on what Labour would propose instead. Debate is polarised between those who believe we should stick to the fiscal plans of the last government and a pledge to “halve the deficit in four years” and those who think any timetable risks constraining fiscal policy in an uncertain world.

There is of course a political element to this debate – many, see for example Hopi, argue that without a credible plan Labour will not be taken seriously by the electorate. As I’ve said before, I’m not in favour of a strict timetable – I’d prefer a more flexible plan to cut the deficit centered on growth, a greater share of taxation and more gradual cuts, as the private sector strengthens.

But my real worry is this – what if we are all actually right on the economy and Labour win in 2015. What sort of economy would Labour inherit? I’ve made my rough predictions of what the coalition’s plans will achieve by 2015, after 5 years of tepid growth unemployment will still be high – around the 8-10% mark, the economy will have suffered from a five year investment drought damaging its long run growth potential and crucially the deficit will still be in the region of 3-5% of GDP and debt levels would still be rising.

Would a Labour Party that has committed itself to tackling the deficit be forced to look at the situation afresh? Clearly there would be case for more government action, especially after the failure of the coalition’s cuts to either solve the problem of the deficit or to get the economy moving again. Surely it would be better to maintain a flexible position of “we’ll cut the deficit as the economy grows” than to have adopted a slogan of “halving the deficit in four years” and then be forced to drop that?

I’d like to suggest that Labour moves the economic debate of the deficit, clearly appears very hard in the short term but as the cuts bite and unemployment remains high it will become easier.

To get this started I’d like to hear the leadership contenders outlining their strategies for growth, their ideas to get investment flowing in the economy again and their notions of how to create jobs. I’d be much happier if Labour spent the next five years articulating their growth plans and vision of the economy then if we spent the next five years haggling over which departments should face the axe.

One Person’s Waste is another Person’s Wage

 One person’s waste is another person’s wage. This something Mr Osborne would do well to remember as he wields the axe.

During the election campaign, the Conservative’s were keen to argue that they could cut £6bn in 2010/11 entirely by reducing waste. What has happened is far from the case – Sheffield Forge Masters, Building Schools for the Future, the child trust fund – hardly all waste.

Even aside from these cuts – evidence is starting to emerge of the effects of the “easy” cuts, the “getting rid of waste”, the cuts in IT and consulting and so on.

The warning shot has come from Cable and Wireless. 

On Tuesday morning shares in the confusingly named Cable & Wireless Worldwide fell 12p, or 14 per cent, to 71.5p after the telecoms company warned profits would be at the low end of City forecasts because of a sharp slowdown in UK public sector spending brought on by the newly-elected chancellor’s emergency budget.

Then there’s social housing maintenance company Connaught:

 The group cautioned that local authorities had “deferred” capital expenditure and that it, as a result, was cutting profit forecasts for the year to the end of August by more than 20 per cent.

Stockbrokers Execution Noble have summed it up:

 The UK government’s commitment to reducing the structural deficit raises the question of whether it is possible to cut debt via spending cuts and tax increases without significantly increasing unemployment and reducing consumption. Current economic forecasts suggest that it is. We take the view that a period of fiscal austerity will result in a lower level of economic growth than is currently being forecast.

…

Given our more pessimistic view on the UK economy we have reduced our expectations for the UK equity market in 2010. While we admit that on traditional metrics the UK equity market looks cheap, we believe earnings upgrades have peaked and expect incremental cuts from here. We have already seen evidence of how fiscal austerity measures and budgetary cuts have impacted a number of UK companies and we expect this to become more of an issue as the year progresses. As a result we have reduced our year end FTSE 100 target from 5950 to 5400 and no longer expect smaller companies to outperform.

Even the “easy cuts” are hurting the private sector and will certainly lead to job losses and falling investment in the private sector.

Add this to the job losses coming in the public sector and one has to ask, where are the jobs and investment we need going to come from?

There will come a time for fiscal consolidation, but that has to wait until the private sector is growing strongly.

What we have now is a simple rebuilding of inventories in the private sector that the government seems to have mistaken for a robust recovery. Remember without the contribution of government spending, we would have been in recession in the first quarter of this year.  

Now is not the time to be cutting.

Cheap Money Revisited

As regular readers might remember, last year I did series of posts on financial capital and the control of long term interest rates. In particular I argued that a truly “Keynesian” policy would be the cheaper money policy pursued by Dalton as Chancellor from 1945-1947. This would involve using debt management techniques to hold down long term interest rates.

This culminated in a very, very, very long post. Essentially my point was that many economists misunderstand the savings/investment relationship and have forgotten the crucial insights of Keynes’ liquidity preference theory. There’ll be more blogging on this soon I’m afraid.

There was a lot of scepticism at the time about how possible this all was.

Well, just quickly, take a look at this new paper from the Fed. In particular this bit on the effects of the Fed’s purchases of US treasury bonds:

Contrary to long and widely held conventional wisdom, large asset purchases can affect long rates, both domestically and abroad. Monetary policy’s effect at the zero bound includes international channels. The reduction in foreign bond yields and the value of the USD might have stimulated the U.S. economy through export channels, for example. From an international perspective, study of the LSAP [Large Scale Asset Purchases] effects implies that central banks should coordinate their asset purchase policies to avoid contradictory or overly stimulative effects. (my emphasis)

Or try this piece from last week’s FT on the world’s shortage of safe assets.

What this means for investors is the premium on safety and liquidity should remain high. Yields on Treasuries, Bunds and gilts can remain at historically low levels. This view contrasts with mainstream orthodoxy that government yields must rise along with soaring debt-to-GDP ratios.

Next to benefit will be highly rated corporate debt with low historical default rates. The longer government yields remain low, the more likely spreads will compress on investment-grade corporate bonds. Liquidity and safety in emerging markets are improving yet yields remain attractive and the upside potential for currency appreciation is strong. This must continue if the global safe asset shortage is to be properly resolved. (my emphasis).

Or examine how Greece (Greece!) successfully manged to sell E1.6bn of bills last week, with a bid to cover ratio of over 3.5x, after deciding to issue six month bills rather than one year ones.

Maybe liquidity preference matters, maybe central banks and debt management authorities can set, or at least hold low, long term interest rates. If so, this requires a fundmental rethink of how we conduct both monetary policy and debt management policy.

Keir Hardie or Harold Wilson?

In the last week, following David Miliband’s Keir Hardie lecture a debate has sprung up in the Labour blogosphere about the Party’s early history. In particular Keir Hardie’s views on liberalism and co-operation with the Liberal Party.

This is all very interesting and I’d highly recommend the posts over at the Fabian’s Next Left blog. Sunder, who knows his history, opened with a post on how far Keir Hardie actually rejected Lib-Labbery.  There have also been posts on Jon Cruddas’s views as expressed in his own Keir Hardie lecture and guest post from historian and newly elected MP Greg McClymont.

But are we debating the wrong period? I agree with Sunder that the rise of Labour and the political strategies utilised by Keir Hardie may be worthy of detailed study by Caroline Lucas and the Greens, but is this the period, broadly put the 1890s to the 1920s, the right period for Labour to be looking back to now? And era of fluid politics, hung parliaments and changing allegiances certainly looks, at one level, to be very relevant.

Much of this debate seems to be harking back to earlier works by David Marquand and Peter Clarke, we’re back with a progressive dilemma and how to work with/deal with the Lib Dems. Anthony Painter writes that:

It would be a tragedy if the conclusion of this exercise was that Labour should pursue a majoritarian path. The UK is an increasingly pluralistic society and a majoritarian politics sits increasingly uneasily with that. At the very least, the future for the party means finding ways of building a centre-left dialogue that is open and forward-looking. Across the political spectrum there will be increasing unease at the impact of the fiscal strategy pursued by the Coalition. If Labour’s response is ‘we told you so, now make the Vichyist Lib Dems pay’ then that won’t be convincing at all. This is not to suggest that the Coalition’s policies should not be critiqued and in the strongest terms when they get it wrong.

The thing is, I’m not sure this is right at all. I don’t think we are heading back to a fluid three party system, I think we are more likely to see the Lib Dems squeezed out of contention as a prominent Parliamentary force, the clock is turning back –  but only 40 years, not 90. The polling evidence so far, would seem to back this up.  I agree with The Old Politics that:

It became clearer to me while listening [to Nick Clegg], though I was already thinking that way, that his colours are now so firmly pinned to the coalition mast – developing arguments within an ideological and historical framework of the right even if denying that the cuts agenda is driven by pure ideology – that if the next election also results in a hung Parliament then unless the Conservatives are roundly rejected within it, there’s no way the Liberal Democrats can swing back into a coalition of the left, or at least if they do it will have to be under a different leader.

If we are heading back to an essentially two party system, then the leadership contenders could do worse than look to the record of Wilson, Labour’s second most electorally successful leader with four wins out of five. (I know Paul will grimace at this). What is perhaps most interesting about Wilson is that, in the 1960s at least, he oversaw a period of broad ideological truce in the Party, certainly when compared to the decade before or afterwards.

This is certainly a period worthy of study and with all of the leadership contenders broadly committed to some form of industrial activism it may be the time to study what went wrong with the DEA.

EDIT: 20.40, to remove three crazy typos. I’m not aware of any party led by a Mr Cledd.

Ten Commandments for Fiscal Adjustment

Over at the IMF blog, Oliver Blanchard has set out “ten commandments for fiscal adjustment in advanced economies”.

Go read the post – there’s a paragraph on each one. I don’t entirely agree – but the rules are a good starting point for debate and very different from the path outlined by the budget.

Commandment I: You shall have a credible medium-term fiscal plan with a visible anchor (in terms of either an average pace of adjustment, or of a fiscal target to be achieved within four–five years).

Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it.

Commandment III: You shall target a long-term decline in the public debt-to-GDP ratio, not just its stabilization at post-crisis levels.

Commandment IV: You shall focus on fiscal consolidation tools that are conducive to strong potential growth.
Commandment V: You shall pass early pension and health care reforms as current trends are unsustainable.

Commandment VI: You shall be fair. To be sustainable over time, the fiscal adjustment should be equitable.

Commandment VII: You shall implement wide reforms to boost potential growth.

Commandment VIII: You shall strengthen your fiscal institutions.

Commandment IX: You shall properly coordinate monetary and fiscal policy.

Commandment X: You shall coordinate your policies with other countries.

Interestingly enough this chimes with Hopi’s thoughts.

The New Globalisation

Martin Wolf’s column today is well worth reading (as ever). It could be fairly retitled “the decline of the west”. His fundamental point is that the global recession has not only effected the financial and economic standing of the West compared to Asia, but also its moral and political standing.

We already know that the earthquake of the past few years has damaged western economies, while leaving those of emerging countries, particularly Asia, standing. It has also destroyed western prestige. The west has dominated the world economically and intellectually for at least two centuries. That epoch is over (see charts). Hitherto, the rulers of emerging countries disliked the west’s pretensions, but respected its competence. This is true no longer. Never again will the west have the sole word. The rise of the Group of 20 leading economies reflects new realities of power and authority.

Yet this is far from the only change in the global landscape. The crisis has revealed deep faults within western economies and the global economy as a whole. We may be unable to avoid further earthquakes.

This fundamental change in the world balance of economic power will have huge political and social ramifications across the globe.

In his book, Prof Rajan points to domestic political stresses within the US. Related stresses are emerging in western Europe. I think of it as the end of “the deal”. What was that deal? It was the post-second-world-war settlement: in the US, the deal centred on full employment and high individual consumption. In Europe, it centred on state-provided welfare.

In the US, soaring inequality and stagnant real incomes have long threatened this deal. Thus, Prof Rajan notes that “of every dollar of real income growth that was generated between 1976 and 2007, 58 cents went to the top 1 per cent of households”. This is surely stunning.

“The political response to rising inequality … was to expand lending to households, especially low-income ones.” This led to the financial breakdown. As Prof Rajan notes: “[the financial sector’s] failings in the recent crisis include distorted incentives, hubris, envy, misplaced faith and herd behaviour. But the government helped make those risks look more attractive than they should have been and kept the market from exercising discipline.”

The era of easy credit, much of it backed by housing, is now over (see chart). Meanwhile, in all western countries, the state supports the welfare of the individual. But the fiscal consequences of this crisis – a huge rise in deficits – will interact with pressures from ageing, to make fiscal stringency the theme of policy for decades. The long bear market in shares and prospects for a “jobless recovery” add further to these woes.

The fallout from the crash can already be seen in Southern Europe, as Paul Mason reports:

The question now though is how Spain goes forward. As I’ve written before, the social model in Southern Europe has been based on two decades of cheap credit, property speculation and growth. Now that’s over, it’s obvious a country like Greece has to go through a painful adjustment. Here the austerity plans are nowhere near as draconian, and the resistance is also not exactly at Greek pitch.

His BBC colleague Stephanie Flanders has today emphasised what lies ahead for Britain:

The other stand-out figure for me – and perhaps the Bank of England – is the figure for earnings growth. Pay, excluding bonuses, rose by just 1.4% year-on-year in May, the lowest rate since the end of last year. That’s a 2% real pay cut at a time when the annual rate of CPI inflation was 3.4%.

As we know, things have been even tougher for private sector workers. Earnings in that part of the economy rose by just 0.6% year-on-year in May, though the average over the quarter was a bit better.

The Bank has rightly been concerned about rising inflation expectations. But even if people are expecting prices to rise at a higher rate than in the past, there is little evidence in these figures that workers can expect higher pay to compensate.

The bottom line is that UK households are still seeing a significant squeeze in living standards as a result of the financial crisis, even if more people than expected have found paying work.

And, lest we forget, the squeeze from higher taxes and lower public spending has barely begun. (Emphasis added)

This pain in the West, both current and promised, is all set against a world where the centre of economic activity is moving eastwards. Danny Quah, head of economics at the LSE, has an excellent (if unfinished and in draft form) paper on this topic. (“The Shifting Distribution of Global Economic Activity”, link available here)  As he writes:

The configuration of economic activity across nations helps determine explicit and

implicit systems of global governance: the international financial architecture,

patterns of cross-country trade, global capital flows, and, not least, effective global

policy-making.  But what is known of the dynamics in that global landscape of

economic activity?  This paper provides an empirical assessment of the hypothesis

that the world’s spatial distribution of economic activity is secularly drifting from its

20th-century moorings.  By considering a range of indicators—the shift in the world’s

economic centre of gravity; the dynamics of global poverty; decoupling and the

emergence of cross-country trade clusters; and the cross-geography relative

contribution to world economic growth—this paper quantifies a profound ongoing

eastwards trend in global economic activity.

In other words, power is shifting east. Perhaps the most vivid illustration of this comes from John Ross.

…for the first time for a century and a half the US had lost its position as the country producing, in gross dollar terms, the greatest amount of finance for investment – i.e savings. The US has been overtaken by China. In short the world’s number one capitalist economy no longer produces the most capital. The New York Times noted this as Newsweek did later.

The fall out from the financial crisis and the speeding up of the movement in financial and economic power eastwards poses huge challenges for the UK and the West in general. The rules of the international economic system will no longer be set on out terms.

And yet discussion of this issue is notable by its absence from most political discourse. Tony Blair touched on in his speech to Trimdon Labour Club during the campaign but didn’t offer anything substantial.

Since leaving office, and spending much time abroad, I can tell you one thing above all else. The characteristics of today’s world are: it is interdependent; it is changing; and power is moving East. And all of this is happening fast, faster than we can easily imagine. Britain’s challenge is not a 20th Century one and its politics cannot afford 20th Century political attitudes. The country has to go forward with energy, drive, determination and above all understanding. Closed minds close off the future. That would mean the challenge is failed, but it would also mean the opportunity is squandered.

Osborne too seemed aware of the issue but offered a glib response.

Borrowing from China so that we can buy the goods they make for us may be Gordon Brown’s idea of the future, but it is not ours.

We want Britain to be selling to China and the world.

The world economy is changing, we can’t rely on cheap credit and cheap imports any longer. The economy needs to be thoroughly rebalanced against a back drop of a large budget deficit and this all needs to be done within the realistic framework of accepting that Britain is, in the global scheme of things, a small economy. I’d like to hear more politicians engaging with this new, emerging phase of globalisation – one where the rules of the game are as likely set in Beijing as Washington and one that will not look like what has come before.

One major difference between the new post-crisis globalisation and it’s pre-crisis relative, is the relationship between the state and capital, especially in the West. As investment strategist Russel Napier has written:

There is a conflict between western governments’ need for finance to sustain living standards and capital’s need to seek out greater growth opportunities in emerging markets. Whatever the long-term benefits in boosting returns on savings, the short-term political necessity of public financing is likely to necessitate slowing capital outflows.

Capital controls seem impossible to many, but when a choice has to be made between economic principle and government bankruptcy, they are a likely response.

In 1931, Keynes, as director of the Independent Investment Trust, refused to sanction a financing arrangement that involved shorting sterling. According to his biographer, this reluctance was due to public interest considerations rather than the shareholders’ interests. Within the month, sterling had left the gold standard and the Trust had missed out on a profit of £2m (in today’s money).

A hedge fund manager with such priorities today would risk big fund outflows and perhaps a civil action.

In the west’s long boom, capital and the public interest were largely aligned. That ended in 2008. Conflict between government and capital is the future of investment.