The Economic Contradictions of Mr Miliband

There is much to welcome in Ed Miliband’s address last Saturday to the Labour Party’s National Policy Forum.

For example, his argument that Britain suffers from a low-pay economy. While the number of those in employment has grown, real pay has fallen dramatically over the lifetime of the present government.

At PRIME, we calculated the fall in real pay from May 2010 to May 2014 as 6.1%, using the CPI inflation and total pay stats from the Office for National Statistics.

In his weekend column in The Independent on Sunday, David Blanchflower estimates the fall in real pay as 8% over the identical period, using the somewhat higher (but now less “official”) RPI inflation numbers.

Whether you choose 6% or 8%, that is a huge decline in real pay over such a short period.

So Ed Miliband’s espousal of an increase in the minimum wage, and promotion of a living wage, are very welcome – and if implemented will help to “balance the budget” (by increasing tax revenues) and enhance the UK economy as a whole, as well as helping millions of (auto-insert “hard-working”) individuals and households.

His speech included many other points with which we agree, and which if implemented would change our country for the better.

But on the crucial issue of economic policy, Ed Miliband also made commitments that will prove disastrous if ever applied in a recession without reference to the actual state of the economy - and which are potentially in direct contradiction with his promises on pay and greater security for workers.

He reinforced the deeply flawed “there is no money” meme - which outgoing Treasury minister Liam Byrne helped to legitimize when in May 2010 he left a note (and political godsend) to his Coalition successor saying: “there's no money left”. (Byrne had clearly not heard of Quantitative Easing).

The Miliband commitments

Here is the excerpt from Mr Miliband’s speech, drafted in the staccato soundbite prose reserved for such occasions:

“…[T]he answer [to the UK’s economic problems] cannot be our traditional answer either.

Of spending to fix the problem.

You and I know we won’t have the money.

For all of the cuts, all of the pain under this government, Britain still has a deficit to deal with and a debt to pay down.

That’s why our programme starts with a binding commitment to balancing the books in the next government.

We will get the national debt falling as soon as possible in the next parliament.

And we will deliver a surplus on the current budget.”

“You and I know” – implies that we all have a sound understanding of how much money there is available to government. But many of us were surprised when the government, working with the Bank of England, seemed to conjure £1 trillion (equal to the whole of the UK’s annual income) “out of thin air” – to bail out the banks in 2009. It taught you and me that the Bank of England and Treasury might have some tricks up their sleeve which we do not know or understand – and which only ever seem to be deployed in the interests of the City of London!

“We won’t have the money” – implies that a Labour government will not expand good quality employment by supporting public and private investment, and by that means increase the tax base – both direct and indirect.

“We won’t have the money” – makes this potential loss of government income inevitable – when it is not.

The annual budget deficit

Yes, the UK still has a government budget deficit. But by itself this is no danger to the UK, as has been proved for 5 years – against all the warnings of doom from orthodox economists. The reason is simple: the government is not like a household. It has its own (nationalised) central bank, the Bank of England, which can purchase its bonds (used to fund investment for example) at very low rates of interest.

Since the UK – unlike Eurozone member states – can borrow in its own currency at low rates of interest, and in effect (though not under EU law directly) from its own central bank, there is no threat posed by a budget deficit at a time of high unemployment. Indeed a government deficit is necessary at a time of economic contraction, high levels of youth unemployment, and falling pay.

A government deficit means the government is pumping money into the economy. A government surplus implies that the Treasury is sucking money out of the economy. For the government to extract more out of the economy as incomes are falling would be deeply resented by the British people.

We need to remember that the recession was caused by the 2007-9 financial crisis, which had its origins in excessive, and reckless, credit creation by the private banking system. The expansion of credit expanded the money supply – and in turn inflated the price of assets.

When credit “crunched” in August, 2007, this led to a contraction of the money supply, and with it a contraction in investment, a fall in profits, a rise in unemployment and an acceleration of falls in income.

The private sector was too indebted, and too damaged by the crisis, to come to the rescue. Only the public sector – in the shape of central banks backed by taxpayers - could act in those circumstances.

How deficits may help the economy

So, while the private sector is still trying to fix the damage, to clean up balance sheets and to deleverage bloated debts, a government deficit is a sound buffer against the real threat of outright economic failure.

Indeed, we know from evidence provided by the UK Coalition government that since 2012, government spending, and a deliberate but unacknowledged slowing down of the austerity programme, has led to a relative improvement in the UK economy. And the UK has in turn been helped by another central banker, Mr Draghi of the European Central Bank, who promised to do “all that it takes” to defend the Euro. This has led to a painfully slow and uneven recovery in the Eurozone, which has also helped the British economy to edge towards recovery.

In the end, it is positive economic activity, with more Britons employed in quality jobs, doing productive work, earning reasonable pay and paying reasonable taxes, which “deals with the deficit”. If governments try to slash deficits by big cuts in public spending at the wrong time – as was the case with the Coalition’s cuts in 2010-12, and even more emphatically, the Eurozone’s tough austerity programmes – they end up making the situation far worse, with contracting private sector activity, sustained mass unemployment and greater inequality.

Wrong framing

Ed Miliband is anxious to mimic the Coalition’s, and in particular George Osborne’s, framing of public finance management as the need to behave like a prudent household and “to balance the budget” or even run a small surplus.

While we are not politicians, we think it unwise for a political party to adopt their political opponent’s framing. Especially since the Chancellor’s framing of the crisis was adopted precisely in order to draw attention away from the private debt crisis (and wider private sector failings), and focus public attention instead on cutting back the state and public sector services – where much of Labour’s support lies.

It is also economically unwise, and will, we confidently predict, at minimum require the kind of U-turn that Chancellor Osborne was forced to adopt when in 2012 he began the process of easing austerity.

It would be particularly unwise for Labour to make a “binding commitment” to balance the books, no matter what the state of the economy. What if the British economy is hit by another “credit crunch”, or by a further deterioration of the Eurozone during the lifetime of the next Parliament? Given the growing volatility of financial markets, the heavy burden of private debt dogging both the British and US economies, and growing geopolitical risks, the threat of another major recession is not unthinkable.

To make a “binding commitment” to “balance the budget” regardless of such threats, and even in the event of a major recession, is truly misguided.

Merkel’s Germany - ‘softer’ than UK Labour?

In fact, in the unqualified form expressed in his speech, Mr Miliband’s “binding commitment” goes even further than the budgetary straitjacket which Germany – with its ordoliberal economic philosophy – has chosen to impose on itself.  The “Schuldenbremse” (debt brake and balanced budget) provisions introduced in 2009 into the German Basic Law (constitution) permit a slight softening in case of recessions, allowing modest deficit borrowing of up to 0.35% of GDP in a year, to be balanced by surpluses in the up-years of the cycle.

The stock of national public debt

The statement that we “have a debt to pay down”, allied to the commitment to “get the national debt falling as soon as possible in the next parliament” also offer up foolish and unnecessary hostages to economic and political fortune.

First, even the European Union’s budget rules do not require nominal debt to be reduced – they seek to require that gross public debt as a percentage of GDP should not exceed 60%. That means that if in any year GDP grows faster than an increase in nominal debt, the position under the EU rules improves, as opposed to worsening – even with debt rising!

Alas, Mr Miliband did not even say that Labour would get the public debt as a proportion of the economy to fall in the next parliament. This implies that he and his advisers do not understand that public debt as a percentage of GDP can fall of its own accord, as the economic cake expands, and not as a result of any direct action by policy-makers.

Second, once again the chance is not taken in the Labour Leaders's speech to make clear the difference between borrowing to cover current budget expenditure, and borrowing to enable positive investment to take place, which enhances the country’s longer-term economic future. Instead, we are lured back into the stupid political territory that assumes all government borrowing to be “bad”, irrespective of the situation or the purpose.

The most damaging part of the Coalition’s programme of spending cuts was the sheer scale of cuts to public investment – most of which would have benefited private sector firms and their employees!

Contradictions and classical economic ideology

Keynes did not argue that governments should run budget deficits in “good” years in which there is full employment and strong economic activity. His title “General Theory of Employment, Interest and Money” makes his priority clear: it is full employment that we should be seeking – for economic, budgetary but also for social reasons. Employment (if fairly remunerated) generates the income - tax revenues - needed to “balance the budget”. Unemployment and low-paid, insecure employment shrink the very revenues needed to “balance the budget”.

If taken literally and seriously, the Labour Party, in its Leader’s speech last weekend, has once again forgotten and ignored the work of Keynes and his successors, and adopted the neoclassical economic paradigm. In this neoclassical world, economies are self-righting and find their own equilibrium. Deficits are always wrong, even in times of high unemployment. Creditors’ interests take precedence over all other actors in the economy. Public debt has to be “paid down”, even at the cost of contracting the economy – as governments so “successfully” did under the neoliberal Gold Standard of the 1920s and 30s.

Market-clearing wage rates

The logic, of course, is that wages must be self-regulating which means that real pay must fall to “market-clearing rates” in times of recession and high unemployment. But this runs absolutely counter to the progressive parts of Mr Miliband’s speech, in which he gives a commitment to higher pay and greater legal protection for those on lower wages today.

If all goes well with the economy, the contradictions may for a time remain unresolved. But if the economy runs into stormy weather, something has to give.

Mr Miliband and his colleagues would do well to remember the fate of the 1929 to 1931 Labour Government. Its binding commitment to “balanced budgets”, and its genuflection before classical economics, caused its outright collapse and the disintegration of the Labour movement.

As JK Galbraith once said of the Great Crash and Depression: “There is merit in keeping alive the memory of those days”.*

 

*Hat tip to Philip Augur in the Financial Times, "Britain versus the Banks", 18th July, for reminding us of this quotation.