How Labour should deal with Fiscal Responsibility Act

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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.

Labour’s response

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.

Corbyn Danger? Danger for Whom?

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Backing Corbyn

The “Corbyn Danger”: Danger for Whom?

@johnweeks41

Fear & Loathing on the Campaign Trail 

Hunter Thompson chose the title above for his book relating his eccentric take on the 1972 US presidential election.  In a somewhat different way, it is singularly appropriate to the current campaign for the Labour leadership.  With the outstanding exception of Ed Miliband, the notables of the Blair-Brown era can contain neither their fear nor their loathing of the front-runner, Jeremy Corbyn.  From this collection of “yesterday’s men” the attacks on the MP from North Islington come thick and fast, slings and arrow of the outrageous (á la Hamlet, Act II, scene 1).  Ex-PM Blair advises supporters of Corbyn to consider heart transplants.  Ex-cabinet member (now Lord) Mandelson quakes before the threat of a “lurch to the left” by the Labour Party.  And to these I can add former leader Neil Kinnock, ex-spinner Alastair Campbell and in veiled language ex-PM Gordon Brown.

Equally thick and fast come the attacks on Corbyn’s economic policies, notably in the Financial Times where the insurgent is described as a doing “potential harm to…British public life” for his advocacy of “radical” policies.  An inspection of his policies seems relevant with this and other allegations including from members of the Labour Party that Corbyn inhabits some extreme/hard left territory,

To do this I went to the source, the website for Mr Corbyn’s leadership campaign a virtual visitor can download a statement of his economic policies, The Economy in 2020.

Anti-Austerity

I begin with a Corbyn policy certain to send the neoliberals into anxiety, public ownership (aka nationalization/re-nationalization).  A pledge to take the railroad into the public sector features prominently on the campaign website.  After 35 years spent selling off public assets, this commitment to public ownership comes as a shock.

But, is it radical or hard-left?  A look to the continent suggests otherwise, where the public sector owns the railroads in France, Germany, Italy and Spain.  None of these countries have or had radical governments.  In the United States, very much neoliberal territory, the passenger rail company Amtrak is publicly owned.  Further, in 2013 the citizens of Hamburg voted to bring all public utilities into public ownership.

While public ownership is less common today that in the past, it is sufficiently frequent across the globe not to be unusual or rare.  The same point applies to the Ten Priorities listed in The Economy in 2020, which fall into three categories, opposition to fiscal austerity, taxation and re-structuring of the UK economy.

We find no ambiguity in the candidate’s position on fiscal cuts.  “Austerity is a political choice not an economic necessity”, and Corbyn opposes it, promising “always to protect public services and support the most vulnerable”.  Closely related to opposition to austerity is “a publicly-led expansion and reconstruction of the economy with a big rise in investment levels”.

The commitment to “publicly-led” growth is likely to be more controversial that opposition to austerity, because anti-austerity does not necessity imply more expenditure while an increase in public investment would.  The implicit argument in defence of an increase in public investment is that it would generate faster growth and the taxation induced by the greater output would quickly eliminate the increase in the fiscal deficit required to fund the investment.

Also implicit is the “crowding in” process, that properly targeted public investment would foster private investment to restructure the economy.  Public investment priorities would be implemented through “a multibillion pound programme of infrastructure upgrades” including broadband networks.

Controversy has focused on the mechanism to fund the infrastructure update, “a National Investment Bank”, which some confuse with Corbyn’s references to a “People’s Quantitative Easing”.  The investment bank could fund its project either by sale of bonds to private buyers (“capital markets”), or by selling bonds to the Bank of England (“monetization of the deficit”).  The major difference between the two is that the former leaves the money supply unchanged, while the latter increases it by the amount of the investment.

The possibility of funding through selling bonds to the Bank of England prompted an attack on Corbyn from Labour shadow chancellor Chris Leslie, who alleged that this would be inflationary, and therefore “risks hurting some of the most poor, the most vulnerable, those on the lowest incomes”.

The “hurts those you wish to help” argument suffers from two serious problems.  First, the UK economy now suffers from pressures toward deflation not inflation, so that expansion of the monetary base is the appropriate policy.  Second, much empirical evidence indicates that contrary to Mr Leslie’s allegation very low inflation hurts the poor and benefits the rich.  One of the reasons should be obvious, inflationary pressures are associated with rising employment and wages.  In addition mild inflation devalues household debt and the poor are heavily indebted.

However, the mechanism to fund public investment and whether it would prove inflationary provides no support for the “hard left” accusation by Leslie.  We find national investment banks advocated by solidly mainstream economists (for example, Robert Skidelsky).  Funding of investment by borrowing from central banks is even more common – indeed, in the 1980s Ronald Reagan used this funding technique to cover current expenditure without generating notable inflationary pressures.

Taxation

The revenue generating policies in The Economy in 2020 focus on increasing the progressivity of the overall tax structure.  This has three components: 1) a shift from indirect to direct taxes for households, 2) stronger measures to eliminate personal and corporate tax avoidance, and 3) “large reductions” in corporate tax relief and subsidies.

Economists, even if they prefer indirect taxes (taxes on expenditures) agree that these are regressive;  their share of gross income falls as income rises.  A reduction in VAT and an increase in personal income taxes that leaves total tax take unchanged would reduce income inequality.  A reform of the tax structure that would reduce inequality hardly qualifies as “hard left”.  In a recent FT article the decidedly right of centre Chris Giles cited the negative impact of inequality on economic growth (drawing on a study by the OECD, which confirmed an earlier study by the IMF).

The tax policies proposed by Jeremy Corbyn are not hard left, but they are controversial because they would reverse the inequality-enhancing trend of our public finances over the last thirty years.

The Corbyn Danger

The economic policies proposed by Jeremy Corbyn are certainly a break with the current consensus in the Conservative, Labour and Liberal Democratic Parties (though not so different the anti-austerity Greens, SNP and Plaid Cymru).  This makes them radical only if one has an extremely narrow view of the limits of legitimate debate.

The surprising aspect of Corbyn’s economic policies is not that they are radical and hard left, but that they would be perceived as such, especially by prominent people in the Labour Party which has many MPs committed to social democratic values.

Since the other three candidates for the leadership profess to different degrees concern with inequality, I would have expected criticism to focus on the inadequacy of Corbyn’s policies rather than their radical nature.  For example, his programme could place more emphasis on enforcing a “living wage”, more on legislation to strengthen collective bargaining, plus policies to limit the grotesque inflation of corporate salaries.

It appears that the source of Jeremy Corbyn’s radicalism and the outrage his candidacy provokes in the Labour elite lies not in his policies.  While leader of the Labour Party Ed Miliband introduced fundamental reform in the process by which future party leaders would be chosen.  From a previous system of voting that gave the Parliamentary Party proportionally much greater election strength, the new system is one-member-one-vote, a change that two backbench MP called “disastrous” for which Miliband should apologize.

Therein, we find the profound radicalism of Jeremy Corbyn’s threat to  become Labour Party leader.  Should he win, it will be by a process that does not require the approval of the Labour Party elite.  Corbyn is not the danger that fills them with fear and loathing; it is the spectre of democracy.

Economist John Weeks is a Professor Emeritus of the School of Oriental and African Studies, University of London.