Project Syndicate 24th of July 2024

by
Robert Skidelsky
My articles My booksMy videos
Follow on:Twitter

Labour’s Economic Plan Lacks Keynesian Ambition

Jul 24, 2024 Robert Skidelsky

Today’s risk-averse economic climate calls for increased public investment to attract reluctant private capital. But British Prime Minister Keir Starmer’s insistence on adhering to strict fiscal rules casts doubt on his ability to pull the United Kingdom out of its economic malaise.

LONDON – In a recent speech, the United Kingdom’s new Chancellor of the Exchequer, Rachel Reeves, reiterated her commitment to “fiscal rules.” These rules require that “the current budget must move into balance” and that “the [national] debt must be falling as a share of the economy by [the Labour government’s] fifth year.” This involves reducing the debt-to-GDP ratio from its current level of 100% within five years and eliminating the budget deficit, which stands at £121 billion ($157 billion), or 4.4% of GDP

At the same time, Labour has pledged to avoid significant tax hikes. Instead, the government has opted for minor adjustments like abolishing the “non-dom” tax exemption for people who live in the UK but declare a permanent residence in another country, imposing a 20% value-added tax on private-school fees, and closing tax loopholes.

Consequently, the government must boost economic growth to meet its goals for deficit and debt reduction. While Labour aims to increase annual GDP growth to 2.5% (from an average of 1.1% between 2008 and 2023), achieving this requires increased public investment. Notably, the UK currently spends less than most G7 countries.

To change this, the government plans to invest heavily in the green transition through the newly established Great British Energy and a planned National Wealth Fund. But given that its strict fiscal rules will inevitably constrain public investment, Labour’s economic agenda is more of a bet on growth than a strategy for growth.

Labour’s emphasis on fiscal rules represents the latest chapter in Britain’s ongoing tug-of-war between fiscal rules and discretion. During the Victorian era, British economic policy was built on three main pillars: the gold standard, which required the Bank of England to convert its notes to gold on demand at a fixed price; the balanced-budget rule, which ensured government spending was always covered by revenue; and the so-called “borrowing rule,” which established an annual sinking fund to retire debt, primarily incurred during wars. The economists of the time viewed war as the chief engine of debt build-up.

But these pillars of “sound money” collapsed in the first half of the twentieth century following the two world wars, the intervening Great Depression, and the extension of the franchise. Enter John Maynard Keynes and the economics of discretion. According to Keynes’s liquidity-preference theory, when the future is uncertain, people generally prefer to keep their assets liquid rather than commit to projects that would generate returns at some undetermined future date.

Keynes believed that economic booms occurred only during periods of irrational exuberance and that the normal state of the capitalist economy was one of “underemployment equilibrium.” The solution lay not in “abolishing booms and thus keeping us permanently in a semi-slump” but in “abolishing slumps and thus keeping us permanently in a quasi-boom.” The mechanism for achieving this was autonomous investment by the state, which would bridge the gap between what banks were willing to lend and what borrowers were willing to invest.

Keynesian economic policies were discretionary: fixed exchange rates became “adjustable pegs,” budgetary policy depended on employment levels, and the government would tell the Bank of England what interest rates to set. Despite the reliance on massive increases in public spending to meet growing welfare entitlements, the Keynesian era proved to be a huge success. From the mid-1940s to the mid-1970s, the UK enjoyed full employment, annual growth rates averaging 2-3%, rising GDP per capita, and stable inflation. As Prime Minister Harold Macmillan famously remarked in 1957, Britons “never had it so good.”

The situation began to deteriorate in the late 1960s. While this was arguably the result of external shocks like the Vietnam War and the quadrupling of oil prices rather than hubris on the part of Keynesian policymakers, skyrocketing inflation and growing industrial disorder ultimately set the stage for Milton Friedman’s monetarism and the return of fiscal rules. Monetary policy would be entrusted to independent central banks tasked with securing low and stable inflation. Without strict fiscal rules, argued a new generation of political economists, a competitive democracy would inevitably lead to excessive public spending. Consequently, the budget needed to be “balanced over the business cycle,” and government debt as a share of GDP had to remain low.

These new rules, essentially modified versions of Victorian-era principles, led to two reasonably good decades in the 1990s and 2000s. But then came the great financial crash of 2007-08, from which the British economy and most of its European counterparts have never completely recovered.

It seems that whether you try to steady economies by discretion à la Keynes or by rules à la Friedman, you ultimately mess up. Promises to “get the economy moving” are invariably followed by economic crises. There is no clear explanation for this, except perhaps that mediocrity is humanity’s lot.

Two reflections are pertinent to Rachel Reeves’s dilemma. Britain suffers not from a lack of money – the financial system is awash with the money created by quantitative easing – but from underinvestment. Today’s risk-averse climate can be read as a vindication of Keynes’s liquidity preference story. So public investment is needed to “crowd in” reluctant private investment.

The other crucial point is geopolitics. The American-style Keynesianism that faltered during the Vietnam War was “military Keynesianism” – borrowing and rising debt were justified by the demands of the Cold War and the arms race with the Soviet Union. Fiscal rules were subordinated to the need to “contain” the enemy, and national-security demands always had ample resources to draw from.

Labour’s stated mission is to make Britain greener. I suspect it will end up focusing on making the country safer rather than greener, with borrowing to “get Britain moving” justified not on economic grounds but in the name of national security.

This is a dispiriting prospect. Given the history of the rules-versus-discretion debate, it is hard to believe in British Prime Minister Keir Starmer’s promised new dawn.