A more active state is essential to a new economy

We cannot address our deep problems unless we are prepared to give government a larger role in economic management and policy. 

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What’s the appropriate role for the state in economic policy? As the 10th anniversary of the financial crash approaches, it’s a timely question to ask.

As the crisis unfolded the state played a critical role, first in bailing out the banks, then in injecting demand into the economy in the Keynesian stimulus packages of 2009-10, and subsequently in the unconventional monetary stimulus of quantitative easing. 

But the conventional economic view was always that these actions were necessary evils in crisis conditions, rather than the proper role of government. And very quickly, governments reverted to the orthodoxy - austerity replaced stimulus, deficits were fetishised and public spending cut. 

The entirely predictable result was slow growth, insufficient to raise interest rates to anything like normal conditions, while investment has faltered, productivity growth has stalled, wages have stagnated and wealth inequality risen. We’ve effectively had a “lost decade” of economic output.

This is why the publication today of the report of the IPPR Commission on Economic Justice is an important moment. Following a two-year examination of the under-performance of the UK economy both before and since the crisis, the commission has reached an unambiguous conclusion: that we simply cannot address our deep economic problems unless we are prepared to give the state a larger role in economic management and policy. 

The argument rests on two important theoretical insights. First, “market failure” is an inadequate justification for government policy. The conventional wisdom is that governments should act when markets fail. Hence it is widely accepted that governments should regulate environmental pollution and fund basic science research. These are important microeconomic solutions. But markets also fail systematically, and this demands a much wider response from government.

The financial crisis, inadequate investment, rising inequality, and worsening environmental degradation are examples. Only government can ensure the economy achieves acceptable outcomes in macroeconomic impacts like these. If we do not give it this overall strategic role we will leave such outcomes at the mercy of unaccountable and arbitrary market forces. We can see the results all around us. 

Second, wealth is not produced by the private sector alone. Businesses rely fundamentally on the activities of the state - not just in infrastructure and public services, but in providing the conditions and expectations of future growth that make investment profitable. This was one of Keynes’s most important but frequently forgotten insights. It is a recognition that in reality wealth is co-produced by private and public sectors working together.

These insights inform the commission’s policy recommendations across a range of fields. Drawing on the ideas of Professor Mariana Mazzucato (a member of the commission), the IPPR report calls for a “mission-oriented” approach to innovation policy. Governments should set out ambitions to achieve key social goals - for example to achieve the “decarbonisation” of the economy and to respond to an ageing society - and then use industrial strategy to drive up private sector investment.

The commission seeks a stronger role for fiscal policy in creating and sustaining demand, including a doubling of currently planned public investment. It argues for the creation of a National Investment Bank to help fill the gap in long-term “patient” capital, with the aim of co-investing with private finance for infrastructure and innovation. It proposes a Sustainable Economy Act to ensure the economy remains within sustainable environmental bounds. And it wants the state to promote collective bargaining between employers and unions in key sectors to drive up productivity and manage the acceleration of automation - with the rewards fairly shared. 

This expanded role for the state does not represent the old clichés of “state planning” or “central control”. Markets are vital - indeed the commission argues for more open and competitive markets in general, not least in the digital field. But it makes a powerful case for government to act on behalf of the nation at large in guiding the economy towards the key goals of broadly-shared prosperity, justice and environmental sustainability. 

The commission is not complacent about the ability of the state to play an expanded role of this kind. It argues for strong and independent public institutions which can build expertise and capacity, as experience in other countries has shown. This means breaking down the silos of government so that innovation and investment become key not only to the Business Department but also to the Treasury. It argues for devolving much more economic power and responsibilities to the nations and regions, including newly empowered and accountable 
regional executives” in the North of England, Midlands, South West and South East.

The commission’s call for a more active and purposeful state comes after thirty years in which governments have largely (apart from during the financial crisis) stood back from the workings of the economy. The commission itself notes that this would be a fundamental shift in approach. But it also notes that such shifts have occurred before after periods of crisis. Around ten years after the Great Depression, Keynes’ ideas underpinned a complete overhaul of our understanding of how economies worked and the policies required to achieve full employment. Around ten years after the crises of the 1970s, the ideas of Milton Friedman and Friedrich Hayek underpinned the Thatcherite revolution which overturned the consensus again.

Next week it will be ten years since the collapse of Lehman Brothers heralded a crisis of production and inequality from which we have still not recovered. It is time for another fundamental rethink.

Michael Jacobs is Director of the IPPR Commission on Economic Justice, whose final report, Prosperity and Justice: A Plan for the New Economy, is available from bookshops or online at www.ippr.org/cej.

Michael Jacobs is visiting professor in the Department of Political Science / School of Public Policy at UCL and at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics. He is co-editor of the Political Quarterly