If Labour is to succeed, it must end its addiction to the state

Having distanced himself from neo-liberalism, Ed Miliband needs to redefine British social democracy as more participative, more socially liberal, and more community-focused.

2014 will usher in a new dynamic in British politics, a time when Labour’s credentials as a potential party of government will be subject to sustained, critical examination. This is the moment when the party has to reveal more about the policy directions it intends to pursue, signalling where its real priorities for Britain lie. And this is the year that will reveal whether Labour has used its time in opposition to think imaginatively about its mistakes – and governing achievements.

It is vital that the party’s policy review is ruthlessly tailored to the challenges and pressures of the post-crisis age, and neither refuses to evade current realities nor reverts to the managerialist populism which characterised New Labour’s final days. It has to address key strategic challenges, signalling its acceptance of the hard choices that policy-making inevitably entails in today’s world.

The first challenge is the sheer scale of the retrenchment that the current administration has been inflicting on the public sector, and its long-term implications. According to the Office for Budget Responsibility (OBR), by 2017-18 government consumption of goods and services will be at its lowest level since the end of the Second World War. A centre-left party will have to learn to govern with far less public money around. It should avoid becoming trapped in a defensive, austerity-lite mindset, salami-slicing departmental budgets without determining the major social priorities it intends to pursue.

Labour needs to make a compelling case for 'switch spending' – allocating resources according to distinctive priorities beyond those favoured by its opponents, while identifying itself as the party that speaks up for the public realm. This means making a case for the social and economic value of public investment in those areas where the market cannot be relied on to deliver - infrastructure, universities, childcare, and social care. In the stringent fiscal circumstances Labour will inherit, identifying national priorities means starting to level with the public about the areas where spending needs to be  tightened , while signalling the kind of tax regime which it believes is required to perpetuate growth and ensure a fairer recovery Saying hardly anything about  these questions, for fear of offering a target to the party’s opponents, is likely to undermine Labour’s chances of securing the kind of electoral coalition which it needs to secure victory in 2015.

The second related challenge concerns the impact upon the UK’s society and economy of the financial crisis, and subsequent recession. Overly stringent austerity has eroded the productive base of the UK economy yet further. The scarring effects of the recession are manifest in the appallingly high numbers of young unemployed and crippling poverty levels among families with 'working poor' parents. Social mobility has ground to a halt while the capacity of middle class parents to horde the advantages of money and human capital accrued across generations are a major obstacle to an inclusive and fair society. A party that seeks to sustain a principled, reforming government needs to prepare the ground for the kinds of measures – mansion and land taxes, a higher minimum wage, an expansion of the pupil premium (right up to university level), and investment in childcare – which are urgently required.

The third strategic challenge that Labour must confront is the implications of the growing crisis facing the future integrity of the United Kingdom. The party is not alone at Westminster in failing to establish a cogent response to the dilemmas posed by a referendum on Scottish independence, the threat posed by the populist nationalism espoused by UKIP, and the UK’s membership of the European Union. Indeed, the fumbling, confused response of the UK parties has fermented a governing crisis at least as potent in its implications as the global financial crash. Were Scotland to vote ‘yes’ to independence in 2014, or  the UK to vote to leave the EU  in 2017, the shocks administered to the British political system would be nothing short of seismic.

If Labour is to become the party that breaks the extraordinary concentration of political and economic power in London - distorting the social and economic balance of England and the rest of the UK - then it must engage with rising resentment about the absence of a political voice and economic levers for many different English communities. A road map is needed for how power will be devolved to cities and counties as a credible answer to the English question, for so long evaded in British politics.

Labour needs to face up to these issues and to give a broad indication of its intentions in the face of them. At present, the temptation is to revert to the well-intentioned redistributivism and Treasury orthodoxy that were a hallmark of the Brown era. Yet the notion that Labour might pursue a fairer society primarily through the long arm of the central state – using familiar tools such as public spending and tax credits – is fraught with danger. Such a notion ignores the problem of legitimacy which that kind of top-down statism now faces in England – the sole remaining territory directly controlled by a Westminster government. An approach that merely ameliorates the dysfunctional and systematic inequality generated by markets and inequitable public service provision is also expensive and wasteful.

A shift of focus towards preventative up-front investment; a new model of social partnership – between government and civil society, and  the dispersal of power to agencies more likely to address the problems faced by different localities – would signal a distinctive approach to tackling some of the major problems facing England, and tackle  Labour’s reputation for excessive managerialism. It is increasingly evident that complex policy challenges – entrenched pockets of social disadvantage and isolation, the looming threat of obesity and lifestyle diseases, the prospect of catastrophic climate change – require a markedly different use of public power, a new model of partnership which is co-ordinated at local level, not the corridors of Whitehall.

The imperative to devolve more economic and political power across England should be reflected in a concerted programme of public service reform relying on the values of voice and locality, as well as choice; a welfare system in which contribution and protection are re-combined; and an explicit focus on SMEs and promoting local entrepreneurship. Only the concerted dispersal of power to individuals, communities and localities will provide the basis for an attack on elite vested interests and class-based inequalities that hold people back.    

Examples of this vision can be glimpsed in the work that local authorities throughout England from Oldham to Southwark are doing – drawing on the resources of communities, sharing front-line services, forging creative partnerships with the charitable sector and business, focusing on well-being and cultivating a  sense of place, while bringing neighbourhoods together to create public assets serving the common good.

Since 2010, Ed Miliband has demonstrated an impressive capacity to open up ideological territory and go against the conventional political grain. This quality might yet prove to be his winning card. Having distanced himself from the 'neo-liberalism' of the previous era, he needs now to redefine British social democracy as more participative, more socially liberal, and more community-focused. This kind of politics draws upon the non-statist strand of Labour’s heritage, reconnecting with those traditions that have woven decentralising and pluralist ideas with a determined opposition to injustice, alongside an understanding that the public realm means much more than the central state.

Patrick Diamond is vice chair of Policy Network, lecturer in public policy at Queen Mary, University of London, and a former Labour adviser

Michael Kenny is research associate at IPPR and professor of politics at Queen Mary, University of London

Ed Miliband speaks at the Labour conference in Brighton last year. Photograph: Getty Images.
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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?