The ideas that served Labour well while in opposition will not be the ones that serve them well while in government, argue Dan Corry and Peter Kenway. The party needs to show degree of flexibility and pragmatism when it comes to its economic policy and meeting its missions.
As Labour moves into government, setting its economic policy and preparing for its first Budget and Spending Review in the autumn, its key players need to recognise that habits of mind that were essential in opposition are not always suitable now they are in government. The unwavering focus must be on acting in ways that have a good chance of meeting the hopes of the electorate. When it comes to economics that means not hitching oneself too much to rigid “rules” from the past.
It’s hard to do economic policy in opposition, especially for Labour. Even a spending commitment of just a £100m on something (“small change” in Treasury terms), is at risk of being presented as evidence of a tax raid. Yet if a government announces billions in spending, people usually shrug their shoulders. This is madness, but it is also the reality. The government sets the framework, and the opposition has to set out its stall in relation to that. When Labour was in opposition, it was wise for it to not move too far outside the framework. But now it’s in government, it must do what it can to bring about the positive change in people’s lives it has promised.
There are plenty of ideas which, now it is in government, Labour needs to be ready to re-consider.
This is not a matter of dumping what it committed to before – doing so in egregious ways can lead to a loss of trust. But sticking rigidly to what Labour said before an election can stop the Government from delivering on its missions, and that is also not a way to build trust. Ideas and frameworks really matter, and the danger to be avoided is letting the ideas that Labour politicians and advisers took into government from their years of opposition campaigning stick around for too long. There are plenty of ideas which, now it is in government, Labour needs to be ready to re-consider.
Here are four economic ideas where we urge flexibility, First, be pragmatic about debt. Second, lean on the fiscal rules to tell a coherent policy story. Third, draw on Keynesian insights into the importance of demand. Fourth, keep conscious of the fact that the big picture on tax is much more political than economic.
Once in government, treating debt as one factor to be weighed among several, is both feasible and correct.
There is no natural ceiling on debt so be pragmatic about it
No party in opposition can say it intends to be pragmatic about debt – and Labour was no exception. Once in government, however, treating debt as one factor to be weighed among several, is both feasible and correct.
Of course, debt needs to be managed carefully, with an eye to avoiding interest payments becoming too great a financial burden or alarming the financial markets. And Rachel Reeves was right to try and get an early grip on things in her statement this week upon the discovery of how many unfunded commitments the previous government had left her. But the dangerous idea is that government debt itself holds back economic growth. This idea came to the fore in 2010 thanks to a high-profile academic paper that claimed to have measured how harmful debt’s impact would be above a certain level. This offered crucial support to those advocating austerity. Although challenged by economists at the time and later found to be the result of a spreadsheet error, the resulting belief in a “dangerous debt threshold” endures despite the evidence for such a threshold being very thin indeed.
The right course of action on debt depends on detail and context. This includes whether newly borrowed money is to be used to create long-lasting assets, both physical (e.g. the capacity to generate renewable energy) or human (a better trained workforce) assets that contribute to growth and so reduce the debt GDP ratio further down the line. That is the basis on which Labour should approach its attitudes to the debt ratio now it is in government.
These self-imposed rules, which history shows can easily be changed with little blowback from the markets if done carefully, cannot be there to stop governments from doing things which make economic sense.
Fiscal rules should not be a straitjacket for government but a help
Just as Labour in opposition had no real choice about deviating from the Tory government’s debt rules, so too with the fiscal rules more generally. But the key thing about the government’s fiscal rules are that they are set by the government itself. It is free to change its rules, something the Conservative government did more often than most.
These self-imposed rules, which history shows can easily be changed with little blowback from the markets if done carefully, cannot be there to stop governments from doing things which make economic sense. Instead, Labour needs to see their role as providing clarity about where the government’s policies are expected to lead over several years and reassurance about the coherence of their economic policy making in the round. The OBR’s assessment gives that reassurance weight. The Bill announced in the King’s Speech to give the OBR the power to decide for itself whether to undertake an assessment may mean that it is heard from more often in future, on a wider range of smaller scale fiscal policies.
The financial markets lost confidence in the UK government not when it changed the rules but when the Truss-Kwarteng mini-budget of September 2022 seemed to abandon them. Its combination of immediate tax cuts with the promise of unspecified spending cuts some time in the future created great uncertainty and sent contradictory signals which led to a disorderly market and interest rate hikes.
If fiscal rules can help explain where it sees its policies leading, there is no economic reason why the Labour government should not regularly re-consider whether its rules, inherited or otherwise, fit with the story it wants to tell.
Labour needs to keep aware of the Keynesian insight that businesses will only take advantage of an improved supply side if they are confident there will be a demand for new products or services.
Keynesian approaches to running the economy matter
The most important Keynesian idea is that economic activity is driven by effective demand. By pushing up economic activity, effective demand – in other words, spending – stimulates employment and boosts income. This is the opposite of the situation facing the household, for whom it is income which makes spending possible.
While it is true that the household must live within its means, the economy is not constrained in this way. Indeed, well –directed investment spending will increase its means.
Demand’s central place in Keynesian thinking also tells us that business’s expectations about its market prospects are crucial. At present, the economy is constrained by almost a decade and a half of failing to invest in the supply side of our economy. Labour’s plans for investment in skills, energy and infrastructure make good sense. But Labour needs to keep aware of the Keynesian insight that businesses will only take advantage of an improved supply side if they are confident there will be a demand for new products or services.
A record-high tax share mean decisions about it are political, not economic
At the time of the March Budget, the OBR reported that by 2028-29, tax as a share of GDP would (at 37.1 per cent) be “the highest level since 1948”. In opposition, Labour sensibly relied on this observation to dampen Conservative claims to be the party of low tax and avoid talking too much about its own views.
In government, though, it must make a choice. For however fast the economy grows, there is always the question of whether public spending should grow faster for a while, pushing the tax share up – at least temporarily.
Viewed internationally, the UK’s tax share (35.1 per cent in 2022) is not out of order – at 16th out of 37 OECD countries, four percentage points below Germany and eleven below France. This suggests there is room for the UK’s share to move either way.
Labour’s economic priority is the revival of growth, and if that requires changes over time to the tax share – even temporarily – it would be unwise to totally rule that out. The prize of stronger growth is too big to ignore that option if it can help.
As Keynes said, “Ideas shape the course of history” and they certainly influence decision-making in ways people often do not even realise. Greater flexibility and taking a broader view does not mean the Labour government should U-turn on what it was saying pre-election. But while nobody should go wilfully against what they said in the heat of election battle, ideas need reviewing once in office if challenges and opportunities are to be met in a considered and thoughtful way.
All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.
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