Ed Miliband outside No 10. Photo: Getty
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What should the Labour party's priorities be for government?

Labour should be prepared to go in to coalition to prioritise strategic investment, a modern constitutional settlement and fairer austerity measures in government.

In the wake of a dismal party conference and a clutch of underwhelming by-election performances, the Labour party has been gripped by a mood of collective despair. Many Labour MPs fear their party will not secure an overall majority. Others ask whether it is worth winning given the dreadful circumstances in which Labour will have to govern after 2015. They ought to remember that for all the travails of holding office in the aftermath of the deepest depression since the 1930s, Labour can do more good in power than on the sidelines in opposition. 

The objective situation facing a Labour government would, indeed, be bleak. There is a huge fiscal "black hole" given the size of the structural deficit, with the UK the most indebted of the G7 economies. The structural weaknesses that precipitated the 2008 crisis are clearly still prevalent: rising levels of private and public debt; an unsustainable boom in an inflated housing market; company investment falling more than 30 per cent since the crisis; anaemic growth due to faltering Eurozone confidence; accompanied by plummeting wages and living standards fuelling runaway inequality.

Self-evidently, no fundamental rebalancing of the economy has occurred since 2008: Britain has an enormous current account deficit coupled with weak exports. Sterling has increased in value as demand for British assets rises, further derailing the "export-led" recovery. The governor of the Bank of England, Mark Carney, has labelled Britain "a crisis economy". The economic problems inherited by Labour would be unparalleled since the Attlee government came to power following the ravages of war in 1945.  

Nevertheless, despite these tough circumstances, Labour can still make a huge difference in government. First of all, Labour can take the sharpest edges off austerity. Yes, severe cuts will be necessary to reduce the stock of debt, keeping down long-term interest payments. But better choices can help to protect the worse off in society, while maintaining vital services. The coalition's plans entail fiscal consolidation on a ratio of 78:22 in favour of spending cuts over tax rises, compared, for example, with 58:42 under John Major in the 1990s. Labour is committed to raising the 50p rate of income tax as a temporary measure, so those with broadest shoulders bear a fair share of the burden. A renewed focus on taxing property and wealth will help to plug the fiscal gap ensuring public services are less aggressively squeezed. 

Secondly, Labour can give Britain the industrial strategy it desperately needs to rebuild our economic and industrial base. The coalition has adhered rigidly to a philosophy of economic liberalism, an outdated laissez-faire approach which has meant too little government intervention to support the British companies and growth sectors of the future.  Britain needs strategic investment in high-speed broadband, physical infrastructure, skills, training, innovation, and science, coupled with a regional strategy closing the gap between southeast England and the rest of the UK. A public investment bank is vital, channelling funds to businesses starved of capital by risk-averse institutions. Only by improving the growth rate and workforce productivity will it be possible to get more resources flowing into public services, while improving living standards and real wages which have fallen more than 10% since their pre-recession peak.

Finally, if Labour is in power it can complete the work of the post-1997 government, ensuring the UK has a modern constitutional settlement. The future is of Britain as a federal polity with a distinctive constitutional role for England (including "English votes for English laws") within a diverse, multinational state retaining a strong commitment to European Union membership. The guiding principle should be maximising the decentralisation of power, not only to new political institutions and representatives, but to citizens themselves and the localities where they live. 

These are the priorities for Britain in the next decade to achieve a fairer society and a competitive economy: moderating the cuts; regalvanising economic growth; forging a modern constitutional settlement. These are only some of the reasons why Britain would be immeasurably better off with a Labour government.

In the late Seventies, the British left lost heart. The purity of opposition was ultimately preferable to the tough compromises of office, symbolised by the austere IMF cuts which bitterly divided the British Labour movement. Labour’s error was to believe that Thatcherism was an aberration – it was assumed the Tories would soon be out of office, as the British electorate rejected the harsh medicine of market liberalisation. Exactly the opposite occurred: the Conservatives governed for 18 years unleashing a Thatcherite "firestorm" that restructured Britain's economy, liberalising its industrial base for an age of "globalisation" – but at vast human cost.

If Labour had held on in 1979, it would undoubtedly have faced immense challenges, carrying out economic reforms that would have further destabilised the labour movement. Jobs would have been lost. Industries would not have survived. Cuts in Britain's social service state would have been unavoidable.

What is undeniable, however, is that the worst excesses of Thatcherism could have been avoided. Since it is always better to be in power, Labour should be prepared, if necessary, to enter into a coalition with other parties. Of course, it is always preferable to govern alone, but that may no longer be possible in an age of party political fragmentation. Not to do so would be a betrayal of Labour’s animating purpose, protecting the most vulnerable in society. RH Tawney once decreed the party exists to ensure that every citizen has access to "the means of civilisation". That can only be achieved by using the power conferred by governmental office, with all the inevitable compromises it entails.

Patrick Diamond is vice chair of the Policy Network, lecturer in Public Policy at Queen Mary, and a former adviser to Tony Blair and Gordon Brown

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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?