Jonathan Todd

I had this on Labour Uncut a few weeks ago. I think events since have justified my argument.

Public debt, said to be the consequence of Labour largesse, is the problem for the governing parties, and aggressive cutting the medicine. Labour contends that this remedy is too tough to close the deficit. As we recover from a global shock of 1929 proportions, slower cuts are required for strong enough growth to generate the tax revenues needed to achieve deficit closure. Lack of growth, as well as the deficit, is the problem targeted by Labour.

Are these well-established positions shifting?

Not as far as Labour is concerned. Some twitching can, however, be detected on the government side.

First, John Redwood wants an improved growth strategy. This is echoed by Liberal Democrat Mark Littlewood. This doesn’t mean the Tories and Liberal Democrats are about to concede, as Labour has protested, that they have no growth strategy. Since the formation of the government they have argued that the deficit needs to be addressed to retain the favour of bond markets and so control upward pressure on interest rates. They prefer this monetary stimulus to greater fiscal support. Yet the comments of Redwood and Littlewood are not insignificant. They acknowledge that the resources of the shrunken state could better target growth.

Second, Norman Lamont has stressed that the government is battling the headwinds of a global crisis. Osborne has long sought to frame our economic problems as being wholly the consequence of Labour profligacy. Lamont may have carelessly forgotten this script or his comments might indicate that the Tories want to start to get some excuses in.

Third, George Osborne has flagged the “flexibility” in his plans. This isn’t a policy shift, but a change of emphasis. The automatic stabilisers of tax and benefits were never removed by him. The treasury might also define “trend growth” to create wriggle room on the extent of cuts needed to eliminate the structural deficit.

Osborne’s commitment that Ireland would be the only eurozone member he would bail out was shattered, as was always probable, in Portugal. His officials must have briefed him that Greek default now seems inescapable. Fireworks will follow, probably knocking our economy still further off course. So much so that Osborne may resort to the Lamont defence.

With this, the chancellor’s pretence that the deficit is entirely caused by excessive Labour spending and nothing to do with global conditions would be nakedly exposed. While this would be a significant concession to Labour, half of voters now blame Labour for the cuts, as compared with a quarter attributing them to the government implementing them. Osborne’s acknowledgement that the UK is not an island would help. But probably wouldn’t be enough in itself to reverse these numbers – especially if Osborne gets traction behind a subtler Lamont defence.

The simple version of this defence is a global crisis. The more subtle and accurate one is a European malaise. The euro’s principles “have proved unworkable at the first contact with a financial and fiscal crisis” (Martin Wolf) and the currency zone “is looking very much like a system that amplifies shocks rather than absorbs them” (Ken Rogoff). Swathes of southern Europe are unable to generate the growth they require to manage their debts within the eurozone. This isn’t sustainable. Either consolidation into a currency and fiscal union occurs or bits of the struggling south must break away.

Eurozone leaders have not confronted this choice squarely. The economic interests of the UK are best served by having them do so before this dilemma overcomes them. However, Osborne potentially has a tenable political position even if our economic interests are not so protected. While the shocks triggered by Greek default may destroy his economic projections, he will shift his account of the economic problem to the European variant of the Lamont defence. It won’t have worked. It will have hurt. But it will be Europe’s fault as well as Labour’s.

The bond markets and the polls will then give their verdicts on this argument. The markets will want Osborne to hold fast to plan A. As the pain accompanying this plan deepens, the polls instead might indicate an increased sympathy for Labour’s slower cuts. Labour should not, however, seem to be willing this grim scenario.

Labour should be building on the criticisms of Redwood and Littlewood and spelling out how smart policy can secure faster growth. We should also be getting ahead of the debate on the euro. Ed Balls ought to demonstrate that he is capable of leading in Europe in a way that Osborne has not. Then any deployment of a European-flavoured Lamont defence would be followed by Labour contrasting the paucity of Osborne’s response to that of Balls.

I wrote for Labour Uncut today on the challenge for the new shadow chancellor.

The Labour leadership election will, finally, end on 25 September. But the identity of the shadow chancellor will be unknown until 7 October, when the results of the shadow cabinet election are announced. 13 days after this the new leader and shadow chancellor will lead our response to the comprehensive spending review. “It is”, as a leadership contender has said, “an incredibly tight timetable for the new leader and their shadow chancellor to map out a policy that might yet determine how we are viewed for the rest of the parliament.”

The general election too quickly gave way to the leadership election. (Which should have started later and been shorter). With the end of the leadership election, the formal involvement in the shadow cabinet election of four of our would-be leaders begins. This is a grueling pace. But the new leader and shadow chancellor will need immediately to demonstrate economic literacy, which means robustly critiquing George Osborne and articulating a credible and appealing alternative economic approach. While this is challenging, there are some relatively simple points that are worth underlining.

First, like the Liberal Democrats, we consistently warned prior to the general election that it was too much of a risk to the economy’s recovery to cut public spending this year. There is no evidence that these risks have significantly diminished.  Business credit remains weak. Lending to businesses fell for the eleventh consecutive month in July. Consumer demand remains sluggish, as tens of thousands of homeowners are expected to face at least four more years of negative equity and redundancies in the public sector are thought unlikely to be absorbed by additional private sector employment.

Second, no matter how the Liberal Democrats defend the shift in their position on public spending cuts this year, the UK is not Greece and was never in danger of becoming Greece. As Rachel Reeves has noted, national debt in the UK in 2009, as a percentage of GDP, was 72 percent, while in Greece it was 119 percent. Additionally, and crucially, having our own currency and a central bank that can set interest rates in the interests of the domestic economy provides us with far more flexibility than is available to the Greeks within the eurozone.

Third, our opposition to cuts this year derives from a deeper view: sustaining economic growth is an indispensible precondition of deficit reduction. In the absence of growth, the deficit will widen as tax receipts fall and unemployment benefit payments rise. Public debt levels are generally more sensitive to growth than changes in tax and spending. George Osborne can cut as aggressively as his Thatcherite heart desires, but if we slip back into recession this cutting will do little to contain the deficit. Indeed, it also risks a deflationary spiral if Osborne responds to recession by persisting with his cuts.

The risk to public finances posed by a double dip recession must be balanced against the risk of higher interest rates cascading through the economy – further credit crunching businesses and raising household mortgage payments – if the deficit reduction plan fails to convince markets. Reduce public spending too early and the double dip risk increases; cut too late and upward pressure on interest rates becomes more likely. George Osborne, in cutting earlier and by £40bn more deeply over this parliament, is putting more emphasis on the later risk than Alistair Darling’s plans do.

Yet, as no lesser economic authority than the FT’s Martin Wolf has observed, “the market is screaming its lack of concern about UK fiscal credibility”. In these circumstances, forcefully illustrated in Ed Balls’ Bloomberg speech, it is perverse for the chancellor to underplay the double dip risk of cutting too early and too deep for the sake of masochistic cuts ostensibly justified by market concern about the deficit.

In truth, Osborne’s plans are driven by an ideological imperative to reduce the size of the state. This goes against the premium which Anatole Kaletsky places upon pragmatism in Capitalism 4.0; his weighty tome on the financial crisis and capitalism’s future. “In an indeterminate world”, he writes, “both economic and institutional decisions will have to proceed by a zigzag process of trial and error.” Rather than this flexibility and adaptability, Osborne, as Pat McFadden has noted, has given us “faith-based economics”.

Labour must be careful, however, that we too do not become inflexible and dogmatic. While Osborne is underplaying the double dip risk, which even those red-blooded socialists at the British chamber of commerce worry about, and is willing a private sector led recovery through little more than his faith in it, the interest rate risk attached to the deficit should be squarely confronted by Labour. Being squeamish about this not only betrays our credentials as the party of pragmatic economics but leaves us seeming trapped in what Phil Collins has called “the comforting illusion that state spending is a straight line to progress”.

This illusion can attach to social as much as to economic policy. And the public sees through it. The mood music emanating from Labour risks seeming too statist if we seem unwilling straightforwardly and even-handedly to address the deficit. Alistair Darling has left plans which should take us a long way towards avoiding this outcome. But our new shadow chancellor will still have crucial decisions to take during a testing first fortnight in office.

“The best books … are those that tell you what you know already”, wrote George Orwell in 1984. While, pace the likes of Henry Porter, our country isn’t Orwellian, there is a lot of truth in this line. And so it was when I read Martin Wolf on Iceland last week. He powerfully and intelligently argues for that which I have always instinctively felt about events there.

The British and Dutch governments are seeking agreement with the Icelandic government for the repayment of debts, which now amount to 50% of Icelandic GDP, owed to British and Dutch savers in now collapsed Icelandic banks. If we attempt to see things from the Icelandic perspective, this observation from Wolf is particularly striking: “In the UK context, this would be equivalent to a demand for £700bn. It is not hard to imagine how far Mr Brown would get with a suggestion that the UK should accept such a debt to refund depositors in foreign branches of bankrupt UK banks.”

We most probably do not have to fear the rise of Nazism in Iceland, (though, Icelanders do have unnecessary misery and Brits needlessly lost goodwill to fear), but Wolf’s analysis seems as persuasive and prescient as J. M. Keynes’ The Economic Consequences of the Peace proved to be on the Versailles Conference.

“Do Iceland’s taxpayers have a moral obligation to pay this loan? My view is: no. The delusion that finance was the path to riches was propounded by countries that should have known far better. I cannot blame Icelanders for succumbing. I certainly do not want generations of Icelanders to bear the cost.”

Iceland has many things going for it. However, not so many that more measured approaches from the British and Dutch governments could not considerably improve the prospects of Icelanders for many years to come.

“The final and, in truth, most important question is whether these demands are reasonable. After all, in every civilised country it has long been accepted that there is a limit to the pursuit of any debts. That is why we have introduced limited liability and abolished debtors’ prisons. Asking a people to transfer as much as 50 per cent of GDP, plus interest, via a sustained current account surplus is extraordinarily onerous.”

Not only is it extraordinarily onerous but it is only justified if we accept that several generations or more of Icelanders should pay the full price for the follies of a small Icelandic elite. What would the likes of the Labour Party argue in similar circumstances in the UK? Surely, we’d argue in favour of the many and not the few? So, why should we think any differently about an event in Iceland?

Let’s take a deep breath, step back and extend a modicum of decency to a fundamentally decent people, who, incidentally, were amongst the first to get aid to Haiti this week. If Icelanders can do the right thing by Haiti, Brits can do the right thing by Iceland.

Recently Hector Sants, head of the Financial Services Authority (FSA), said:

“The question of the size of individual payments is not one for financial regulators. That is one for politicians and society as a whole. If politicians wish to take a view on that, then they should say so, but they should not be asking the regulator to carry out a pay policy”.

Politicians should step up to this plate. So, it is welcome to read reports that Alistair Darling, the Chancellor, is considering means of doing so.

Any nervousness that might be felt in relation to this should be quelled by reflection that Martin Wolf, Raghuram Rajan and Paul Krugman were arguing for this long ago. Of course, we should, as ever and as the Times argues, be wary about unintended consequences. But the Times – hardly a bastion of red blooded socialism! – proposes a sensible way ahead:

“Only a small fraction of a bonus should be paid at once. The rest of the payment would follow only if subsequent years of good performance confirmed that the profitability was sustainable. In this way, the incentive to make short-term profits with very risky transactions might be avoided. It would be reasonable to penalise banks that did not comply by requiring they offset the risk by holding more capital”.

Deferred compensation schemes seem the way forward.

The point of Roger Casale, which I highlighted in my last post, seems all the stronger in light of an observation made by Martin Wolf today.

“The relationship between the US and China will become more central, with India waiting in the wings. The relative economic weight and power of the Asian giants seems sure to rise. Europe, meanwhile, is not having a good crisis. Its economy and financial system have proved far more vulnerable than many expected. Yet how far a set of refurbished and rebalanced institutions for international co-operation will reflect the new realities is, as yet, unknown”.

It is towards global institutions, like the IMF, the World Bank and the UN, that we must first look for the refurbishment that our Chinese century requires. However, Wolf’s comment – along with the criticisms of Charles Clarke, Wolfgang Münchau and Helmut Schmidt that my last post also noted – would seem to suggest that the EU too is also ripe for some refurbishment.

In absence of such refurbishment – or at least an improved claim upon output legitimacy – Europe can expect to drift ever further from the real crucible of global politics as this century progresses. The seeming addiction of Europe’s body politic to navel-gazing and nation-centric politics – exemplified by the current EU elections in which anything other than EU issues are being discussed - is corrosive in its inability to rise to the bigger global picture as set out by Casale. The longer Europe persists with this inward-looking, complacent, arrogant attitude the more likely this global picture is to take a form that is displeasing to European values and interests.

China is ascendant and hardly seems to have an excessive respect for the Copenhagen criteria. India may be closer to satisfying such criteria but Russia and Iran seem likely to increasingly feature amongst the global picture and the stuff of the Copenhagen criteria are as much of a joke to them as the idea, pace Francis Fukuyama, that history has ended.    

History moves on. But the EU seems increasingly left behind, as its poor response to the economic crisis well illustrates. The Copenhagen criteria embody the kind of values with which Fukuyama presumed that history had ended and so, in this sense, they seem more univeral than European values. Nonetheless, the way that history has developed since Fukuyama made this claim would suggest that, perhaps, these values are not necessarily quite so universal after all – at least not yet. The EU needs to raise its game if these values are not to become not so much universal as the preserve of Europe and north America.