Why austerity is not Labour’s Legacy

On the relationship between finance and fiscal policy

When Momentum put out this tweet following the latest spat between Corbyn and Blair

“Blair favoured deregulation of the banking industry - leading to one of the worst crashes in modern history. While spending on public services was higher, his legacy will ultimately be the austerity that followed his failure to stand up to big finance.”

I responded with this

“This is parroting the Tory line that austerity was Labour's fault. As wrong coming from the left as it was from the right. Austerity wan't inevitable after the Global Financial Crisis. It was Osborne choosing to shrink the state, because Labour hadn't. Know your true enemy.”

Big mistake. I had criticised momentum and, in some eyes, supported Blair and twitter did its stuff. Among those supporting the momentum tweet was Clive Lewis and (maybe) Grace Blakeley, and among those agreeing with me where Tom Kibasi and Chris Dillow.

A lot of these tweets were totally irrelevant to the original tweet and my response. The original tweet is pretty clear. Blair’s failure to regulate the banking industry led to austerity. So the gradual appeasement of austerity we saw from Labour from 2010 to 2015, which I have strongly criticised elsewhere, is not relevant. Nor are Darling’s plans for cutting the deficit before the 2010 election. As I have said before, it is unfortunate that Darling won his battle against Brown and Balls and allowed reducing the deficit to be part of Labour’s short term objectives. But that has nothing to do with the momentum tweet, which involved the financial sector. [1]

Did Labour’s failure to regulate finance lead to austerity? In a very basic sense the answer is clearly no. Osborne didn’t need to embark on cutting public spending in a recession for the simple reason that no Chancellor since Keynes has done so. It was his choice. Perhaps if Labour had been tougher on banks the UK might have been less vulnerable to the Global Financial Crisis. UK banks collapsed largely because of overseas assets they had on their books (little to do with domestic debt), so the regulation would have had to stop them buying those assets, or forced them to substantially reduced their leverage. But I find it hard to believe that we would have avoided a recession of some kind.

A recession - even a mild one - was all Osborne needed. He was looking for ways to reduce public spending, and he saw a rising deficit as his opportunity. He committed to his policy in 2008, which was well before the extent of the recession was known. So it seems almost certain that the deficit would have risen sufficiently to allow Osborne to undertake austerity.

But why did he undertake austerity. I think it is because he wanted to shrink the state, something he had failed to convince voters to do on its merits [2]. What I call deficit deceit is using the supposed need to reduce the deficit to cut spending. But Grace Blakeley and Clive Lewis suggest something more complex. Here is Grace:

“I suppose it depends on how you view the emergence of neoliberalism - I see it as an ideology that both emerges from and reinforces a change in the balance of class forces under which finance capital becomes hegemonic. ‘Shrinking the state’ is generally political cover for empowering or enriching a particular group and disempowering another - eg PFI used to allow investors to profit from state spending, and austerity used to disempower small l labour at a time when it otherwise might have organised to challenge the status quo.”

Suppose Labour had regulated finance to a much greater degree, and that would include not giving it a central role in Treasury decision making, much as Brown had in 1997 with the Bank and financial sector regulation. If that had reduced the size of the UK recession that would be a good thing. But would it have prevented austerity. I cannot see how. Would it have changed Osborne’s mind about wanting austerity? I cannot see how.

Did finance assist in some ways with the austerity bandwagon. Of course it did, from City folk who said the market for UK bonds was about to collapse to pressure brought through the Treasury. But much of that would have happened even if there had been greater financial regulation. Again there was nothing a Labour government could do to prevent all that, short of nationalising the entire sector. So calling austerity Labour’s legacy makes no sense on these grounds.

Another way to link finance with austerity, pointed out to me by Clive Lewis, was in this paper by Obstfeld. The idea is fairly simple. Too big to fail is all about the state bailing out the banking system. The state has to have the ‘fiscal capacity’ to do that. Ergo we need to moderate government debt levels to preserve that capacity. To look at this argument we need to examine the concept of fiscal capacity and fiscal limit.

Can a government run up a stock of debt relative to GDP that is unbounded? MMTers are quite right to say that, in a country that prints its own currency, a government can never be forced to default. But debt to GDP might get so high that the political burden of paying taxes or curtailing spending to pay the interest on that debt becomes more than the political cost of defaulting. Defaulting can take two forms: a literal default (failure to pay interest) or excess inflation devaluing the value of nominal bonds.

That limit is clearly way above the level of current UK debt. When some say we do not know where that limit is that may be a prelude to saying ‘and it might be near the current level’ which is just designed to scare governments. Governments know their own fiscal limits and the strength of their inflation targets. But Obstfeld’s point is that a financial crisis might push a government beyond its fiscal limit.

I do not think this argument held much weight with Osborne. As I noted above, he chose his policy in 2008, and I think it would have taken him a little longer to work this one out. (Obstfeld’s paper is 2013.) It might have influenced King and some Treasury officials in 2010. But you can see how weak the argument is in a recession by looking at what the Labour government did. In 2008 it bailed out the banks and in 2009 it undertook fiscal stimulus. The reason is straightforward: a recession is as bad for the financial sector as the real economy. The financial sector is hurt by loans going bad in the real economy, something that is made more likely in a recession. The priority in a recession should always be to get out of recession. Indeed I suspect Obstfeld would agree, as his paper is not an argument for austerity.

Even though I do not think there is much credence to the argument that Labour’s failure to regulate the financial sector caused UK austerity, that does not mean that the influence of the financial sector was not crucial elsewhere. Fear about the health of the financial sector in core Eurozone countries lead directly to the imposition of first austerity, and then to a second recession. Greece was hit hardest. In 2010 Eurozone leaders were happy to let Greek leaders pile on extra debt rather than default on debt their banks partly owned. That finance ministers in the Eurogroup were then prepared to tell a subsequent Greek government that they had to pay every penny back or Greece would be out of the Eurozone. (This episode tells you a lot about the Eurozone and those finance ministers and nothing about the EU.)

Banks, and politicians failure to be honest about the need to bail them out, were central to austerity in the Eurozone. Mark Blyth’s phrase “what starts with the banks ends with the banks” remains very apt there. In addition the desire to cut taxes on the rich, many of whom work in finance, is clearly a key motivation behind austerity in the US. But if austerity in the UK is anyone’s legacy, it is George Osborne and not Brown/Blair. He, and he alone, chose to cut spending in the middle of a recession, something no Chancellor has done since Keynes wrote the General Theory in 1936.

[1] For what it is worth, a different economic policy might have changed the 2010 election outcome: Labour might have got more or less seats. But it is absurd to call something a government’s legacy just because the other side were able to do it because they won an election. Under this logic Brexit is Corbyn’s legacy etc etc.

[2] Chris Dillow and others have suggested that his main motive was just to have something to attack Labour with. Some have suggested he just got the macroeconomics wrong (or more accurately it was at least 10 years out of date). It is difficult to bring evidence to bear on this debate, but all three explanations suggest Labour’s financial regulations policy had little to do with it.

Labour’s Brexit policy is long past its sell-by date

Labour cannot bring the country together with any kind of deal because a large majority will always hate the deal they have done.

Most people think about Brexit as a binary divide. While true in terms of Remaining or Leaving, this framework is misleading when thinking about any Brexit deal. A better model is to think about three different groups. The first comprise Remainers who see no value in compromising over Brexit. The second is made up of people who will be satisfied with nothing less than a complete break i.e. No Deal. Finally you have a group, that includes some Remainers, who would be prepared to accept some kind of Brexit deal that falls short of No Deal: the compromisers.

The size of the compromiser group may vary depend on how hard the deal we are considering is. As the deal becomes softer it loses some Leavers to No Deal and gains some Remainers. But in no case does this group of compromisers come close to being a majority of the population.

Exactly the same divisions apply to MPs in parliament, although the exact proportions may be different. This is why it is so hard, and perhaps impossible, to get a majority in parliament for any type of agreement. It is why any type of agreement is likely to fail It will be blocked by some combination of uncompromising Remainers and No Deal Leavers, who together will form a majority. This also applies to No Deal, which will be blocked by the other two groups. The only option that has any chance of getting a majority in a referendum is Remain, because both uncompromising and compromising Remainers will vote for it.

The reason we have these three minority groups when it comes to any deal is twofold. First the 2016 referendum did not specify the type of deal that people were voting for, and indeed the Leave side suggested a variety of deals. This is why compromising Remainers are wrong to think they ought to compromise. 2016 did not provide a mandate for any particular form of Brexit and could never amount to a blank cheque for any kind of Brexit. Leavers voted for one of the variety of deals suggested at the time, which all involved more money for the NHS and the EU giving us the benefits of membership without the obligations. They most certainly were not voting for no deal at all.

Second, the Brexiters have realised along with many Leave voters that the only way the UK as a whole can avoid being bound by EU decisions is to leave with no deal at all. Unsurprisingly, the EU will not allow the UK to stay in the Customs Union and Single Market when the UK can also decide its own tariffs and regulations. Brexiter ideas of negotiating a free trade deal with the EU has been spoilt in their minds by the EU’s (and anyone who cares about peace in Ireland) insistence on a backstop. In time I suspect they will embrace a limited Northern Ireland backstop, but for a variety of reasons they are not there yet.

It is the reality of these three minority groups that Labour’s current Brexit stance fails to recognise. They cannot bring the country together with any kind of deal because a large majority will always hate the deal they have done. This is the basis for my argument that they could never get agreement for any kind of Brexit if they were the government. They would be opposed by Conservatives and many of their MPs in parliament and in any referendum (which parliament would force on them if they didn’t choose to have one themselves) they would lose badly. The only possible (but unlikely) exception to this rule is a deal between Labour and the government without a public vote attached that might just scrape through parliament. Even in this case the deal would be hated by most people in the country and both parties would be punished for it.

The upshot of all this is that no one, including Labour, can enact Brexit. Their current policy is simply a non-starter for very good reasons. Their policy did make much more sense in 2017. At that point it was not clear that the Brexiters themselves would scupper any kind of deal. But during 2018 that became clear, and at that point Labour should have acknowledged reality and changed its policy to embrace not just a People’s Vote but also the Remain cause.

The main excuse for Labour supporting something that cannot happen is to keep the votes of Leavers. The argument goes that if they supported Remain they would lose seats in the old Labour heartlands. Embracing Remain might win them a few votes, but in seats they have comfortable majorities in already. At the end of the day most Remainers will vote Labour whatever its Brexit policy because they want the other things a Labour government would bring.

In 2016 and 2017 that argument had some force. However it is no longer valid. Let’s take the Remain side first. There is CHUK which explicitly aimed to capture disaffected Labour voters on the Remain side. The fact that CHUK contains former Conservative MPs will limit their appeal to Labour voters, but they do pose a threat to the Liberal Democrats. The LibDems are as a result likely to stress their more radical side, which makes them more appealing to Labour voters. The days when their history as part of the Coalition government was a millstone around their neck are dying, as recent polls show. Finally you have the Greens, who are likely to look increasingly attractive as the perceived threat of climate change grows.

In it certainly true that if Labour embraced Remain they would lose some voters who support Leave. But comparisons with voting patterns in 2016 are now out of date, because more Leave voters have changed their minds than Remain voters. Crucially, minds have changed predominantly among Leave voters who find their financial situation difficult, who are also likely to be Labour voters. This was confirmed by a recent UCL study.To quote

“Of Labour voters who chose Leave in 2016, fully 18% have changed their minds and say they now prefer Remain as their top outcome. In contrast only 4% Conservative Leave voters have changed their mind. One reason might be differences in economic circumstances between Leave voters in the parties.”

Peter Kellner now estimates that in Leave areas Remain supporters now outnumber Leave supporters three to one. That is a huge margin. It means that seats that voted Leave in 2016 are more vulnerable to switching Remain supporters than if Labour loses Leave supporters.

None of this would matter of it was only Leave supporters who were likely to forsake Labour, with Remain voters staying loyal. But poll after poll has shown the opposite is true. To quote from the UCL study again:

“For Labour, at least a fifth of their voters in every region say they are going to vote for a different party – and in every region defecting voters are overwhelming plumping for parties holding a definite Remain position (assuming the bulk of the “Other” vote is likely to be Green, particularly in London and Scotland). Only in Wales is Labour losing significant voter share to UKIP and the Conservatives, and even that is outnumbered by those switching to Plaid Cymru, the Lib Dems and Others. The picture is particularly stark in Scotland where almost half of Labour voters are intending to vote for a different party, mostly the SNP. In London too, the Labour vote could be hit hard by a shift to the Liberal Democrats and the Greens.”

This is confirmed by polling analysis after the council elections.

Does the rise of the Brexit party change any of this? In fact it reinforces it. It splits the Leave vote, which reduces the impact any switching from Labour by Leave supporters as a result of adopting a Remain position would have.

Would Labour lose too much face if it moved to support Remain? I don’t think so. The story they should tell is that the 2016 referendum has been respected because all the government’s resources, and Labour’s energy, have been devoted to trying to find a form of Brexit that a majority could accept, but it has become clear that a feasible deal does not exist. In particular there is no possible way of getting parliament or the country to support the kind of Brexit Labour prefers. As a result, Labour will now unconditionally support the Remain side.

The logic of the argument I have put forward would also be as, if not more, consistent with revoking Article 50. That would avoid the anger at not including No Deal in any referendum question. No Deal cannot be an option. To make it so learns nothing from the 2016 referendum. One of its lessons is don’t put to the people options that MPs know would be a disaster for the country, and with a rabid Brexit press and broadcasters that balance facts with lies we cannot trust the people not to vote for this disaster. The argument for revoking is that the country has already wasted too much time because Leavers cannot decide on the Brexit option they want, and we need to move on.

As Tom Kabasi argues, a campaign based on making Brexit about priorities rather than about staying in the EU or leaving is likely to be a winning strategy. People are fed up with Brexit, and they do not want it to dominate politics for years ahead. If Remain supporting Labour could convince voters that Brexit will be never ending and that we need to move on they can win the debate.

Will Labour move towards a position where it supports Remain of its own accord. The logic I set out has been clear for some time yet they look unmoved by it. That is why many Remain supporting Labour voters will continue to vote for Remain supporting parties into the indefinite future. The hope is that Labour, if it will not move through analysis of the true situation, will do so because of the fear of losing Remain supporting votes.

Does free movement really enable a low wage economy?

Tom Kibasi writes

“Immigration is such an important issue precisely because free movement of labour is the crucial enabler of the low skill, low productivity, low wage economic model that has been imposed on much of the country.”

This line may be very attractive to the liberal left: it gets to love immigration controls and can begin again to represent the part of working class that dislikes immigration. 

The reasoning is attractive. Starve firms of cheap labour, and they are forced to innovate and invest in labour saving machinery and/or in training their workers, which drives up productivity and real wages. In a world where capital is not mobile, that mechanism could work over a very long time period. But when capital is mobile, the firm has an obvious alternative: produce somewhere else where labour is cheaper. Keynes taught us not to make the mistake of assuming output was fixed, and the same is true here. Labour shortages could equally lead to less production, more imports, and a depreciation that makes everyone poorer.

Chris Dillow talked about these issues some time ago. He wrote

“The answer to this set of problems is to increase workers’ bargaining power – which requires, among other things, policies such as stronger aggregate demand and greater redistribution.”

Chris is right. If wages are low because of immigration, that will also mean that wages are unlikely to rise if demand expands. That in turn reduces the level of unemployment at which inflation is stable, allowing stronger aggregate demand and higher output. It is this additional demand that will allow firms to invest in more productive techniques, driving up productivity and real wages.

The endogeneity of aggregate demand and therefore output is key here. We could argue about whether labour shortages would be more likely to encourage firms to invest in labour saving machinery or move production abroad. But there is a third option which can achieve higher investment without running the risk of firms going overseas, and that is to expand demand. At the end of the day the only constraint on demand expansion is inflation, and if immigration is holding back wages it will also hold back inflation. We should not base policy on the assumption that governments undertake unnecessary austerity or central banks make deflationary mistakes. [1]

The link with austerity is even clearer when Kibasi writes

“What’s more, there is nothing progressive about declining to invest in skills in this country, while plundering poor countries of nurses or doctors or carers and then approaching immigration as if people were commodities to be bought up on the open market.”

This makes exactly the mistake that right wing newspapers have encouraged voters to make, which is to confuse the symptom for the cause. It is not private sector firms that have failed to invest in training nurses or doctors, but the public sector, most recently because of continuing austerity. Once again, what would be the consequence of cutting the immigration option? More money spent on the NHS, or a smaller NHS? It seems bizarre to argue that immigration enabled austerity, and that therefore EU immigration should be controlled. [2]

There is no evidence that immigration has in practice had any significant (in term of magnitude) impact on real wages. The trend in UK GDP per head had remained remarkably constant until the global financial crisis, despite periods of low or high immigration. The initial years of A8 EU immigration showed no fall in average earnings growth, with real wages continuing to rise. What we do know is that immigration helps the public finances, which means reducing it will mean either lower spending per head on public services like the NHS or require higher taxes. 

This point about public services illustrates the real problem with how the government dealt with A8 immigrants. As Nicholas Watt and Patrick Wintour relate, it was not a problem of poor forecasts: the forecasts were not bad once you factored in that Germany would impose transitional controls. It was a problem that the migration was concentrated in particular areas or towns, and nothing was done by government in response. So these towns saw greater pressure on public services, while the taxes immigrants paid went to the Treasury in London.

The data suggests that people in the UK have always favoured lower immigration. I suspect this is similar to questions like ‘do you favour lower taxes’: faced with something that naturally raises questions and concerns, it appears most people would rather have less of it. What began to happen at the beginning of the century is voters started saying that immigration was a key issue, alongside the economy or the NHS. This rise predates A8 immigration, and is strongly correlated with concern over defence/terrorism until 2008.

In truth, immigration is too tempting for some politicians and the media. As Tim Bale reminds us, the Tory opposition quickly started talking about Britain becoming a ‘foreign land’ after Labour was elected. Stories about benefit tourism play upon existing fears, and when politicians join in they appear to validate the problem. If that happens voters can easily turn their concerns about real wages or public services into concern about immigration, erroneously believing that immigrants are the underlying cause. So when austerity began, the government exploited these associations and the media either led or played along. If spending on the NHS was being ‘protected’, what else could rising waiting times be due to other than immigration? As concern about the NHS rose, so did concern about immigration. The truth was that the NHS was not being protected, but that truth was hard to find. 

The coup de grace of this strategy was to then associate immigration with the EU, which until the beginning of 2016 had been way down the list of popular concerns. Leavers managed to convince voters that reducing immigration required leaving the EU, even though non-EU immigration remained as high as EU immigration. The Prime Minister and Chancellor, having both pretended that immigration was a major problem, could not turn around and start singing its virtues. In that sense austerity beget Brexit.

As the referendum shows, no good comes from a strategy of using immigration as a scapegoat. The obvious way of handling such a close referendum vote would have been to leave the EU but stay in the single market. But by electing a Prime Minister who had spent 6 years trying and failing to reduce immigration, that option was ruled out because it would preserve free movement. EU immigration may fall anyway as a result of the Brexit and the depreciation it has caused, but beyond that it will be difficult for the government to reduce it further without hitting businesses at a very difficult time.

You do not kill immigration as an issue by talking about British jobs for British workers, still less by pretending that low wage jobs and a decade where GDP per head has hardly increased is the fault of immigration. As I argued here, to allow policy to be dictated by popular concerns risks making exactly the same mistake of those on the left who wanted to embrace austerity, although as I also noted popular concern is more deep rooted in the case of immigration. For that reason, turning the tide on attitudes to immigration will need much more than just facts and figures.

Although that task may seem daunting now, in five years or so it is likely to seem much easier. The chances are we will have left the EU, and the benefits that so many expect in terms of their access to public services or their real wage will not materialize. Either the government will avoid bringing immigration down, or if immigration does fall no obvious benefits will follow and there will be plenty of stories of firms suffering from labour shortages and leaving to produce elsewhere. Arguing then that lower immigration will usher in a period of high wage jobs will seem even more far fetched than it does now.

[1] A point that opponents of immigration often make is that immigration puts upward pressure on house prices. If there is no constraint on building houses, that in itself is no problem, just as it is no problem that immigrants will need refrigerators or cars. Those who argue that the country is full up have obviously never been to Scotland. Of course it may be a problem that most immigrants will go to English cities rather than Scotland, but that is again an existing problem of regional or industrial strategy which can and should be solved.

[2] The language of ‘people as commodities to be bought up on the open market’ is really too much. Are people in Poland forced to go and work in the UK? Of course not. They choose to do so, and most are better off as a result. If you want to be emotive then be accurate, and talk about how immigration controls cut off the chance of potential immigrants making a better life for themselves.