I welcome the election of Ed Miliband as the new leader of the Labour party, and believe that he can turn the party into the effective opposition that a healthy democracy requires. To do this, he will need to repudiate the failed economic policies of the New Labour experiment, and develop strategies better aligned with the interests of working people.
Under Tony Blair and Gordon Brown, New Labour pushed ‘light-touch’ regulation to and beyond the point of negligence, thereby fostering a disastrous property price bubble. Being ‘intensely relaxed’ about a minority becoming ‘filthy rich’ was an abrogation of Labour’s historic purpose. As New Labour let credit markets rip while letting public spending get out of control, a wealthy rentier elite prospered, as did the top-echelon apparatchiks of the state.
Though the government did its best for those at the very bottom, working people in the second and third income quartiles struggled with stagnant real incomes and rising costs. This neglect of the working majority cost Labour the election.
In the face of an imperative need to close the deficit, Labour must realise that the economy is in a deleveraging recession, which is quite different from the destocking recessions of the past half-century. Classic Keynesianism cannot counter a deleveraging downturn – it would be illogical to try to borrow one’s way out of excessive debt, and immoral to pile ever greater burdens on to the young people of today and tomorrow.
Rather, Labour needs to campaign for tighter regulation of financial services, and specifically of mortgage lending and consumer credit. The removal of taxpayer underwriting of speculative activities through the re-introduction of banking separation is natural left-of-centre territory, as would be the espousal of a wholly elected upper house.
In the public sector, Labour needs to take aim at the over-remunerated apparatchiks at the top rather than fighting to defend every single penny spent on their over-administered fiefdoms. Public sector outcomes are not an automatic function of resources committed, and the new Labour leader should recognise – as his predecessors did not – that privatisation is not always the best way of delivering high-quality public services.
A healthy democracy requires an effective opposition, but the election of a new leader will not of itself turn the Labour party into a credible government-in-waiting. After 13 years of power in which failures far outweighed successes, Labour needs to develop a new sense of purpose, and to offer Britain a balanced and realistic left-of-centre economic and social philosophy.
Seldom has a party stood in greater need than Labour of a fundamental, root-and-branch philosophical reappraisal rooted as much in history as in economics.
For the avoidance of doubt, I believe in the effectiveness of a balanced economy that avoids the perils of excess. The recent financial crisis and the current recession prove beyond peradventure that a deregulated, unfettered free market can result in disastrous excesses based upon the accumulation of unsustainable debt. On the other hand, an unfettered state results in inefficiency, bureaucracy, waste and the destruction both of incentive and of individual liberties.
The aim for Labour should be to embrace the best of both worlds. The fault-line at the heart of the New Labour project was that it espoused, not the best of market liberalism and state intervention but, rather, the worst aspects of both.
According to conventional analysis, Britain now has its first coalition administration since 1945, but, in one sense at least, all political parties, and hence all governments, are coalitions. This is certainly true of Labour. The party was founded as the political wing of a labour movement of which the trades unions were the industrial wing, and of which the objective was the betterment of the living conditions of what was then an identifiable and largely homogenous working class.
But, as social change has altered the economic dynamic of the UK, so this relatively straightforward value-set has been complicated almost out of recognition – for a start, who exactly are today’s ‘British working class’?
Along the way, Labour’s original core has attracted a constellation of interest groups, to some of whom (such as pacifists, and the various libertarian groupings), many of the policies of Blair and Brown were anathema.
The leadership contest has illustrated some at least of the tensions within the left coalition led by Labour. Some luminaries have insisted that the party must adhere to the ‘New Labour agenda’ (popularly associated with Blair and Peter Mandelson), while others counter that Labour should, instead, renew its connection with its core support base.
Though I think that Labour needs to develop a wholly new philosophy, advocates of the ‘core support’ view have a good point, whereas the New Labour philosophy is a proven failure and is dead in the water. The greatest single criticism of the New Labour administration lies in the extent to which it betrayed and alienated natural Labour supporters by turning its back on the party’s history, principles and objectives.
Leaving aside singular disasters (such as the invasions of Afghanistan and Iraq), the failure of the New Labour project can be ascribed to a cocktail of factors which included excessive deregulation, a blind belief in privatising public services, moral absolutism, and a commitment to excessive spending in the mistaken belief that public service outcomes are coterminous with resource commitments.
Over-zealous deregulation leads inevitably to excess, while over-expansionary spending creates not just unmanageable debt but a public sector which, in its upper echelons, is arrogant, wasteful, inefficient and over-administered.
Amongst these failings, arguably the most serious was an excessive devotion to unfettered free markets. When Labour stalwarts complained that Tony Blair and his team were ‘more Tory than the Conservatives’, they were bang on target. Far from reversing two of the key trends of the Thatcher era – deregulation and privatisation – New Labour accelerated both. The guiding philosophy was that the financial services industries, liberated to prosper, would pay for a new welfare state. It was a disastrous miscalculation, in that it failed to understand the ultimately destructive, bubble-building nature of unfettered market liberalism.
New chancellor Gordon Brown started well, by conferring a degree of independence on the Bank of England. But at the same time he made a grave mistake by giving the Bank a remit driven entirely by retail price inflation. Quite apart from tying monetary policy to the Consumer Price Index (CPI) – a seriously flawed inflation indicator – this rate-setting mandate wholly excluded the very concept of asset price inflation. Consequently, the governor of the Bank would have to stand by and watch property prices escalate in a lethally dangerous manner, leaving interest rates too low at a point where previous governors would have intervened by raising rates.
This fundamental mistake was compounded by the ‘tri-partite system’, whereby the Bank’s previous regulatory role was now shared with the Treasury and the newly-created Financial Services Authority (FSA). Brown further exacerbated potential problems by imposing the notorious tax ‘raid’ on pension funds, a shameless case of pinching from the provident.
Quite apart from wholly excluding asset price inflation – in other words, ‘bubbles’ – from oversight, this new approach was disastrously flawed because it carried ‘light-touch’ regulation to the point of negligence. To be sure, this was a continuation of Conservative policies, but party supporters were entitled to ask whether ‘greater Toryism’ was a proper objective for a Labour government. (They were later to ask the same question about Blair’s unstinting support for the most right-wing US administration in decades, and in neither instance did they receive a remotely satisfactory answer).
Predictably, consumers were bombarded by junk-mail offers of mortgages and credit. Mortgages were now being offered on earnings multiples that would have given earlier generations of bankers apoplectic fits, and borrowers’ often-fanciful claims about their earnings were routinely accepted at face value. Far from demanding a reasonable deposit, reckless lenders began offering mortgages for more than the purchase price of the property.
The historically prudent lending rules – a deposit of at least 10%, and a multiple of no more than 3 or 3.5x proved income – had been thrown out of the window. ‘Buy to let’ (BTL) investment became fashionable even though the economics of BTL were wholly dependent on perpetual property price escalation (because yields seldom if ever covered capital and running costs).
As borrowings escalated, the domestic savings ratio collapsed, for three main reasons. First, interest rates were too low to encourage saving. Second, pensions investment had been deterred by the tax ‘raid’. Third, and most importantly, unfettered lending had created a ‘spend now, pay later’ consumerist mentality.
Together, a dearth of savings and a glut of lending sucked in huge overseas borrowings. Between 2000 and 2008, Britain’s external debt increased from £1.9 trillion to £6.2 trillion, falling back slightly (to £5.65 trillion) during 2009. Per-capita foreign debt of $149,000 for every man, woman and child in Britain was a drastically higher figure than that of France ($78,000), Germany ($63,000), the United States ($44,000) or Italy ($40,000). One would have to turn to Iceland or Ireland to find equivalent per-capita national indebtedness to foreign lenders.
Just as importantly, the influx of foreign borrowings had added massively to apparent economic activity. Money funnelled into inflating the housing market moved directly into consumer spending, in two main ways. First, it provided a wholly artificial boost to a gamut of property-related trades such as building, plumbing, electrical installation, white goods, estate agency and legal services. Second, homeowners, deriving an excessive level of comfort from inflated equity, plunged into consumer debt, and/or used equity release to turn their houses into cash-card machines (ATMs).
The ‘boom’ to which Brown referred was no such thing – it was a national borrowing glut, not a rapid growth in real income. Some of the social implications of this debt binge were nasty, but the purely financial results were bad enough, not least because excessive consumer lending was replicated in the corporate sector through the escalation of leverage. Since rates were low, capital gains were taxed at levels lower than income, and interest expense was tax-deductible whereas dividend payments were not, business moved increasingly from an equity to a debt basis.
Consumers and businesses, then, became borrowed to the gunwales during the New Labour years. All that was needed to complete the picture was an escalation in government debt. This duly arrived when excessive bank debt became unsustainable during the credit crunch. Through a process of ‘toxic asset transference’ (TAT), bank debt was transferred to the taxpayer. As the economy moved into a deleveraging recession – and as the artificial prop of the ‘borrowed boom’ dropped away – government borrowed 18% of current GDP in the space of just two years.
Meanwhile, a process that can be described as a ‘monetary ratchet’ had reached its logical endpoint. A monetary ratchet is, at least in principle, a straightforward concept. Unduly low interest rates create a bubble. When the bubble bursts, rates are cut further in order to prevent a severe economic downturn. As conditions recover, low rates prompt a new bubble, and the cycle starts all over again.
But, by 2008, policy rates were close to zero, essentially neutralising rate-setting as a stimulus tool. At this point, the only lever left to the central bank was quantitative easing (QE), the current euphemism for the printing of money. QE need not lead to inflation so long as the velocity of money remains depressed but, if used excessively and not reversed, inflation is the inevitable result as soon as velocity recovers. In addition to the 18% of current GDP pumped in through deficits in the course of just two years, the Bank added a further 14% through QE. As temporary expedients, deficits and QE were sensible policies. But making these an integral part of ongoing fiscal policy would be a recipe for disaster.
I have argued previously that the spending cuts planned by the coalition administration are not only necessary but comparatively modest given what has gone before. To understand this point of view, one needs to understand that, comforted by an apparent (though in fact illusory and borrowed) boom, Brown ditched any lingering attachment that he might have had for prudence, and opened the spending taps.
In 1999-2000, the New Labour government spent £343bn. If that sum had simply matched inflation, it would have reached some £440bn by 2009-10. In fact, spending totalled £669bn in that year, meaning that government expenditures had risen by more than 50%, in real terms, in the space of just eight years. The alliance government’s aim to reduce spending from 47.5% of GDP to 40% over five years is thus a reasonable response to a spending binge which has left Britain dangerously exposed to potential interest rate rises in the future.
A sharp rise in interest rates could have potentially horrific implications for over-leveraged mortgage payers, hiking monthly payments to unaffordable levels whilst creating a negative equity chasm.
Whilst the use of Keynesian stimulus naturally has attractions, anyone thinking of flirting with rate-risking policies should be aware that it could condemn millions of home-owning second and third-quartile earners to penury. Keynesian stimulus, long an item of faith for many left-leaning economists, has come back into fashion with a vengeance after a generation-long infatuation with monetarism took the global financial system to the brink of collapse.
Deficit spending can indeed carry an economy through a ‘conventional’ recession, by which is meant a de-stocking process. But the post-2008 recession does not conform to this historic definition. What we have this time is something fundamentally different – this is a deleveraging recession created by a panic retreat, on the part of industry and consumers alike, from a drastically over-borrowed situation. In this context, the Keynesian calculus ceases to function.
Far from parroting inappropriate and ultimately futile Keynesian solutions to a deleveraging crisis, Labour should seek out a solution to a mess caused by the debt consequences of excessive deregulation. This solution can accord with traditional Labour values by winning a better deal for working people whilst simultaneously curbing the excesses of market rentiers.
The term ‘rentier’ is generally associated with the French Revolution, when it referred to an aristocracy which lived not by working but by harvesting returns on land and other capital. But it has a modern application because of the extent to which western economies have become ‘financialised’.
As leading US political analyst Kevin Phillips has explained, recent decades have witnessed a decisive switch from productive activities to the movement of money for its own sake. Between 1950 and 2008, the share of US GDP attributable to manufacturing declined from 29% to 11%, whereas the financial services contribution rose from 11% to 20%. Much the same thing has happened in Britain.
The only difference between the rentiers of today and those of the past is that most of the modern successors of the French aristocracy live not on the yields from capital but, rather, on the proceeds of moving capital around. Courtesy of more than three decades of monetarist dogma and excessive deregulation, what we now have, in fact, is a resurgence of the historic conflict between capital and labour.
This could present Ed Miliband with the policy opportunity of a lifetime. Instead of advocating pouring the petrol of deficit financing onto the bonfire of excessive leverage, Labour could be campaigning for strengthened regulation of the financial sector. Labour should begin by recognising that what matters to the public good is not the absolute scale of the financial markets, but the interface between the financial and the ‘real’ economies.
Fluid capital markets are essential for the efficient allocation of capital, and Labour may look to campaign for the reintroduction of complete separation between retail and investment banking, which would leave the latter free to engage in speculative activities but stripped of the current implicit taxpayer guarantee.
Where credit markets intersect with the consumer, Miliband should position Labour as the party that champions responsibility over excess. In mortgage markets, Labour should campaign for strictly-enforced earnings multiples and tight LTV (loan-to-value) rules, together with an end to self-certification.
At the same time, Labour should call for a clamp-down on the pushing of consumer credit, quite possibly calling as well for a legal cap on consumer credit interest rates. Labour should also advocate the progressive limitation of corporate interest tax relief.
In the same spirit of moderation and opposition to excess, Labour should scrutinise (and seek to cut) the pay and perks of the top echelon apparatchiks in the public sector, and seek to narrow the income chasm between front-line public sector workers and their bosses.
In an economy requiring structural reform, there are significant opportunities for Labour to position itself as a party which champions sound finance, fairness and the reduction of excess. To achieve this, Miliband needs to repudiate the New Labour experiment, avoid any temptation to retreat into a public sector bunker, and position the party to campaign for moderation and a truly balanced economy.
There was always something more than faintly ludicrous about a Labour government feeling intensely relaxed about people becoming filthy rich. New Labour did its best to help those at the very bottom of society, but in the process neglected the working majority, people for whom debt and the cost of living have risen inexorably whilst real incomes have stagnated. Electoral defeat was the inevitable result.
New Labour policies put huge debt burdens onto the young people of today and tomorrow, and it is difficult to see how this can be reconciled with traditional Labour principles of fairness. For Ed Miliband and his party, then, the best route to electoral viability lies in repudiating the excesses of New Labour and standing up instead for hard-pressed working people, whose best interests lie in a productive and balanced economy which turns its back on excess.
Dr Tim Morgan is global head of research at Tullett Prebon. This is an edited version of a Strategy Note published on 28 September
