Depression, Recovery and the Politics of Nations

David Purdy

In what follows, I take up three of the issues raised by Stuart Fairweather in his recent posting Two Years of Crisis: What Potential for Change: the prolonged economic depression induced by the financial crash of 2007-8; the current state of British politics; and the referendum on Scottish independence to be held in the autumn of 2014 under protocols finally agreed this week by Alex Salmond and David Cameron.


Escaping from depression


At a meeting in London organised by NPEN (New Political Economy Network) to consider responses to the current economic crisis, the Tory MP for Hereford, Jesse Norman, asked: Where is the left? It is a fair question. For some nine months after the banking collapse of September 2008, the right was in disarray, but since the financial crisis morphed into a fiscal crisis, the right has dominated policy discourse. To be sure, the crash toppled a central pillar of the neo-liberal temple – the notion that the financial system needs nothing more than “light touch” regulation – but the edifice still stands and in the name of repairing our public finances and rebalancing the economy, Britain’s coalition government has set about dismantling what remains of the welfare state.


We should not despair. Sometimes it is better to swim against the tide than to go with the flow. In any case, there are signs, discussed below, that the tide may be turning. The important thing is to keep on challenging the combination of monetary activism and fiscal austerity that both in the UK and across much of the eurozone has either stifled incipient recovery or plunged the economy deeper into recession. In some cases, the resultant fall in tax revenue and rise in social security outlays has more than offset savings from tax hikes and public spending cuts, widening the budget deficit that these fiscal adjustment measures were intended to reduce.


However, the perverse consequences of fiscal orthodoxy should not blind us to the scale and make-up of the UK’s budget deficit, currently equivalent to about 8 per cent of GDP, down from 11 per cent when the coalition was formed in May 2010. Roughly half the deficit is structural in the sense that it would still be there even if the economy were operating at full employment. At some stage, therefore, any government, whatever its political complexion, would need to cut public spending or raise taxes by about 4 per cent of GDP. There is no need to make the structural adjustment all in one go: better to build up to it gradually over three or four years. But in any case, adjustment should not begin until recovery from recession is assured. In other words, the alternative to coalition policy is not no cuts or tax rises ever, but a policy of short-term fiscal expansion, focused on public investment, complemented by cheap money, and followed, once recovery is under way, by a period of sustained fiscal restraint. In the long run, this measured approach to deficit reduction will do far less damage to our economy and society than gung-ho fiscal overkill.


As it is, private spending is still insufficient to ensure that the European and US economies produce and employ at their full potential. Accordingly, those governments that can still command the confidence of bondholders and/or are running persistent trade surpluses – the US and UK qualify on the first count, China qualifies on the second, while Germany and Japan qualify on both counts – should act as spenders of last resort, not hesitating to finance any temporary (widening of their) budget deficits by issuing new bonds and adding to the stock of public debt.


Provided governments act in concert, taking care to explain in advance what they are doing, there is no reason why internationally co-ordinated fiscal stimulation should spook the bond markets, driving up interest rates and “crowding out” private spending. In point of fact, there has never been a better time for creditworthy governments to finance public investment by borrowing, for long-term interest rates have never been so low. The nominal rate of interest on ten-year bonds currently paid by the German government is around 1.5 per cent per annum. Since prices in Germany are rising by 2 per cent per annum, the real rate of interest is negative: investors are actually paying the German government to put their money in German bonds. The corresponding rate of interest on UK government bonds is 1.7 per cent per annum. With the annual rate of consumer price inflation currently running at 2.2 per cent, the real rate of interest is minus 0.5 per cent.


There is nothing particularly left-wing, let alone “socialist”, about an “invest now, adjust later” policy. It seems plain common sense that a global crisis calls for a co-ordinated global response. And spending on any kind of public investment produces both immediate and longer-term benefits. In the short run, it creates new jobs and stimulates higher household spending as newly employed workers spend some of their additional income on consumer goods. For both reasons, as economic activity revives, tax revenues grow and social security outlays fall, offsetting any temporary rise in the budget deficit. And when the investment is complete, society benefits from the assets created. What specific projects should be undertaken is a matter of priorities. In Britain today, as advocates of a Green New deal have long argued, we urgently need to build more social housing and to improve the energy efficiency of the existing housing stock, as well as developing renewable energy sources and implementing other measures to combat climate change.


It is, though, important that the fiscal stimulus should come from the government’s capital budget, not from current public spending on wages and consumables. The current budget should continue to be restrained, partly because we need to shift the allocation of national resources from consumption to investment, and partly because the government has to convince its creditors that it is serious about eliminating the structural component of the budget deficit as soon as the economy is strong enough to take the strain. The left should not, therefore, support calls from public sector unions for strikes over wages. (Short demonstrative stoppages to protest against government policy are a different matter).


In current circumstances, sectional wage militancy, though understandable, is misguided. Politically, it plays into the hands of fiscal conservatives and even if the government were to concede inflation-busting pay rises for public sector workers, in the absence of any compensating increase in departmental budget allocations, the result would simply be more public sector redundancies and higher unemployment. Since the first post-crash recession levelled out towards the end of 2009, the number of people wholly unemployed in the UK has oscillated around 2.5 million, about 8 per cent of the workforce. This compares with 5 per cent when the economy was at its pre-recession peak. Some 900,000 people have been out of work for 12 months or longer, and the youth unemployment rate stands at 20 per cent. In addition, some 1.5 million people are working part-time either because their hours have been cut or because they are unable to find full-time jobs. In these conditions, reducing joblessness and underemployment must take precedence over pay rises for full-time jobholders.



The turning of the tide


Since Britain re-entered recession in the last quarter of 2011, there have been growing signs of unease among the business community. Employers’ organisations such as the CBI (Confederation of British Industry) and the Institute of Directors have been pleading with the government to ease up on fiscal austerity and to promote infra-structural investment, though in common with the Bank of England (which is supposed to take no view on fiscal policy, a convention that the current governor, Sir Mervyn King, has flouted several times during his term of office) they are still reluctant to endorse straightforward deficit-budgeting, instead proposing various convoluted forms of public-private partnership. The idea of temporarily adding to the national debt in order to promote economic recovery is still anathema.


Last week, however, the IMF (International Monetary Fund) acknowledged that it had previously underestimated the impact of fiscal austerity on economic activity. Two years ago, it reckoned that other things being equal, every dollar of fiscal adjustment would lead, over the following twelve months, to a fall in GDP of fifty cents. The IMF now believes that the true impact is more like one dollar thirty cents. Thus, unless in any twelve-month period total private spending – the sum of consumer spending, business investment and net exports – rises by enough to add 1.3 per cent to GDP, fiscal adjustment equivalent to one per cent of GDP will cause overall output and employment to fall. This finding clearly reinforces the case for postponing fiscal austerity until the world economy is in better shape. 


The reasons for the IMF’s change of mind have not yet been reported, but two factors are likely to be at work. Like all governing institutions, the IMF is a site of struggle between rival theoretical standpoints and general views of the world. Hence, its reports and pronouncements often reflect an uneasy compromise between opposing positions. As the crisis has unfolded, the balance seems to have shifted from hard-line fiscal conservatism to pragmatic managerial realism. In addition, the initial, over-optimistic estimate of the effects of cuts was based on experiences such as that of Sweden in the early 1990s when the government, faced with a threefold banking, budgetary and foreign exchange crisis, introduced a tough, but even-handed programme of fiscal adjustment against a relatively benign background of global economic expansion. But when most Western governments launch austerity packages simultaneously, the result is a mutually ruinous depression.


This is one of the lessons of that governments were supposed to have learned from the 1930s. That it has been forgotten is testimony to the continuing grip of neo-liberal ideas over the minds of political leaders and opinion-makers, doubtless influenced by the fact that nowadays Western governments spend much higher proportions of GDP on public services and social transfer payments than their counterparts eighty years ago, while taxes absorb a correspondingly higher share of national income. We must, however, insist on disentangling arguments about how to cure depression and stabilise the economy from disputes about the “proper” size of the public sector. The case for active fiscal policy applies just as much to countries like France where the cyclically adjusted ratio of public spending to GDP is nearly 60 per cent as it does to those like the US where the figure is closer to 30 per cent.


One-nation politics


To his credit, Ed Balls has consistently opposed ill-timed and over-zealous fiscal austerity, whether imposed in London, Brussels or Frankfurt. Austerity is hurting, but not working and Europe’s governments need to change course. This is indeed “a consummation devoutly to be wished”. But how is it to be achieved? Neither Labour nor the Conservatives contemplate international action to tackle the crisis. The horizons of both parties appear to stop at Dover. Labour, of course, has just rebranded itself as the one-nation party. From a Westminster perspective, this is a smart move, neatly disposing of yesterday’s quarrel between Old and New Labour by laying claim to the mantle that the Tories discarded in the 1980s when Mrs Thatcher purged her government of one-nation Conservatives, contemptuously denouncing them as “wets”. It also enables Ed Miliband to proclaim the politics of the common good and to disavow sectional interests, whether in the City or the unions, while insisting, against the SNP, that what matters in Britain is the division between rich and poor, not the border between England and Scotland.


Whatever one thinks about the future of the UK and relations between its constituent nations, from a wider European or global standpoint, one-nation politics is obtuse. These days, of course, few people can find a good word to say about the EU. Nevertheless, we need to draw two distinctions: between the euro and the eurozone; and between a currency and a continent. My own view is that the best or at any rate least bad way to rescue the euro is to slim down the euro area to a central core comprising Germany, Austria, the Benelux countries, Finland and other small northern European states which are closely integrated with the German economy and are willing to embrace Germany’s social market model, including the budgetary discipline implied by further fiscal integration. The so-called peripheral members – a suitable term, perhaps, for Greece, Portugal and Ireland, but hardly apt in the case of Italy and Spain – would revert to their old national currencies, at least for the foreseeable future. France would have to decide whether to cling to the old Franco-German axis, albeit in a subordinate role reflecting its diminished competitive strength, or to join its “Latin” neighbours outside the new “euro nord”.


Larry Elliot, the Guardian’s financial columnist, recently expressed the hope that the euro would be “smashed to smithereens”, comparing the single currency to the ill-starred attempt to revive the gold standard after the First World War. This is irresponsible talk. An orderly reconfiguration of the eurozone is one thing, but a disorderly break-up could easily wreck the EU itself, risking a resurgence of the currency and trade wars that followed the piecemeal demise of the gold standard and helped to inflame international relations in the “low, dishonest decade” before the real fighting started in September 1939. Certainly, the institutional design of the euro was flawed and its geographical coverage over-extended, while the conduct of crisis management has been, by turns, indecisive, dogmatic, myopic and fractious. But none of these failings provides any reason to give up the attempt to build trans- and supranational forms of government. Some problems in today’s world, from the protection of the environment to the regulation of banking, cannot be adequately handled by “sovereign” but separate nation-states. Similarly, while policy- and decision-making in the EU, as it is currently constituted, enjoys little democratic legitimacy, simply repatriating powers and responsibilities to member states, as demanded by UKIP and the Tory right, will do nothing to resolve the inherent contradiction between national democracy and global capitalism.


The Tories have no European strategy: they simply want to leave the EU. As Martin Kettle wrote in The Guardian (11th October, p. 33), “The Cameron government’s guilty secret is that it understands withdrawal would be undesirable for Britain. Ministers know this, but won’t say so. They dangle the prospect of a referendum, but not the in-out one that the party or the Europhobes crave. As a result, the UKIP threat to the Tories steadily rises.” A large part of Cameron’s “sink or swim” speech to last week’s Tory party conference was predicated on the assumption that Britain can somehow go it alone. Like Miliband, he offers a one-nation strategy: Britain against Europe or even Britain against the world. This may win short-term popularity, but it remains an illusion and thus, in the long run, a source of weakness. In a world where the balance of economic and political power is shifting from North America and Western Europe to China, India, Russia and Brazil, isolation is not “splendid”, just stupid.


Scotland’s Referendum


While Europe burns and Cameron fiddles, Scotland prepares to decide whether to remain part of the Union or to become an independent state. It was always more likely than not that Scottish voters would eventually have to choose between these polar options: in negotiations over whether there should be a third option in the shape of devo max (maximum devolution short of independence), Westminster’s legal prerogative in constitutional matters trumped the SNP’s electoral mandate. For almost nine months, Alex Salmond held out for two questions, but in the end, although this proposal was backed by civic Scotland and proved at least as popular in opinion polls as the other two options, it was not taken up by any political party and thus lacked political clout.


Even so, from a democratic standpoint, the Edinburgh Agreement is a disgrace. Those voters whose first preference is devo max – roughly a third of the electorate – must now decide whether Scotland will be in a better position to govern itself by staying in the Union or by becoming independent. Given that the SNP wants to retain the monarch as head of state, to form a monetary union with the rest of the UK and to stay in NATO, this is tough call. But at least “undecided” voters know more or less what the SNP is offering, even if many details remain unclear. The same cannot be said for the Unionist parties. Having succeeded in squeezing the referendum debate into a narrow frame, they would do well to explain what further powers they wish to see devolved to the Scottish parliament, how they envisage using these powers to help make Scotland a better country, and what, for them, “a better country” looks like. Would it, for example, be one that is fairer, happier, greener, less divided, more cohesive and more democratic than it is now? In the absence of such a forward offer, “undecided” voters will surely be drawn into the nationalist camp.


Provided the three Unionist parties can see where their best interests lie and can agree on a sufficiently attractive forward offer – both strong assumptions – current polling evidence suggests that the Better Together camp will carry the day. Since devo max will not now appear on the ballot paper, perhaps the democratic left should keep it alive as an unofficial presence in the referendum debate by spelling out answers to the three questions posed just now: What would devo max entail? How would it help to build a better Scotland? And what, in this context, does “better” mean?


Why bother explaining and defending an option that is not on the table? Because the exercise would set an example to the Unionist parties and provide a benchmark against which to judge their efforts. And because if the result of the referendum is close, allowing neither side to claim a decisive victory, it would provide a focus for further discussion and negotiation about the governance of Scotland and the future of the Union.


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