Labour needs a bold economic policy that’s electorally credible and effective in government

The party should dip into diverse schools of economic thought


Labour’s economic policy needs to be both credible in an election and effective when in government. What if policies cannot be both? Sometimes the policies which will work best in practice do not chime with the common sense economic of the electorate.

Popular opinion is not a good guide to economic effectiveness. As JM Keynes said:

“Practical men who believe themselves to be quite exempt from any intellectual influence are usually the slaves of some defunct economist.”

The common sense economics of practical men and women today derive mainly from the neoliberal ideas which have dominated recent decades. Such ideas are not yet defunct but in the 2008 crisis they were fatally wounded.

Policymakers whose views were formed in this period may believe that floating currencies, independent central banks, open capital accounts, inflation targets and fiscal rules are the essentials of economic success. In fact, they are the economic institutions of one period of history which may be superseded in the next.

To design effective policies, we need to free ourselves from the common sense of practical people and listen to the insights of more than one school of economic thought.

Common sense tells us that wages are a business cost which competitive firms aim to minimise, that the productive economy generates the income to pay for public services, that saving is always good and inflation is always bad, that a firm’s only duty is to its shareholders, that people are paid what their work is worth and that exports make us richer.

All of these propositions are debatable, some are just wrong.

Classical economists (Adam Smith and those who  followed on) believed that labour was the source of a nation’s wealth. Rather than seeing workers as a cost to enterprise we should understand labour as the key resource and public policy should support giving workers the skills, equipment, and infrastructure to be as productive as possible.

When statisticians compile GDP figures they do not subtract the cost of hospitals, schools and police stations from the total. The value added by public services is an integral part of the estimate of national income or GDP. Public services are not a cost to the economy but a contribution to the nation’s prosperity.

Household savings we think are sensible whether it is for unforeseen events or future indulgence. However, when firms save rather than invest their income, the economy slows.

This was Keynes’s key insight. A nation’s income is equal to the demand for consumption goods and the demand for investment goods. If investment falls then so does overall income. When private investment is low public investment should rise. Governments need to rediscover the importance of effective demand and the techniques of demand management.

Keynes also pointed out that as incomes rise more is saved. Wealthier people save a higher proportion of their income. This is one reason why rising inequality leads to slower growth. If a higher proportion of income goes to richer people who then save more the result is lower effective demand.

A large part of Adam Smith’s most famous book is devoted to refuting the idea that countries grow rich on exports. To the classical liberal the purpose of exports is to pay for imports and the purpose of production is consumption.

Some countries repress wages to encourage exports, not realising that they are sending more of their output to be consumed abroad while denying consumption to their own workers.

Lessons on the true value of exports are available from the economics of development. Countries which have industrialised successfully used exports to provide a market for their new industrial production. Countries which export low value-added goods have failed to develop. The trick is to use exports to support an industrial policy which seeks to expand high productivity sectors of the economy.

Sometimes evidence is more important than theory. For example, empirical studies have shown that inflation at low levels is beneficial for growth. Up to about five per cent more inflation correlates with higher growth. Above eight per cent the negative effects set in. Governments should be cautious about setting too low a target.

We need to free ourselves from the common sense of neoliberal era to design effective policies. At the same time policies must be soundly based on economic theory. The difficulty is that while the old idea is dying no new framework has yet gained ascendancy.

If Labour is to offer a different vision for its economic policy it needs to be eclectic, taking insights from Keynes, the classics, development economics and empirical economics.

Such a vision would lead to a policy which put working people at its heart and aimed to provide the investment in skills, infrastructure and capital to increase their productivity. It would recognise the need for higher wages to incentivise investment as well as to support demand and reduce inequality.

Its macroeconomic framework would take account of demand as well as supply. Its industrial policy would seek to expand the proportion of high value-added sectors in the mix and see trade policy as a means of supporting industrial strategy.

Jos Gallacher has lived in Brussels for 15 of the last 18 years. He has been active in the Labour Party since 1979 and currently represents Labour International on Labour’s National Policy Forum. Labour’s policy consultation ends on 31 May. The consultation documents are available on the NPF website.

See: Leaving Europe is an industrial problem, not an economic one

Like this article? Sign up to Left Foot Forward's weekday email for the latest progressive news and comment - and support campaigning journalism by making a donation today.