How Labour should deal with the Fiscal Responsibility Act
By Michael Burke
Previously Published on Social Economic Bulletin here
Jeremy Corbyn and John McDonnell are frequently in advance of many of their supporters on economic matters, including their supporters in academia and economic commentators. They are correct to argue against permanent budget deficits and in favour of the central role of public investment as the path out of the crisis, identify People’s Quantitative Easing as a useful policy tool, and to question the ‘independence’ of the Bank of England. They have faced unwarranted and confused criticism on all of these from some on ‘the left’.
The recent indicators point to a slower pace of economic activity and the Tory government is about to embark on Austerity Mark II, in nominal terms exactly the same level of cuts and tax increases as the £37 billion George Osborne announced in 2010. As the Tories have little popularity (the second lowest popular share of the vote for any government) it has been necessary for this project that there is a pretence that this not a return to austerity, after the boost to consumption that helped the Tories get re-elected. So, there was the fiction that recently there was a ‘One Nation’ Tory Budget, that Osborne was ‘stealing Labour’s ideas’ and similar nonsense.
Politically it is crucial for the Tories that there is no opposition to the latest version of cuts, as this would show the blantant falsity of the claim that the Tories have a commanding parliamentary majority and that There Is No Alternative. This necessity explains why the other Labour leadership candidates were so wrong to give the Tories a free pass on welfare cuts.
However the election of Jeremy Corbyn and the appointment of John McDonnell as Shadow Chancellor changes the previous situation in which Labour did not in fact challenge the Tories’ central economic policies. Now the Tory tactic is to set a series of political traps for the new team in the hope of detaching them from either, or both, the majority of the population or their base of supporters. This is taking place primarily on the area of foreign affairs and the military. But on the economic front this will be the introduction of an amendment to the Fiscal Responsibility Act. This proposed Act precludes borrowing in normal circumstances/over the course of the cycle not only for current government expenditure but also for investment. It also commits future governments to run budget surpluses when the economy is growing, to be overseen by the Office for Budget Responsibility.
Initially, George Osborne hoped that by announcing the new law and holding it over to the autumn that it would dominate the Labour leadership campaign. That has failed spectacularly. Instead it is possible to turn the tables on Osborne and use the debate and vote to set out clear differences with him.
To achieve this it is necessary to approach these questions soberly and intelligently. To paraphrase a remark by Trotsky, the appropriate economic policy is not at all automatically derived from the policies of George Osborne, simply bearing only the opposite sign to him – this would make every madcap pundit an economics guru. It is necessary for Labour to put forward a positive economic policy based on a correct economic theory.
Labour should formulate its own policy and pose that sharply in contrast Osborne’s. It must be based on a clear understanding of the difference between consumption and investment. Investment is the chief motor of economic growth, with the latter in turn being the chief determinant of the population’s living standard. Therefore the way to ‘grow the economy out of the crisis’, as Jeremy Corbyn and John McDonnell have correctly put it, is to increase the economy’s level of investment. As the private sector has failed to do this the state should step in. This should be expressed in a policy to increase state investment, and to create National Investment Bank – which should finance both state and private investment.
The key question is where the savings equivalent to such investment should come from, and this in turn relates to the current expenditure in the budget. Current expenditure can be financed in one of two fundamental says. It can be financed by borrowing, but in that case this reduces the proportion of the economy devoted to savings/investment, which is undesirable as it will slow economic growth and therefore the increase in living standards. Or consumption can be financed by taxation, in which case it merely means privately financed consumption is being replaced by government financed consumption (either government final expenditure or transfer payments) in which case the level of investment is not being reduced and growth will not be reduced.
It therefore follows that for a coherent and sustainable policy current government expenditure should be financed out of taxation, in particular on higher incomes and luxury consumption, and not out of borrowing.
Expressed in terms of budget deficits and borrowing his means that the aim should be for a balanced current budget over the business cycle, but reserving the right to borrow for state investment. This is the correct position expressed by John McDonnell. This therefore means that an amendment to Osborne’s Bill expressing that position, of no deficit over the cycle for current expenditure but permitting borrowing for investment, should be moved by Labour. This will establish its position clearly.
But, in the likelihood an amendment of this type were to fall, although some other parties may vote for it, then Labour should vote against the entire bill – as it excludes borrowing for investment. (In fact the level of state borrowing for investment currently should be considerable, up approximately 3-5% of GDP). Labour should explain its position of voting against the bill as a whole because of the defeat of its amendment.
In this way, Labour’s approach would be very clear. It is not in favour of public borrowing to fund current expenditure and is in favour of borrowing to fund investment. As a balanced budget law does not allow that investment, Labour would be opposed to the Tory policy.
Labour should not support the Bill without this amendment as this would preclude borrowing to invest and leave the economy at the mercy of a private sector which has achieved only chronic under-investment. Neither should it simply oppose the Bill without offering an alternative, especially not on the spurious grounds that any public sector surplus should be ruled out because it ‘obliges the private sector to run a deficit’. Sometimes the private sector, or at least the business component should be obliged to run down its savings, if it is hoarding cash and refusing to invest. Many countries accumulate budget surpluses in their sovereign wealth funds, to be used for investment at a later date. This is what should have occurred with the windfall of North Sea oil, rather than wasting it on consumption in the ‘Lawson Boom.’
In taking a clearly different approach, Labour’s new leadership will be able to demonstrate it has an entirely different policy to the Tories based on increasing investment to increase prosperity.