After austerity - what happens next?

Labour has to show it has what it takes to govern through the fiscal vice that it will inherit.

Green shoots: an apprentice horticulturalist at Kew Gardens, London. Photograph: Getty Images

Financial crises cast long shadows over politics and this one has been no different. Prolonged economic stagnation risks fracturing the Coalition and has brought the re-election of a Labour government back into the realm of serious possibility. Should Labour win, it will find that the fallout from the events of 2008 still dominate what it can achieve in the next parliament. Cuts to public spending will continue until at least 2017 and quite possibly the end of the decade, at which point the demographic pressure for more health-care and social-care spending will rise steadily and start to crowd out the demands of many other, less politically salient services.

This fiscal straitjacket will hurt those on both sides of the political aisle but not to the same degree. Conservatives can use the era of austerity to redefine the boundaries between the state and the market. For progressives it means the prospects for another instalment of Croslandite social democracy, in which increases in public spending provide the basis for new attempts at a more equal society, will be vanishingly thin.

At the same time as public finances are further squeezed, living standards for a typical low-to-middle-income household are likely to be no higher in 2020 than they were before the recession started, and quite plausibly around their turn-of-the-millennium level. This poses a deep challenge to any rethinking of economy policy. While Britain’s economy has many strengths – far more than facile declinist or anti-neoliberal narratives admit – sharing prosperity widely is not among them. In contrast to the pre-recession period, however, we can no longer look to rising tax credits to mask the stagnation in real wages that underpins the hit to household incomes. Nor can personal debt take the strain. The structural problems in British economy must be addressed.

To navigate a way through this bleak terrain, the centre-left needs to embrace a mix of fiscal realism and economic radicalism. In some respects this is an uncomfortable blend for Labour. It means leading a candid conversation about the nature of the nasty fiscal choices it would face in office, as well as reversing some established ways of thinking about the economy.

Vice squad

While it is still far too soon for Labour to set out detailed tax and spending plans for the next parliament, in the years ahead it has to show it has what it takes to govern through the fiscal vice that it will inherit. If it’s not prepared for what it will face, it could consign any incoming administration to a fraught first few years and increase the risk of a fragile and ideologically uncertain period in office.

Labour in opposition has been proved right about the failure of the coalition government’s austerity economics yet by the next election the economic argument is likely to have moved on. A combination of spending cuts, public-sector pay restraint and selective tax rises is inevitable after 2015. Alternative choices are always possible and Labour can make different decisions to those the coalition would have. But they will still be bloody ones. In the years ahead Labour needs to pull off the seemingly intractable task of preparing the country (and its supporters) for that eventuality at the same time as it continues to land blows as an effective opposition.

To its credit, however, and in contrast to the fiscal question, the centre-left is engaged in a lively debate about wider economic reform. Here the charge sheet against British capitalism is familiar: excessive financialisation leading to asset bubbles and weak investment; stagnant real wages; and short-termist corporate governance. So much is clear. The task is to convert this critique into a broad-based reform agenda.

First and foremost, it means a macro-economic policy premised on more than the false belief that if we secure low-inflation then stability will automatically follow. Measures to pre-empt emergent speculative bubbles and constrain the excesses of the financial sector need to be brought to the fore. The Bank of England’s mandate should be revised so that it is tasked to consider asset as well as consumer price inflation.

Nor should banking reform stop with Vickers, never mind fall short of it. There is a strong case for breaking up the big banks and introducing greater competition to tackle rent-seeking. Investment in the productive economy needs to be stepped up, so in addition to incentivising patient capital and creating a new state investment bank, the deep cuts to public capital pencilled by the Labour government and implemented by the coalition should be substantially reversed.

Reforming Britain’s economy will also mean a sharp focus on its low-skill, low-wage sectors and not just those competing at the cutting edge of global markets. We can no longer tell workers that if they gain basic qualifications they’ll automatically get higher wages, nor pretend that low-skilled jobs are disappearing from advanced economies such as ours. Instead, we need a policy agenda that helps nudge up real wages, while shifting pedestrian companies out of low-cost, low-value-added business strategies, in part by helping employers to make more effective use of the skills of their workforce. That may mean slightly lower profits and consumers paying a bit more to avoid poverty pay. In some key sectors there is considerable scope for wage increases through a more imaginative and aggressive national minimum wage policy and the expansion of living wage arrangements.

Hard road ahead

These ideas are just a start. It will be hard, grinding work to achieve shared growth amid a decade of austerity. The electoral promise of buoyant credit, a rising housing market and the fruits of rising public spending is no longer available. A new political coalition needs to be stitched together: one based on fiscal realism and a shared sense of what it will take to chart a course out of the economic crisis to a sustainable new path for the British economy.

Gavin Kelly is Chief Executive of the Resolution Foundation and Nick Pearce is the Director of the Institute for Public Policy Research. Both write in a personal capacity. This article is a based on an essay in the forthcoming edition of “Juncture”, the IPPR’s journal