The Labour party needs a new political economy, writes Patrick Diamond

New Labour’s model of political economy was successful in shoring up the Labour party’s questionable reputation for economic competence, and it was the basis of three consecutive election victories. Labour politicians were haunted by past failures: in 1931, 1949, 1967 and 1976 financial crises destroyed the party’s economic credibility. After the second world war, Labour’s principal idea was a centrally planned economy. During the 1950s and 1960s, planning was discredited: the National Plan introduced by Harold Wilson’s government failed to deliver sustained economic growth, while the Conservatives were able to portray central planning as belonging to the era of austerity. Since Stafford Cripps and Hugh Gaitskell, Labour had increasingly relied on a Keynesian framework of countercyclical demand management to maintain full employment. That was invalidated by the 1976 crisis when the government cut public spending after securing an International Monetary Fund loan following recurrent balance of payments crises. The collapse of planning and postwar Keynesianism created a massive void in social democratic strategy.

The post-1997 New Labour strategy was about securing economic stability while giving the party leverage to secure its centre-left ambitions after two decades of Thatcherism. The state was no longer responsible for guaranteeing full employment, but government would intervene where market failure occurred. The achievements of the Labour government include more than a decade of continuous growth, together with a high and stable level of employment. But the limitations were evident before the financial crisis: the persistence of structural imbalances, particularly rising levels of public and private sector debt; growing inequality and pressures on government to undertake more redistribution which became electorally unsustainable; and, finally, Labour’s struggle to articulate a compelling message on the economy, which in the good times had been taken for granted by voters. Party modernisers were slow to respond to the crisis of social democratic economic strategy following the 2010 defeat. Since the early 1990s, the economy had been a debate-free zone.

Today, there is again an intellectual vacuum. In the 1970s, the Labour left had a genuine alternative developed in conjunction with leading Keynesian economists. The Alternative Economic Strategy necessitated import and price controls, an incomes policy, reflation to increase industrial output, national planning agreements, public ownership, and, of course, withdrawal from the common market; much of this territory has been abandoned.

The left needs a political economy based on a new analysis of ideas and institutions. Ideas are fundamentally important; as John Maynard Keynes argued, ‘the world is ruled by little else’. Labour has to begin from the position that there is nothing inherently ‘anti-business’ about seeking to prevent a race to the bottom in the global economy, or altering the incentives facing companies to reduce short-termism, as former Labour member of parliament Tony Wright recently argued in a paper for IPPR. It has to get away from treating the state and the market as competing alternatives, and instead conceive of how markets and states can work together to promote innovation and the common good. The centre-left has to recognise that it is not enough merely to secure economic stability and rising living standards; it has to offer an uplifting vision of the economy which brings more individuals and communities into the winner’s circle of dynamic growth and prosperity – in particular, more secure, high-quality jobs need to be created.

The role of ideas relates to the importance of institutions which set the rules of the game in which markets operate: institutions serve to embed a political legacy, ensuring that major reforms live on and cannot easily be reversed by your opponents. The Labour governments created landmark institutions after 1997 including the monetary policy committee of the Bank of England setting interest rates, and the low pay commission determining the level of the national minimum wage among employers, trade unions and the state.

Both have become part of the landscape of British economic policymaking; what New Labour lacked, nonetheless, was institutions that had a positive purpose to release entrepreneurial energy and innovation. There was too little genuine local devolution: from skills to infrastructure, the mindset was that ‘Whitehall knows best’. This is where the centre-left has to now turn its attention. Effective, democratically accountable regional institutions are needed to foster growth and close the gap between the south-east of England and the rest of the United Kingdom. The UK needs powerful regulatory institutions to uphold the public interest in product and capital markets, especially financial services, as well as tackling systemic low-wage sectors through a beefed-up low pay commission. A government-backed national investment bank is required to help burgeoning start-ups and small- and medium-sized enterprises respond to the lack of adequate financing. And coordinating institutions are required to ensure that innovations made possible through higher education research are translated into marketable products and services. All of the world’s most successful economies, particularly Germany and the Nordic countries, have strong enabling institutions supported by the state.

Social democrats have to take on private sector vested interests and monopolies that stifle equity and efficiency. The role of a Labour government is to support markets and business; sometimes that means criticising poor behaviour, where necessary employing robust regulatory levers. The financial crisis demonstrated that business does best where government is a critical friend: as Keynes reminded us, the private sector is ‘a good servant but a bad master’. That should be the central principle of any progressive political economy.

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Patrick Diamond is university lecturer in public policy at Queen Mary, University of London, and co-chair of Policy Network

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Photo: dominic campbell