The British economic establishment and what it tells us about Sir Keir Starmer’s newly elected Labour Government
Labour’s economic agenda for government is the political expression of British economic establishment - thinking shaped by Fabian socialist collectivism
The UK general election campaign has offered an interesting insight into the collective mind of the country’s public sector economic establishment. This is expressed in the columns of the Financial Times, the Times, the New Statesman and on the broadcast media in the programming of the national public sector broadcaster BBC Radio 4 and independent television station Channel Four. The shifting balance of British establishment economic opinion arises from the interactions of a series of public bodies and specific research organisations that are closely linked to them. The main public bodies involved are the Government Economic Service, the Office of Budget Responsibility, and the Bank of England. The principal research organisations that are closely connected to these official bodies are the National Institute for Economic and Social Research, the Institute for Fiscal Studies; along with campaigning left of centre research think tanks such as the Resolution Foundation and the Institute for Public Policy Research. As well as illuminating the thinking and policy judgement of Britain's public sector economic establishment, it provides good guidance about the approach of Sir Keir Starmer’s Labour Party and the intellectual instincts of the new Labour Chancellor of the Exchequer Rachel Reeves.
There have been a series of articles setting out the present advice of the British economic establishment. They offer helpful guidance on what ministers in the new Labour government will be told. The key to British economic policy is to raise GDP per capita and to increase productivity growth. This should be done by increased public spending on infrastructure investment and raising overall private sector business investment in the UK. This is considered important because in the UK business investment is lower than in other advanced economies that are considered in the chosen sociological argot of this advice, to be the UK’s ‘peers’.
Labour’s Mission Orientated Growth and Industrial Strategy
The New Statesman in the 21-27 June edition had an election special cover story How to Fix A Nation. Among its contributors were Mariana Mazzucato an American-Italian economist based at University College London, UCL. Her central proposition is that ‘Britain is stuck in a cycle of underinvestment’ the newly elected Labour Government ‘needs to break’. Growth is needed and should be generated by five related policy measures. Investment is the key. Public investment should be financed by public debt. Public debt is neither an obstacle nor a break on economic growth. Government spending on education, training and research and development will expand the productive capacity of the economy. The selection of investment projects matters. Spending to improve health, make progress on climate change and to reduce the digital divide will create market opportunities that will act as catalysts innovation and investment. Public sector subsidies, grants, guarantees, debt and equity instruments will create opportunities for private investment to be combined with public policy and solving specific challenges. This will be done through a mission-orientated industrial strategy. Professor Mazzucato’s ideas that she laid out in her book Mission Economy: A Moonshot Guide to Changing Capitalism have been accepted by the Labour Party and are included in the Labour Party Manifesto published on 13 June 2024. Government procurement and spending on the welfare state should form part of the mission-oriented growth and industrial strategy. Projects involving private sector contracts should require the companies involved to support community development, workforce training and development and childcare. She suggests the model here should be the Biden administration’s Chips and Science Act 2022. The direct capacity of the civil service and wider public sector should be increased, and less use should be made of outside consultants. The state needs its own tools and capabilities to frame markets as part of its mission. Public procurement should be a focus and mobilised given that a third of public spending flows through procurement. Decisions should not be made on grounds of price but be based on a wider social value framework.
The veteran Oxford development economist Professor Sir Paul Collier’s contribution in the same New Statesman cover piece was that the British state is over centralised and too much power and decision making is vested in the Treasury. He had contributed advice to the previous defeated Conservative Government’s regional economic development policy ‘Levelling Up’ programme and has concluded that over centralisation and supervision of spending on projects bid by local authorities and other government departments, such as the Home Office, vitiated effective policy. Sir Paul believes that more local decision making, and devolution are the key to better economic and social policy decisions. Where Professor Mazzucato is sanguine about government borrowing and the stock of public debt, Sir Paul is more reticent. He worries that ‘foreigners who buy government debt are now wary. Italy found itself in a similar doom-loop of declining foreign confidence and rising interest rates a decade ago.’
In its The Left Power List edition on 7-13 June 2024, the New Statesman identified the former chief executive of the Resolution Foundation Torsten Bell as an influential figure. The newly elected Labour MP for Swansea West was Labour’s director of policy during Ed Milibrand’s period of Labour leadership. Torsten views economic policy through the lens of distribution. He contributed to Labours’ ideas ten years ago on ‘redistribution’. That is shaping markets and wages to obtain greater equality before the operation of the tax and benefit system. The New Statesman expects Torsten’s book Great Britain: How We Get Our Future Back will be ‘studied as a blueprint’ for the new Starmer Labour Government.
Part of the economic establishment’s advice that Labour has embraced is that the planning system should be radically reformed to enable housebuilding and other economic change, such as infrastructure and new green technologies. These measures will increase the supply potential of the economy, generate increased economic growth and result in higher tax revenue.
The growth agenda is to generate tax receipts for public expenditure funded by it without the political pain of overt tax increase affecting the principal revenue raising taxes such as Income Tax, National Insurance and VAT. These tax receipts should be amplified by fiscal drag in the context of an income tax system, which because of Conservative government decisions, made by Rishi Sunak is no longer indexed for prices. Higher tax revenue can be allocated to finance discretionary increases in spending across the public sector and particularly on health through the National Health Service.
Common ground between Labour and Conservative economic agendas
This establishment economic agenda coincides closely with that of the Labour Party. As it happens it is very close to the position and policies of Rishi Sunak’s former Conservative Administration. These perhaps most fully laid out in Mr Sunak’s Mais Lecture in 2022, when he was Chancellor of the Exchequer and given in its fullest policy expression in the decisions to raise the rate of Corporation Tax and introduce generous allowances for capital investment. These changes effectively reversed Nigel Lawson’s 1984 reform of Corporation Tax. The common ground between the Mais lectures delivered by Rishi Sunak when he was Chancellor and by Rachel Reeves as Shadow Chancellor in March 2024, is striking. Both lectures emphasised the importance of GDP growth by raising investment.
Labour’s manifesto for government is broadly aligned with the public sector economic agenda
Andy Haldane a former chief economist at the Bank of England set out in a Financial Times article The electoral battle for the supply side on 25 June 2024 set out what he described as the ‘modern supply-side agenda’ This is essentially an industrial strategy that supports infrastructure, business investment and support for the acquisition of skills, along with the creation of an array of new government agencies such as Great British Energy and National Wealth Fund of the sort proposed by Labour’s election manifesto. The veteran economics editor of the Sunday Times David Smith – and in my view the economist with most influence in the business community – in a piece in the Times, on 26 June 2024, We may be wrong to assume the worst about the economy, argued that present estimates for UK growth may be too pessimistic as shocks from covid and the relative energy price effects of the Ukraine war unwind. This is a view held by the former head of the Treasury Lord Macpherson who wrote a column in the Financial Times on 23 March 2024 headed Britain’s economic gloom has been overdone. David Smith’s piece also helpfully draws attention to a letter published in the Guardian from a group of distinguished economists, among them Sir Charles Bean the former Deputy Governor of the Bank of England. The Guardian letter argued that the UK invested too little, needed to spend more on skills, needed reform of the planning system to give greater urgency to decarbonisation and net zero. Its signatories concluded by endorsing Labour’s election manifesto.
Will Infrastructure investment and higher investment deliver reliable increase trend GDP growth?
In these analyses of the merits of infrastructure investment and general business investment there is little or no discussion of rates of return on capital or the profitability of investment. The extensive interrogation of infrastructure investment, its costs and disappointing returns undertaken by the Danish economist at Oxford University Said Business School, Bent Flyvbjerg is ignored. When economists at the Treasury explained Rishi Sunak’s plans for greater investment and infrastructure spending after fiscal events such as budgets and Autumn statements when asked what sort of rate of return is expected or what multiplier the Treasury was expecting they were silent on such matters. Likewise, it is simply asserted that UK business investment is lower than that of other G7 economies. An economy with good investment opportunities and a low relatively small capital stock would be expected to exhibit high profitability justifying increased investment. Yet there is no discussion about the profitability or efficiency of UK business investment.
How efficient and profitable is UK business investment?
As it happens the UK is an international outlier in terms of profitability within GDP and the evolution of factor shares within GDP. In most advanced economies over the last thirty years profits have risen as a share of GDP and wages and labour incomes have fallen. The UK has been an outlier to this general trend. While factor shares tend to be stable as economists such Lord Keynes and Lord Kaldor noted. There is a cyclical pattern to profits within GDP.
UK profits in GDP have trended down over the last 30 years
UK profits peaked in the first quarter of 1973 at 23.4 per cent and then fell sharply by nine percentage points to 14.5 per cent in the third quarter of 1975, when the combination of an incomes policy that failed, raising wages and price controls that were maintained created a crisis of profitability in the UK. Profits then recovered in the 1980s. This reflected a non-accommodating monetary policy, radical reform of trade union law, and overdue industrial restructuring that had been delayed in the 1960s and 1970s. In the 1980s profits peaked at 26 percent in the first quarter of 1989. Over the last thirty years the share of profits has fallen back. The ratio fell to 20 per cent in the second quarter of 2000 and now stands at 20.4 per cent in the first quarter of 2024.
Labour’s factor share in GDP has risen, reflecting a labour market that works
The reciprocal of the share of profits within GDP has been the share of labour. Over the last thirty years it has risen. In the third quarter of 1975 labour’s share of GDP rose to 72 per cent. It then fell to 55.1 per cent in the first quarter of 1989. The cyclical trough of labour share in the UK over the last thirty years was 53.5 per cent. Since the mid 1990s labour’s share of national income has risen. In the first quarter of 2001it was 60.6 per cent of GDP and in the fourth quarter of 2023 it was 59.8 per cent of GDP.
The UK has bucked a trend where over the last thirty years labour’s share has fallen. The point is made powerfully by Loukas Karabarbounis in an article in Perspectives on Factor Shares in the Spring 2024 edition of the the American Economic Association’s Journal of Economic Perspectives. He looked at the labour share of the 16 largest economies of the world based on 2015 GDP.
He comments: ‘Out of these, we can see 13 economies whose labour share has declined. The pattern of these declines is not related in any obvious way to geography, level of the labour share, or level of development. We observe labour-share declines in advanced Anglo-Saxon economies (Australia, Canada, and United States), advanced European economies (France, Germany, Italy, and Spain), advanced Asian economies (Japan and Korea), and emerging markets (China, India, Mexico, and Thailand). The only countries with increases are Brazil, the United Kingdom, and Russia’.
The combined evidence from factor shares for capital and labour within GDP would not suggest that there are huge super normal profits being earned by a scarce capital stock that would merit an obvious increase in investment by economic agents. Nor does this evidence on factor shares suggest that the UK exhibits some kind of productivity puzzle. Instead, it reflects a realistic set of labour market institutions that have resulted in a flexible labour market that enables capital and labour to be combined at a reasonable cost yielding high levels of employment.
What is the appropriate capital stock for a modern economy dominated by services?
Moreover, a mature economy with a very large service sector that accounts for over 80 per cent of GDP and a small manufacturing sector that produces around 8 per cent of GDP is likely to accumulate a smaller capital stock than an economy with a larger manufacturing sector. It is part of a wider phenomenon of a so-called weightless economy where brands, intellectual property rights account for an increasing value of output. This is part of the explanation of why, for example, public equity markets are waning in advanced economies with fewer firms accounting for a smaller slice of advanced economies’ capital stocks.
One proposition identified by official establishment economic consensus to explain lower UK fixed capital investment compared to other economies is shortage of finance partly explained by the behaviour of pension funds which, because of regulation relating to risk, invest too much in bonds, as well as investing too greater proportion of their risk assets abroad. These ideas along with potential remedies were explored by the Conservative Chancellor of the Exchequer, Jeremy Hunt, in his so-called Mansion House proposals. These involved getting pension funds to take on more risk assets in the UK. The Labour Party has broadly endorsed the analysis. Yet, modern capital markets are open and integrated. Good investment propositions in the UK will attract international capital. The days of segmented national capital markets went with the end of foreign exchange and capital controls in the UK in 1979 and across Europe after 1989 in preparation for the Single Market and Economic and Monetary Union. Whitehall, its connected think tanks and British economic commentators discuss these matters as though advanced economies still operated in the 1970s before twenty-four hour global trading books.
There is no harm in investment but discretionary tax relief, tax credits and other tax expenditures and subsidies designed artificially to increase capital accumulation are unlikely to raise the UK economy’s trend rate of growth. Simply accumulating new capital is not enough, it is what is done with the capital and the return on it. The supply-side policy agenda laid by the contemporary British economic establishment’s perspective takes too little account of the way market economies work and the role of incentives in stimulating economic activity.
It is also unclear how the scale of the investment programmes that Labour is proposing would have a significant impact on the UK trend rate of growth. Labour’s formal manifesto programme would raise taxation and spending by about £25 billion. The Labour Party is committed to the Conservative Government’s spending plans that project a fall in public investment as a share of GDP. Labour plans to lever private investment. Yet the experience of private investment in renewables suggests that when investment does not yield a realistic return, without sufficient subsidy the private sector will not replace the public sector. In Post-election, Britain will once again waive the rules in the Financial Times on 18 June 2024 Andy Haldane suggested that a Labour Government could junk the UK’s fiscal rules on debt, giving it greater scope to spend. The fiscal rules make no economic sense and at best have only a presentational role.
For Labour’s economic growth ambitions to be achieved it would involve high rates of return on investment
Yet even then it is difficult to see how higher publicly supported investment could raise the trend rate of growth. The Office for Budget Responsibility forecasts that UK GDP will be £2,786 billion this year. ONS estimated that the UK’s total net capital stock in 2022 was £4.8 trillion. In 2023 Total Fixed Capital Formation was £490 billion and of which £269 billion was business investment. Even a huge increase in the ratio of investment to national income and the existing capital stock is unlikely to have much impact on trend growth. To raise the trend rate of growth significantly there would have to be unrealistically high rates of return on the investment and multiplier effects much greater than it is realistic to expect.
Failure to take account of or explore public spending deadweight costs and losses of X-efficiency in public spending in the context of high historical spending
The UK has a large public sector that, leaving aside the impact of the economic cycle, it deploys more than two fifths of national income. Given diminishing returns at the margin, it is not clear that it yields results that are consistently greater than the costs of the resources deployed. The cost of public spending is greater than its cash cost, given the deadweight costs that public spending involves because of the distortions that it creates. There is a huge efficiency and productivity problem in public expenditure. The public sector exhibits losses of efficiency X-efficiency that arise from resources being allocated without the full discipline of hard budget constraints in competitive and contested markets. There is there is a reticence about exploring these uncomfortable dimensions of public policy across the public sector and the economic experts that frame its policy analysis
The British economic establishment has exhibited little intellectual curiosity about these important questions. This lack of curiosity about the efficiency of public spending and its real resource costs has been reflected in both an asymmetric approach to tax and spending, where tax is raised to accommodate increased spending and fiscal rules are designed to accommodate investment spending and place little effective cap on spending.
A technocratic economic agenda with powerful collectivist political implications - Labour and the British economic establishment’s Fabian inheritance
The analysis and presentation of this British economic establishment agenda is technocratic in character. Yet it is loaded with a combination of often explicit and usually implied heavy political judgement. The analysis has a political bias and a clear political direction of travel. It is rooted in British Fabian collectivism. In 1985 Elizabeth Durbin a Professor at the Graduate School of Public Administration, at New York University and the daughter of the late Evan Durbin the economist and Labour MP (who died tragically young in a swimming accident off the North Cornwall coast in the 1948) published an excellent book, New Jerusalems the Labour Party and the Economics of Democratic Socialism. It is a superb exploration of economic and political intellectual history. She argued that the work done by socialist economists in the 1930s laid out what became the mainstream economic case for government intervention. She explained that it was often framed in the rigour of neoclassical economic analysis and can be intellectually traced to the thinking of Arthur Pigou the great Cambridge economist, developed in Wealth and Welfare, in 1912 and the Economics of Welfare in 1920. He drew attention to negative externalities and costs not captured by conventional prices, therefore requiring government intervention to correct them. Pigou’s famous example is the factory chimney that pollutes with smoke, imposes costs on its neighbourhood, yet does not bear the costs of the inconvenience and damage it does.
This collectivist economic analysis can be framed in an elaborate Paretian analysis of welfare economics and utility, justifying a comprehensively planned economy with extensive interventions to promote perceived benefits such as investment and to accomplish political goals in terms of distribution of income and wealth through taxation. The thinking of neoclassical economists provided the basis for much economic intervention. The marginalist revolution economics provided British Fabian socialists with an alternative to Karl Marx’s rejection of capitalism and market economics. The ideas pioneered by Stanley Jevons, Alfred Marshal and Arthur Pigou enabled British Fabian socialists to adapt orthodox neoclassical economics to their political purpose. It was a focus on micro-economics
The evolution of Britain’s collectivist political agenda
During the twentieth century this Fabian collectivism took various forms. This included the post second world war Austerity policies of Sir Stafford Cripps in the 1940s. They suppressed household living standards by direct controls on things such as food and petrol. Rationing combined with high direct taxation suppressed growth in real personal income and consumption. The Attlee Labour Government’s programme of nationalisation was rooted in this Fabian collective tradition. The removal of prices and market mechanisms from health care when the National Health Service, which was established in 1948 was the most powerful expression of this collectivism. In economic terms, it was a comprehensive exercise in socialist medicine, as Aneurin Bevan argued in his book In Place of Fear. Much of this political collectivism was about detail and micro-economics. A good example is the 1947 Town and Country Planning Act that still controls land use, house building and all economic and infrastructure development. It is this legislation that lies at the heart of many of the UK’s structural problems, that Rachel Reeves the new Labour Chancellor has pledged to reform.
While this collectivist policy agenda was closely aligned to Lord Keynes’s thinking on demand management and actively managing the economy to guarantee full employment, the Keynesian revolution was essentially about macroeconomics and the collectivist reflexes were much more about micro-economic decisions. Many of the economists involved in the Labour Party, who helped frame the British establishment’s collectivism in the 1940s and served as Labour ministers, were suspicious of Lord Keynes. Hugh Dalton, Hugh Gaitskell and Evan Durbin had consistent reservations about Lord Keynes’s attachment, in practice to private property rights and personal choice. It was Keynes that gave the Labour Party and Treasury a macro-economic policy agenda. Fabian economists such as Dalton framed their thinking in neo-classical marginalism, which did not provide a macro-economic analysis. It was Keynes’s General Theory of Employment, Interest and Money published in 1936, that provided the tools of macro-economic demand management.
There were in practice overlaps, not least given Keynes commitment to investment, between Keynesian demand management and detailed micro-economic controls. As inflation became entrenched, first creeping and then accelerating inflation emerged in the 1950s and 1960s, governments were forced, for example, to turn to increasingly prescriptive and detailed price and incomes policies.
Micro-economic controls on the model of Sir Stafford Cripps’s controls, became politically discredited in the 1950s. The public appetite for consumption and choice made it difficult for the Labour Party, led by Hugh Gaitskell, to get political traction during the Macmillan years in the era that is remembered as the age of mass affluence. The 1959 election was framed by Harold Macmillan’s vivid expression ‘most of our people have never had it so good’ and the campaign finished on a fight about taxation and the potent Conservative slogan ‘Don’t let Labour ruin it’.
Anthony Crosland’s Revisionist social democracy based on economic growth
Labour’s defeat by a landslide contributed to a vigorous revisionist debate within the Labour Party about economic policy, planning and nationalisation, in particular. The revisionist thinking was led by Anthony Crosland a former Labour MP, for South Gloucestershire and economics don at Trinity College Oxford. His books The Future of Socialism in 1956 and The Conservative Enemy in 1962, set out a provocative and at the time persuasive critique of the high thinking low living, sort of Fabianism that became entrenched in Labour’s policy making in the 1940s. Crosland was charismatic, led a ‘Bohemian’ life, at his flat in The Boltons in South Kensington. He was famous for hosting parties dominated by writers, economists and actresses. As it happens my partner lived with her parents in the flat below Crosland, at this time. She vividly remembers him: tall, good looking, dark with a very pretty American blond girlfriend – Susan who went on to become his wife.
Crosland was the antithesis of the psychological and emotional reflexes embodied in the Chancellor of the Exchequer Sir Stafford Cripps himself. As my history teacher Tony Knox put it – when Sir Stafford asked the nation to tighten its belt, you knew that if he tightened his own belt any further, he would break himself in half. This was a dry and emaciating economics that Conservative politicians had effectively caricatured and politically exploited in the 1950s. After Labour’s shattering defeat in 1959 he wrote a Fabian Society pamphlet Can Labour? where he urged the party to come to terms with social change. He saw no purpose for example in nationalising the successful retailer shop Marks and Spencer ‘to make it as efficient as the Co-Op’, the dreary historic retailer of the Labour movement.
In many respects Crosland’s intellectual legacy is more relevant to Sir Keir Starmer’s Labour Government driven by mission than it was to Tony Blair’s New Labour
Dick Leonard, a former Labour MP who had served as Crosland’s Parliamentary Private Secretary and later became assistant editor of The Economist edited a collection of essays on Crosland and New Labour published in 1999. In his introduction Leonard argues Crosland was hugely influenced by social democracy in Sweden. Swedish progress had been made on economic and social equality and it had had nothing to do with nationalisation, but in Crosland’s view resulted from the use of general economic powers and progressive taxation. It was not an accident that one of the chapter headings in The Future of Socialism was The Growing Irrelevance of the Ownership of the Means of Production. These essays illustrated that many of the ideas and policies that Crosland had advocated particularly high spending and taxation had become unfashionable among New Labour ministers in the 1990s. They certainly resiled from active industrial policy. Yet it was the Croslandite policy mix of economic growth, rising tax yields and higher expenditure that was at the heart of the New Labour years until growth collapsed with credit crunch and Great Recession in 2008.
The principal economic thinkers that influenced Crosland were Alfred Marshal, Arthur Pigou and Hugh Dalton. Their ideas shaped Crosland’s views on intervention, regulation and equality. Crosland was also rooted in the post-war British Keynesian tradition that meant public spending, public investment, active counter-cyclical demand management and use of deficits, public borrowing and functional finance. He had the state playing an active role in industry. This could include taking stakes in private firms, using tax policy to shape company balance sheets and to control dividend payments to shareholders. He supported active industrial policies, where the state supported both research and investment when the private sector action was deemed insufficient. This included the active reorganisation of companies through merger and acquisition sponsored by the state of the sort undertaken by the Industrial Re-organisation Corporation under the leadership of Lord Kearton in the late 1960s. Much of this part of Crosland’s writing and thinking is relevant to understanding and assessing the Starmer economic agenda of mission government.
The revisionist Labour economic debate was played out in the columns of Encounter. Crosland argued that to accomplish their goals of greater equality Labour governments did not have to engage in a further programme of nationalisation nor extensive planning and control. The key tools were public expenditure and taxation. Public expenditure enabled improving public services to be provided through higher spending on health and education, financed through a progressive tax system, that exhibited very high marginal tax rates and buoyant tax receipts from economic growth and rising prices that provided powerful fiscal drag increasing tax revenue even without discretionary increases in taxation.
The left of the Labour Party fiercely resisted Crosland’s revisionism. Their standard bearer in Encounter was Richard Crossman, another former Oxford don, a politics don, and author of a book on political theory Government and the Governed. Crossman argued that planning in socialist economies in the 1950s had been shown to work in terms of efficiency and economic growth, exampled by the USSR’s space programme and that shortly the success of socialist command economies would not just be evident in terms of technology and defence capabilities, but in terms of everyday consumption and normal standards of living.
Will Richard Crossman’s enthusiasm for state planning, control and direction return as part of a Green agenda?
In the 1970s and 1980s Crossman’s analysis of the command economies and Soviet bloc increasingly looked quaint if not bizarre. Some of Crossman command and control propositions may yet make a comeback in relation to the green agenda of de-carbonisation. They appear to underlie Green Party thinking. As it happens during the election campaign the chief economic commentator of the Financial Times Martin Wolf, wrote a piece asking if market mechanisms would be sufficient to bring about the necessary perceived changes.
The problem of a rising tax burden
At the heart of Crosland’s argument was an expanding state with higher government spending, raising the ratio of General Government Expenditure within GDP, could be accomplished relatively painlessly. This remains the central approach of the Labour Party. This optimistic analysis was predicted on several explicit and implicit assumptions. The explicit assumption was that modern managers were not worried about work incentives. They were content to enjoy salaries that were significantly reduced after tax by very high marginal rates of income tax. The second implicit Keynesian assumption was that workers would not notice inflation. Whereas by the 1960s there was growing evidence that workers and trade unions did notice inflation and fought for pay rises. Higher pay carried workers earning around average incomes into higher tax brackets and higher marginal tax rates. And, moreover, it was plain that they did notice this and did not like it. It is not an accident that the Rooker-Wise amendment to the 1977 Finance bill that introduced indexation for allowances and tax thresholds was introduced by two Labour MPs representing the West Midlands and high paid workers in the car plants. It was passed in defiance of Labour Treasury ministers with the support of the official Conservative Opposition in a manoeuvre organised by the future Conservative Chancellor, Nigel Lawson.
Identifying market failures requiring interventionist remedies
The threads of these intellectual legacies still play in the minds of Britain’s economic establishment. There is a deep collectivist reflex. Intellectual energy is applied to identifying market failure that requires government intervention to correct it. There is an overriding concern with distribution and the way the tax and benefits system modify market outcomes. This analysis is best captured in a book published by HM Treasury, Microeconomic Reform in Britain -delivering opportunities for all edited by Ed Balls, Joe Grice and Gus O’Donnell – respectively the Chief Economic Adviser to the Treasury and later Labour MP and cabinet minister, the Chief Economist and Director, Public Services and the Permanent Secretary at the Treasury, in 2004.
The anxiety about relative economic decline
There are several peculiar British neuroses that colour these collectivist reflexes. The first is a restless concern that Britain is somehow falling behind other economies and that by replicating aspects of policy in foreign economies will improve UK economic performance. This neurosis reflects the relative performance of advanced economies in the 1950s and 1960s. There was a rapid recovery in post-war West Germany, France and Italy. Britain enjoyed what in historical terms was very rapid growth which as the post war Chancellor of the Exchequer Rab Butler told the Conservative Party conference could ‘double our standard of living’ in a generation, but other countries such as West Germany and France grew faster. This difference in growth rates reflected in Germany huge movements of refugees that increased the West German population; and in Germany, France and Italy a shift in the economy from agriculture to manufacturing industry taking them up the chain in terms of higher value added. It was an overdue catch up in Western Europe, probably expedited by post-war reconstruction and the beneficial stimulus of a shock that changed social and political institutions. Moreover, West Germany exhibited good policy – ending price controls, Ludwig Erhard’s economic miracle, enjoying a central bank committed price controls and a social market economy framed by the Ordo-Liberal tradition that resulted in caution in relation to public expenditure.
Germany also enjoyed the serendipity of the Bretton Woods fixed parity exchange rate regime that gave it an undervalued exchange rate despite a steadily growing balance of payments surplus. In contrast, neo-Keynesian British demand management resulted in a stop-go cycle where the normal working of the business cycle appeared to be speeded up but was punctuated by inflation and balance of payments constraints that resulted in repeated policy tightening to protect the exchange rate. There was also a sui generis British political and social issue: the malign role of trade union power that prevented labour markets from adjusting to changing economic circumstances. Where trade union power was present – the docks, the nationalised industries, newspaper printing, ship building and car manufacturing – they were a lock on technology, innovation and necessary adjustment to competition. This neurosis about relative economic decline has been revived by Rachel Reeves speculating that growth could result in Poland overtaking the UK in terms of GDP per capita by 2029, in fact drawing on the Polish Prime Minister Donald Tusk’s happy speculation about such a prospect.
Borrowing policy from Europe – planning, social partnership, the ERM
There were two consistent responses to this. One was that the UK should join the Common Market or remain in the European Union. The other was to replicate identified features of continental European economic policy. In the 1960s French indicative planning was the elixir. Harold Macmillan’s Conservative government established the National Economic Development Council. There was a critique of UK defence spending. It was suggested that too much was spent on defence and too many resources went into defence related science and R&D. This was a tripartite – government, business and trade unions – body set up to stimulate growth. Harold Wilson’s Labour government in 1964 took things a stage further. The Department of Economic Affairs was established to challenge perceived Treasury orthodoxy and in 1965 the government published the National Plan for greater economic growth. In the 1970s it was a cohesive social partnership between unions and business drawing on the Scandinavian and Austrian experience. In the 1980s the model to be replicated was the Bundesbank and the European Monetary System and its exchange rate mechanism. Each of these ended in ignominious disappointment. The worst political disappointment was the collapse of the ERM. The whole of the British economic establishment was fully signed up to it – Treasury, Bank of England, Conservative, Labour and Liberal Democrat parties, Confederation of British Industry (CBI) and the Trade Union Congress (TUC). There is a continuing appetite among Britain’s administrative elite to recreate close economic and political ties with the European Union.
Labour ministers will have greater scope to intervene economically outside of the European Single Market
Civil servants and public administrators feel this strongly, Labour politicians recognise the practical political difficulty and have gone out of their way to explain that Labour will neither return to the Customs Union nor the Single Market. Sir Keir Starmer, the new Labour Prime Minister, has said that rejoining the EU would not happen in his lifetime. Brexit has given the UK greater freedom to pursue active economic intervention of a socialistic character that would not conform to the law of the European Single Market. Given the new Labour Chancellor Rachel Reeves’s interest in active national industrial policy, pursuing a form of repatriation of economic activity analogous to the US Treasury Secretary Janet Yellen’s ‘friend shoring’, Brexit gives the UK greater policy discretion. ‘Securonomics’ policies of the character the Chancellor laid out in her Mais lecture in March this year, will be more conveniently pursued without the European Commission’s Single Market supervision. This convenience cannot be lost on the new Labour Chancellor.
Labour’s budget constraint
In constructing its programme for government ahead of the election Labour has been constrained by the electorate’s distaste for taxation and a historically high aggregate tax burden. Rachel Reeves has promised to leave all the principal revenue raising taxes unchanged. There is scope for the new Labour Chancellor to raise capital taxes. But increased capital taxes of the sort advocated by the Liberal Democrats and the Green Party, along with some former heads of the Treasury, such as Lord 0’Donnell are not reliable sources of recurrent revenue. As Anthony Crosland said in the 1970s, Labour governments have high progressive taxes on income and capital taxes not for revenue but for political purposes. While he supported a Capital Gains Tax and was not opposed to a wealth tax, he was realistic about the lack of revenue yield in terms of tax receipts for spending. Labour’s new Chancellor should also be realistic about the potential revenue yield of such taxation.
Where the new Labour Government may have scope to increase government spending is by borrowing more. The fiscal rules make little economic sense. The new Government could make detailed changes to relax their bite. Or could be guided by Andy Haldane’s advice and completely junk them. Whether higher spending financed by increased borrowing would yield the long-term economic growth that the British economic establishment expects from increased public investment and spending is another matter.
Warwick Lightfoot
6 July 2024
Warwick Lightfoot is an economist and was Special Adviser to the Chancellor of the Exchequer between 1989 and 1992.