Sadly, but predictably, the Labour leadership struggle has been so much mired in bluster and hysteria that its true significance has been largely obscured. A contest of this kind should start, not with who it is claimed has the style and presentation to be the most plausible leader, but with what it is argued is wrong with the country, what policies are necessary to put those things right, and how should they be delivered.
Arguably the most pressing problems for Britain at the present time can be summarised as follows. What were the causes of the financial crash and the consequent prolonged downturn, and what lessons need to be learnt to prevent a recurrence? Does the manifest lack of adequate reform of the financial sector make it likely there could be another catastrophic slump soon? Is austerity the right policy to cut the deficit? How can living standards rise again sustainably against a background of flat productivity and investment together with accelerating household debt and trade deficits with the rest of the world? How can the extreme imbalance between finance/South-East and manufacturing/rest of the country be reversed? How can the extreme and still growing inequality between the top 1 per cent and the squeezed middle and the mercilessly battered bottom 20 per cent be mitigated? And where should the boundaries between the public and private sectors now be drawn, and what should be their relationship, in order to solve all these problems?
First, what caused the 2008-9 financial crash? The evidence here is conclusive, but Labour’s silence in the face of the interminable repetition of Osborne’s narrative of Labour’s over-spending must be one of the most monumental political errors in modern times, allowing him to pour a ceaseless barrage of blame on Labour for policies of bank de-regulation where the Tories themselves wanted to go even further. The truth is that in the Labour years between 1997 and 2007, when the sub-prime mortgage crisis broke, the average budget deficit was 1.4 per cent, half the average under Thatcher and Major. The budget deficit in the Labour decade never exceeded 3.3 per cent of GDP, whereas Thatcher and Major racked up deficits bigger than that in 10 out of their 18 years. Moreover the national debt bequeathed to Labour in 1997 was a fraction under 40 per cent, but by 2007 that had been reduced to 36 per cent. If the charge is profligacy, then the Tories are far more guilty of it than Labour.
But the truth is that the heart of the matter is not about profligacy. The 2008-9 financial cataclysm was in fact driven by the conjunction of several powerful forces. They included an over-lax monetary policy that encouraged an excessive leveraging culture; extreme light-touch regulation that left too much to the markets; the development of a vast global market in credit derivatives which were not well understood and which Warren Buffett notably described as ‘financial weapons of mass destruction’; the role of enormous bonuses which drove extreme recklessness; a banking structure so over-concentrated in the lead banks as to be judged too big to fail when disaster struck; and a banking model that linked speculative investment with retail deposit-taking so that each were protected by an implicit taxpayer guarantee.
All of these need to be dealt with, and yet none effectively has been. Most importantly, financial derivatives, the dark heart of the City of London, are a perennial candidate for causing the next crisis because they add opacity and leveraging to the financial system. Credit default swaps, a £65 trillion global market, and collateralised debt obligations, which are one of the most common derivatives, urgently need regulation. Derivatives should be approved by a regulatory authority before they can be issued, and then either prohibited or accepted perhaps with clear conditions attached and certainly requiring that all derivatives are traded on public exchanges. The rapid promotion in recent years of several dangerous, but highly lucrative, systems outside regulatory control – ‘dark pools’ (where large blocks of shares are sold anonymously with prices posted publicly only after deals are done), high-frequency trading (where shares are often held for seconds only), collateralised debt obligations (where bundles of loans are made to poorly-rated companies that are then sold in slices to investors), various new forms of ‘shadow banking’, etc. – are glaringly obvious signals to the next crash, but ignored after heavy City lobbying.
Even a clean break between the investment and retail arms of banks (the Glass-Steagall enactment) has been discarded from the Osborne agenda. It prevented any major banking crash for 60 years, and its repeal led within a decade to the biggest crash for nearly a century. Even the Vickers Commission’s compromise of ‘Chinese walls’ between investment and retail within the same bank, which would rapidly succumb to regulatory arbitrage, is now being eroded under City pressure. So far from banks being no longer too big to fail, they are now 50 per cent larger. Even the capital ratio, which had sunk to such perilously low levels as 2-3 per cent, is now not being raised to the Basel III safety margin till 2019, and counter-cyclical capital controls which would be a far better alternative have not even been considered. Credit-rating agencies continue to be paid by the very institutions whose creditworthiness they are supposed to be assessing. This irresponsible laisser-faire complacency towards the banks – from whom the Tory party receives half its income each year – should be immediately reversed if Britain is to be protected against massive bank and hedge fund downside risks.
Stuck with the bank-driven collapse and light-touch regulation which evaporated into virtually no regulation at all, the second fundamental problem facing Britain today is how to deal with the enormous budget deficit caused by the bail-outs. There are in principle two ways of dealing with a deficit: either increase income to pay it down quicker or cut expenditure. Alastair Darling in his last two budgets before the 2010 election adopted the former and reduced the deficit from its peak of £153bn to about £115bn by the end of 2011, given that budget measures normally take some 12-18 months to work their way through the economy. Osborne took the latter austerity course and reduced it to its current level of £90bn, having boasted in his first budget in 2010 that he would eliminate it altogether by this year. The reason that he has so ignominiously failed to do so is that he was forced by the collapse of growth in 2012 to abandon deficit reduction to get growth going again. By committing himself now to £12bn further cuts in benefit on top of a further £20bn cut in public expenditure, he is making the same mistake again of flattening growth in 2016-7 from which he will have to extricate himself by a further deficit reduction standstill till growth again resumes, if indeed it does given the slowdown in China, the Eurozone and emerging markets.
Austerity is the wrong policy to counter the deficit on every count. Continuous contraction of the economy makes deficit far harder to achieve than systematic growth and expansion. In fact the record shows that Osborne’s austerity budgets slowed the pace of deficit reduction by two-thirds. And all that still leaves aside the cruel torture of impoverishment and hopelessness which endless austerity imposes on the innocent victims of the crash whilst letting the guilty perpetrators go free. So, it might reasonably be asked, why is Osborne continuing so relentlessly with a patently failing policy? The answer is, as he himself has repeatedly made clear, that his primary aim is not deficit reduction at all, but rather the shrinking of the State back to its dimensions in the 1930s, the squeezing of the public sector, and the privatisation or outsourcing of all public services that can be secured. For the Tories the huge budget deficit was not a burden to be endured, but rather a gift from heaven to secure the completion of the Thatcherite counter-revolution which no other pretext could have achieved.
That’s all very well, but how would growth and expansion be brought about in the current economic climate? How would it be funded? There are three possible sources and a fourth more conventional one which is equally plausible. The latter is obviously to take advantage of the 0.5 per cent lowest interest rates since the Bank of England was founded in 1694 to put together a £30bn investment package which could create 1-1.5 million well-paid jobs in house-building, transport and energy infrastructure enhancement, and laying the foundations of a low-carbon economy within the nest 2-3 years. In addition there are three more ambitious alternatives. One is to retain public ownership of RBS and Lloyds, or if privatised by 2020 to take a government controlling ‘golden’ share in the top four banks in order to shift the direction of financial policy towards the interests of Britain as a whole rather than of the banks themselves. At present only 8 per cent of lending goes towards productive investment in Britain, and the remainder has been largely focused by the banks on overseas speculation, complex derivatives, development of artificial anti-social tax avoidance schemes, and prime property in central London. Regaining the control of the money supply and using it to benefit the future of the British economy rather than the self-interest of the banks will go a long way to reversing the downward spiral into which long-term it is currently cast.
A second option to obtain the sustainable growth which is now so desperately needed is the use of quantitative easing (QE) for infrastructure investment. Previously it has been used for bond purchase in the hope that the banks would then use the extra substantial resources (tranches of £25-50bn) for onward lending to industry. In fact lending to industry declined because industry’s repayment of bank loans actually exceeded new money lent. What should now therefore be done, in consultation with CBI, Federation of Small Businesses and TUC leaders, is to prepare a package of investment projects which over a 2-3 year period offer the best prospect for getting Britain moving again on a persistently sustainable basis rather than the on-off growth roller coaster that the economy is now on. That would have two other key advantages. It would provide the best tonic for British manufacturing industry which has for decades been continuously subordinated to City interests on the altar of high interest rates and a high exchange rate, and it would signal that full employment was now a central objective of British economic policy.
A third option for financing expansion is taxing the ultra-rich. The latest Sunday Times Rich List (April 2015) records that the wealth of the richest 1,000 persons in the country (just 0.003 per cent of the population) more than quintupled from £99bn in 1997 to £547bn this year. This involves an increase of no less than £155bn in the 3 years of austerity to 2013 – an amount equal to the entire UK budget deficit at its peak. And that is without reference to the colossal sums squirrelled abroad in tax havens which globally is now estimated at some £21 trillions, a hefty proportion of which may be accounted for by the British ultra-rich since ten of the world’s tax havens are British Dependencies or Overseas Territories. Osborne has regularly boasted of reclaiming large chunks of these illicitly secreted funds, but has never managed to regain more than paltry amounts and has merely been drawn along in the slipstream of mainly US-German anti-tax avoidance strategies. Given UK control over so many of these tax havens, a seriously determined government will use these powers to ensure full transparency and open exchange of information about British citizens’ holdings in these havens, as well as securing country-by-country reporting by UK-based multi-national companies to counter their transfer pricing systems to minimise tax.
In addition the domestic tax system needs to be rebalanced. A financial transactions tax at a 0.01 per cent rate would raise £25bn a year. Replacing the regressive council tax with land value taxation would transfer many billions from the rentier class, as would matching the rate of capital gains tax to the top rate of income tax. The scandalous banding of national insurance, levied at 12 per cent on earnings up to £805 a week (£41,860 a year), but only at 2 per cent thereafter, could be made much fairer. A wealth tax could be introduced on a scale already existing in many other OECD countries. And there are of course many other concessions in the UK domestic tax system which benefit the very rich, but have malign effects for the British economy – notably the tax deductibility of interest which perversely encourages leveraged loans.
A third fundamental problem for Britain at the present time is the stagnation of living standards. How can these be raised against a background of flat productivity, falling fixed investment, rising household debt and sharply widening trade deficits? Clearly not under the present regime when average real median incomes are still 6 per cent below their pre-crash level and UK total factor productivity has declined at an average rate of 0.8 per cent a year for the last 7 years, and fixed industrial investment has still not recovered to its pre-2008 levels, with FTSE-100 companies still sitting on cash stockpiles of £500bn rather than investing in British industry because they too believe that Osborne’s ‘recovery’ is too fragile. Osborne is looking to consumer spending to provide the urgently needed boost to aggregate demand, but with household debt already tipping the high-risk level of £2 trillions threatening another crash if interest rates rise and with a further £32bn of cuts in benefits and public expenditure promised for this Parliament, that is certainly unlikely to be realised. Moreover the present predicament over demand is intensified by the fact that Britain’s current balance of payments deficit in manufactured goods now stands at its highest level since 1830, as a result of the high and rising exchange rate and the persisting slowdown in key markets like the Eurozone. Even the government’s boasted increase of 1.5 million jobs in the private sector is deceptive: surveys have found that 11 out of 12 of these jobs were confined to London and the South-East, a majority were either self-employment on a pittance income or insecure, temporary or low-paid jobs, and no less than 1 in 6 had been subject to sanctions withdrawing any benefit entitlement.
This is not the way to create a high skill, high productivity, high pay economy. The only way to do that is through a sustained programme targeted initially on infrastructure investment channelled through consultation with industrial leaders rather than the banks of the kind outlined above. It takes advantage of the lowest interest rates in modern times which cry out to be used at the cheapest possible cost, and so far from causing disturbance in the markets they would be far more likely to be relieved that sustainable growth was finally on the way. Osborne’s ideological block against investment in the public sector must be broken. Moreover it would take the first step towards rebalancing the economy away from dangerous over-dependence on the finance sector concentrated in the South-East towards a revival of manufacturing industry throughout the rest of the country – Osborne’s ‘march of the makers’ which never materialised. The UK services sector alone has recovered its pre-crash position, but cannot by itself ensure sustainable growth while manufacturing and construction remain in the doldrums.
Then there is the awkward question, which has never been faced up to, as to how to counter the ballooning of inequality which is not only excessively unjust, but also a barrier to growth. The latest evidence on executive pay indicates that the average FTSE-100 chief executive is now paid about £5 million a year (around £96,000 a week) which is a 5-fold increase since the late 1990s whilst the national average wage has broadly been flat since 2005. The ratio between top and bottom has therefore risen to about 120:1 today. Quite apart from the damage this does to social cohesion, it also entails significant economic disincentives. As the High Pay Centre has cogently pointed out, performance-related payments in the form of annual bonus and long-term incentive plans have increased dramatically but often create perverse incentives. The evidence actually shows that there is a weak relationship between pay and company performance which is perhaps not surprising when it is clearly difficult to single out the influence of one person compared with the cumulative impact of the rest of the organisation, both technology and personnel. Moreover the designated performance measures often don’t align with the long-term interests of the company, and the processes that set performance-related pay are not subject to sufficient challenge or accountability.
So what is to be done? Long-term incentive plans, one of the main vehicles for unearned executive payments, should be abolished. Because executives will unduly prioritise practices such as cost-cutting, share buybacks and under-investment, a wider more strategic approach to performance is required, notably one based on the promotion of productivity which is probably the best proxy from the national interest. But perhaps the best alternative overall approach would be to establish Enterprise Councils in all large companies, required to meet at least once a year attended by representatives of all the main employee grades in the company from boardroom to the shop floor, which would then ‘open the books’ to scrutinise the performance of the company over the previous year and its broad plans for the next year. One of those key elements would be pay, and each representative would offer a pay bid for the coming year which would then be subject where necessary for debate. This would then provide a stringent internally transparent means, freed of the dead weight of external regulation, to bear down steadily on excessively egregious demands for pay at the top and instead to limit them to what was acceptable to the organisation as a whole.
Lastly, where should the boundaries be drawn between the public and private sectors in the national interest rather than to assert the dominance of either one or the other? The prevailing ideology demands that private markets within a self-regulating capitalism should be given a free hand wherever possible and that State intervention, which invariably is counter-productive, should be kept out of the way. Such short-sightedness has led to the exploitation seen not only in the banking, energy, rail, housing, pensions and water industries, but also in the abuses highlighted by G4S, Serco, A4E, Atos among many others. What is needed is not just the reversal of these misdemeanours and a stronger regulatory system, but much greater awareness of the visionary role that the public sector can and has played in complementing the private sector in the development of some of the most exciting and important technological breakthroughs in modern times. Mariana Mazzucato in her book ‘The entrepreneurial State’ gives many compelling examples of this which show that Silicon Valley and its latter day imitators are most effective when acting not alone, but only in conjunction with the sheer broad power of network support and State-funded research unaffordable privately. The emphasis should be much more on mutual co-operation than on narrow-minded, short-termist, privatised value extraction.
That latter business model of unconstrained competitive capitalism was busted by the 2008-9 cataclysm and will not recover. The alternative mounted here finally comes into sight, however unexpectedly, as a result of the extraordinary upheavals of the Labour leadership contest. It isn’t just a beacon of hope, it‘s a real practical possibility.
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