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.

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 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.

“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 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.

“Unfortunately, no consensus exists on the underlying causes of this crisis or on the best ways to escape from it”, as Wolf notes. Robinson suggested to Obama that one’s views on the underlying causes of the crisis go a long way to determine one’s views on the best way to escape it. France and Germany are supposed to blame the crisis on “Anglo-Saxon capitalism” and so see its solution in a new global architecture of regulation. The UK and the USA are the citadels of “Anglo-Saxon capitalism” and are taken to be more attracted to fiscal stimulation. Thus, Robinson asked Obama to comment on the dividing line that he constructed between France/Germany and the UK/USA.

However, perhaps, if Robinson wanted to construct a dividing line he may have found a more solid foundation for it in the Pacific, rather than the Atlantic. Hamish McRae argues that the real summit has been between the USA and China. China runs the world’s biggest current account surplus and the USA runs its largest deficit. The massive imbalances between surplus and deficit economies are at the root of our economic malaise, while correcting these imbalances is also the key to future prosperity.

“In 2007″, writes Wolf, ”three countries ran current account surpluses of $835bn (€629bn, £585bn). Logically, counterpart deficit countries must spend that much more than their incomes. Yet today deficit countries have run out of willing and creditworthy private borrowers”. The credit cards of the deficit countries have been more than maxed out but the surplus economies will continue to decline until they find sustainable, alternative sources of demand. It’s easy to chide the excessive spending and sub-prime mortgages of the USA. Yet more domestic spending in China is part of the long-term solution. Just as much as the USA needs to get closer to Chinese levels of saving, so too the Chinese need to get closer to American levels of spending.

It’s hard to see how “Anglo-Saxon capitalism” can actually be the great evil in this context; nor is the dividing line really to be found in the Atlantic. But there is something of a dividing line in that ocean, as Germany is a leading surplus country. Indeed, there is also a dividing line in the British channel as the UK is a leading deficit economy. Wolf paraphrases Angela Merkel’s position as being: “The rest of the world needs to find a way of absorbing our excess supply, but sustainably, please”.

Merkel may point a disapproving finger towards the deficit countries of “Anglo-Saxon capitalism” but Wolf thinks that some of the solution is to be found zu Hause. “The answer lies partly in changing the policies of surplus countries”. We still seem too far from realising this. However, another part of Wolf’s solution was moved towards at the G20: special drawing rights. So, thankfully the G20 moved somewhat in the direction advocated by Wolf, even if Obama might read his FT more vigilantly. To be fair to Obama, though, so could Robinson. As could Merkel.

“On the one side” of the Labour Party, argues Reeves, “stand those for whom the economic crisis demonstrates the need for a more muscular state; on the other, a diverse group”, including Byrne, “who want to use the state to give more power to individuals”. Similarly, Jesse Norman has previously divided Labour into Trimmers, Romantics and Deniers. Remarks from Matthew Taylor and David Miliband are said to define the Trimmers. “Instead of a Government-centric model of change in which we assume our rulers should be given the blame for what goes wrong and the responsibility for making it right”, claims Taylor, “we need a citizen-centric model in which we reinstate ourselves as the authors of our own collective destinies”. In other words: we want powerful people.

Norman associates Jon Cruddas and Tony Woodley with the Romantic tendency. “They regard New Labour as a tool of neo-liberal capitalism, which has deliberately betrayed its working class roots in order to appeal to the middle classes”. Polly Toynbee and Ed Balls are offered up as Deniers. “They argue that the growth of the state under Gordon Brown has been benign, and should be continued and extended”. If we collapse the Deniers into the Romantics, then Norman’s characterisation of the Labour Party exactly parallels that of Reeves. To mix the terminology of Taylor and Norman, the Trimmers favour a citizen-centric approach, while the Deniers and the Romantics advocate a Government-centric model; precisely the distinction proposed by Reeves.

Certainly, Toynbee – “the high priestess of Denial” - appears to continue to defend what might be described as a Government-centric model. While Neal Lawson and John Harris, both closely associated with Compass, like Cruddas, recently argued that “the government’s responses to changed times have been either too timid or, on the few occasions ministers have still affected to be radical, based on the very ideas that are now part of history … running through the supposed remedies for the financial crisis is a discredited belief in light-touch regulation”. Thus, Deniers and Romantics unite behind ”a more muscular state”.

This side of the argument, observes Reeves, has “the upper hand, and understandably so. The government is bailing out banks, car firms, homeowners and charities … A new corporatism is being hailed”. Compass are certainly keen to move UK politics on from the “ideological vacuum” that Howard Davies sees it as being played out in. “Both Labour and the Conservatives need to find a new way of talking about the government’s role in a stumbling market economy”, contends Davies. The left’s response to Davies’ call for “a British version of Gaullism” might come from the likes of Compass, while the right’s may come from Phillip Blond’s red Toryism.

Davies hears that “within government a debate is under way between those who wish to present the state’s new role as a regrettable short-term necessity and others who think a positive long-term redefinition is required”. The Deniers and the Romantics offer up the positive long-term redefinitions of the left, as the red Tories provide the positive redefinitions of the right. At this stage in the economic and political cycles, all of the energy – the “big mo”, as Americans say – is behind these redefinitions. Those who prefer citizen-centric models to a positive long-term redefinition of a more muscular state, such as Trimmers on the left and compassionate conservatives, like Norman, on the right, now lack the big mo.

“Compassionate conservatism”, argues Norman, “seeks social renewal through the devolution of power and responsibility to people and local institutions, through greater personal freedom from bureaucracy and regulation, through breaking up state monopolies to improve public services, and through a renewed emphasis on the rights of the citizen and the rule of law”. This was very trendy in the early part of David Cameron’s leadership but red Toryism seems more in vogue as concern has shifted from “social recession”, once a key concern of compassionate conservatives, to economic recession, now a massive concern for everyone.

Broadly speaking, compassionate conservatives offer a citizen-centric model that demands a much reduced role for the state and Trimmers provide a citizen-centric model that requires a smarter state. But citizen-centric models are offered from the right and the left; just as the Gaullists – Compass and the red Tories – offer competing Government-centric models from the left and the right. Some future trends point towards the Gaullists continuing to hold the big mo but others point in the opposite direction.

The Gaullist ascendency seems confirmed by the inevitability that Martin Wolf now attaches to banking nationalisation. “In 1978, Alfred Kahn, an adviser on inflation to President Jimmy Carter, used the word “depression”. So angry was the president that Mr Kahn started to call it “banana” instead … We are painfully learning that the world’s mega-banks are too complex to manage, too big to fail and too hard to restructure. Nobody would wish to start from here. But, as worries in the stock market show, banks must be fixed, in an orderly and systematic way. The stress tests should be tougher than now planned. Recapitalisation must then occur. Call it a banana if you want. But bank restructuring itself must begin”.

However, the warning from Steve Bundred of the Audit Commission to brace ourselves for huge public spending cuts augers against the Gaullist ascendency. If Wolf thinks that bank nationalisation is inevitable, then it must be a very real possibility. Equally, who am I to argue with Steve Bundred? And what conclusions should be drawn from the conflicting implications for the Gaullist ascendency offered by Wolf and Bundred?

It seems that there may well be some areas of policy – banks, most obviously – where Government-centric models are unavoidable. This does not mean that Gaullist delight should be unconstrained, however, as the finite nature of public funds means that the more public funds are consumed in these areas of policy the more citizen-centric models become unavoidable in other areas. Put simply: Government-centric models, by definition, tend to make larger calls upon public funds, which reduces the level of public funds available to use on other areas of policy, requiring more attention to focus in these areas upon citizen-centric models that typically make smaller calls upon public funds.

The realities of public budgets are not, though, the only reason for advocates of citizen-centric models to have heart. Let’s consider the full quotation from Mill that Byrne brought to mind. “The worth of a State, in the long run, is the worth of the individuals composing it – a state which dwarfs its men, in order that they may be more docile instruments in its hands even for beneficial purposes – will find that with small men no great thing can really be accomplished”. We all wish that Fred Goodwin has long ago been made a docile instrument but no real solutions to climate change, anti-social behaviour, obesity and much else besides are likely to be offered by either docile instruments or the state – no matter how benign or enlightened – that renders them so.

Instead, argues Taylor, “for society to progress relies on citizens acting more often in ways which match their values and aspirations and doing more for each other than simply obeying laws. To have the society we want, we need to agree to give more back. This is particularly obvious” – even after the credit crunch and the Gaullist ascendency – “in relation to four current public priorities: protecting the environment, improving public services, living together as strangers, maintaining a sufficiently strong democracy and civil society”. Responding to climate change requires citizens to change the way that they live; not simply change in government policy. The NHS needs active citizens to take responsibility for the future health of themselves and their family; not simply a reaction from NHS staff after a health issue has developed. The response to youth crime includes citizens volunteering at youth centres, as well as government initiatives like anti-social behaviour orders. And, ultimately, citizens get the politics that they deserve. Cynicism about politicians is the default position of our times but if the best citizens do not bother to stand for election, where will this leave democracy?   

As much as all of this stands against the Gaullist ascendency, it seems rather trite and common-sensical. Citizen-centric models, as with so many things, perhaps move further beyond the realms of glib cliche when concrete examples are provided. Here I volunteer personalised budgets. Of their application to adult social care, Demos report: “it changes people’s attitudes towards themselves and their role in the service. People who were recipients, whether passive or complaining, became participants in planning and commissioning the services that support them. The service users that we interviewed said that they became less isolated, depressed, dependent and more optimistic, energetic and confident”. They argue that “this participative approach delivers highly personalised, lasting solutions to people’s needs for social care, education and health at lower cost than traditional, inflexible and top-down approaches”.

In short: making people powerful delivers better and fairer outcomes at cheaper cost. I can’t argue with this. Equally, I draw more Gaullist in relation to the banks with every passing day. Yes, I feel citizen-centric in relation to some things and Government-centric in relation to others. Does this make me a bad or mad person? I should hope not. But call me a cross dresser, if you want. Call it being it favour of what works, if you insist.

The debate about the proper role of the state is certainly getting more interesting. But the least helpful response to this debate is to offer the same answer in every context. Just because bank nationalisation seems more inevitable, it does not follow that Government-centric responses are right in all contexts. Nor does the success of personalised budgets in adult social care mean that citizen-centric models are always the best approach. The challenge is when to go Gaullist and when not to.

“At the end of the 19th century, Britain was the world’s superpower. By the end of the 20th it was America. The transition was preceded by two world wars. Some time in this century, the balance of power will change again. Mr Obama has inherited a world of pressing troubles. But as he tackles them he will have to keep an eye on the longer game: how to prepare for the day when America may no longer be sole superpower and only the first or maybe the second of many big powers. To manage that transition peacefully and still promote the spread of free markets and liberal democracy: that will be the mark of a truly great president for the 21st century”.

The longer game increasingly intrudes upon the shorter game. Success in the longer game has to mean modernised multilateral institutions. Martin Wolf makes a fascinating point on an underlying challenge to such institutions in the economic sphere, which has been thrown into much starker relief by the credit crunch.

“The first is the inability to gain a purchase on the policies of countries that run huge and persistent current account surpluses. That was a dominant concern of John Maynard Keynes in 1944. Ironically, the problem then was US surpluses. Today, it is the collapse in the ability of US households and those of a few other high-income countries to offset the vast current account surpluses generated by China, Germany, Japan and oil-exporting countries. Surplus countries love criticising those who spend what they wish to lend. The former will soon discover they cannot do without the profligacy of the latter”.

So China is today to the global economy what the US was in 1944: the leading current account surplus country. The proposals which John Maynard Keynes made at Bretton Woods to deal with such surpluses were rejected due to American opposition. But these proposals may be worth revisiting in any move towards a Bretton Woods II. This would lead to a much reformed IMF and World Bank. Their current structure reflect the global realities of the time of their formation when climate change, for example, was unheard of and World War II had recently ended, as does the UN, which is equally ripe for reform. It will require immense political skill to take any of this forward, however. Still, at least, the President-elect believes in these multilateral institutions, in stark contrast to the President he will replace. George W Bush rode roughshod over these institutions in ways that appeared short-sighted at the time and only appear more so with the passing of time.