Corbynomics: Part 2

The right questions are now being asked, but much fleshing out of the proposed partnership between an enabling state and a dynamic private sector is still needed

Jonathan PerratonThe election of Jeremy Corbyn as Labour Party leader has changed the terms of debate over UK economic policy. Corbyn and his shadow chancellor John McDonnell have already outlined a new approach to economic policy, highlighting a number of weaknesses in the UK economy generally overlooked when focusing on the budget deficit. They have also assembled an impressive and wide-ranging group of economic advisors.

In his vision for the economy in 2020 Corbyn argues that austerity has held back growth, but more broadly that the economy has become unbalanced, with rewards skewed towards the richest. It has also suffered from low productivity, weak investment and skills and a large external current account deficit.  Real incomes have stagnated for large sections of the workforce.  Further cuts in public services, accompanied by tax reductions benefiting the richest, will not underpin a sustained recovery.  Instead, any recovery needs to be based on innovation and investment in skills and infrastructure, underpinned by a new relationship between the public sector, workers and businesses.

At one level much of this is unexceptional, especially on the centre-left. The UK’s weak skill base has been widely noted.  The case for improving infrastructure is now widely acknowledged, with the ratings agency Standard & Poor’s noting that ‘inadequate investment in infrastructure has become a significant obstacle to doing business in the U.K.’  Further, the current economic climate of sluggish economic activity and historically low interest rates has led traditionally fiscally conservative institutions, including the International Monetary Fund and even Standard & Poor’s, to advocate higher public infrastructure expenditure.

The need for a new partnership between the state and business to enable innovation is also widely acknowledged. Mariana Mazzucato, one of Corbyn’s team of economic advisors, has shown in detail how states have been central to nurturing innovation and called for the building of an entrepreneurial state around the creation of a new National Investment Bank (NIB) to lend to firms in key sectors (particularly, but not exclusively, in green technologies).

These various problems of the UK economy are real enough. Austerity, on virtually any analysis, lowered UK income below what it would otherwise have been – Simon Wren-Lewis argues that Office for Budget Responsibility estimates of a cumulative loss of around 5 per cent of GDP are likely to be on the low side. UK productivity has certainly stagnated since the onset of the financial crisis and I have myself covered the state of Britain’s balance of payments elsewhere.

Central to all of this is investment. The UK had a particularly poor recent investment record even before the crisis. Related to this, the proportion of internal funds invested by UK companies has steadily fallen from the 1990s, with companies in this century moving from being net borrowers to net savers accumulating large cash surpluses. There has been some fall-back from this position recently with some signs of a recovery in investment, but overall this remains weak.

A revival of investment is central to Corbyn’s programme. Investment would be central to any sustained rise in economic activity and strengthening of the UK’s industrial base. Investment is needed to raise productivity and, whilst productivity growth may not be a sufficient condition for a growth in real wages, it is a necessary one.  Higher investment is also needed to reduce the budget deficit.  It is not simply that austerity is self-defeating in a downturn, that it simply reduces demand further when an economy is suffering from insufficient aggregate demand.  Logically, if the government is borrowing, some other sector(s) must be saving and lending.  For government borrowing to fall, some other sector must spend more and save less.  This could be households spending more and saving less, but this would imply more private debt-fuelled consumption.  An improvement in net exports would also have this effect, but that seems unlikely at present, even though over the medium term higher investment could contribute to greater capacity for exports.  Effectively, a decline in the government deficit would need firms to invest more and save less.  An investment-led recovery would be likely to generate more decently paid full-time jobs; one key reason why economic recovery has not led to the expected fall in the deficit is the failure of the economy to generate a rise in full-time employees.

So far, so good, one might say. The controversies over Corbyn’s programme have focused more on the proposed means to finance and implement these plans.  Ending austerity through increased expenditure on infrastructure and skills would probably command widespread support, whilst the fact that interest rates are at historic lows indicates that this is exactly the time that governments should be borrowing to invest.  After some initial confusion, Corbyn’s team has rejected Osborne’s fiscal charter as imposing arbitrary limits on government spending that have no coherent foundation and could be counter-productive.  Despite some attempts to spin recent indicators, the fact that inflation has fallen below its target range this year clearly indicates that Britain still suffers from insufficient demand.

Two key areas have been highlighted to improve public finances over the medium term. On the tax side, Corbyn has taken up ideas from tax researcher Richard Murphy. Murphy estimates losses from inadequate collection of taxes owed to HMRC, tackling tax avoidance schemes and measures to address tax evasion of over £70 billion, more than three times the HMRC’s own estimates.  However, Murphy does caution that only a fraction of this may be recoverable: unpaid debts can be hard to collect; successive chancellors have attempted to close loopholes that allow tax avoidance with only limited success; and it is striking that the estimates for the size of the UK underground economy are relatively small.  Murphy’s estimates of these losses have been disputed and other analysts are more sceptical on how much can be collected, even if his estimates of losses are broadly accurate.

On the expenditure side, Corbyn has highlighted the estimate of £93 billion spending on corporate welfare, drawing on Kevin Farnsworth’s paper for SPERI. Since its publication, this work has been widely criticised, although tellingly Farnsworth notes that his critics didn’t contact him before passing judgement on his estimates. The point is not that it would be possible or even desirable to end all state support for companies, but rather that it would be worthwhile examining exactly what is being spent and the justification for this.  Much of the estimated support was for capital allowances, which can provide support for investment. Smaller expenditures also support sensible objectives, such as regional development. However, even where expenditure or tax allowances are directed at desirable objectives it is reasonable to ask whether they are effective in practice.   That said, question marks do still remain over the precise estimates of what is possible.

The second, even more controversial, proposal emanating from Murphy’s work has been for what has been termed (somewhat misleadingly) ‘people’s quantitative easing’ (PQE). The Bank of England’s QE programme thus far has entailed the purchase of a narrow range of assets (government bonds – gilts – held by the private sector).  The argument is that it could purchase a wider range of assets (as the US Federal Reserve has done), including bonds issued by the new NIB, with a view to ensuring that QE would then more directly support productive investment.  John McDonnell has set this out as part of a wider review of the mandate of the Bank of England designed to broaden its focus beyond its current inflation target.

Critics have charged that this would be inflationary and would undermine the Bank of England’s independence from political interference by blurring the boundaries between fiscal and monetary policy. Yet inflationary pressures are currently subdued in the UK and much of the developed world.  Central bank independence is also always qualified insofar as the government sets its target and remit.  McDonnell has thus argued that his proposals don’t compromise independence, but simply change its remit.  In practice, QE has already effectively blurred the boundaries between monetary and fiscal policy.  A range of economists, including former chief IMF economist Olivier Blanchard, have argued that versions of PQE are plausible policy tools, with benefits and costs like any other, that could be used in a stagnating economy. The more persuasive counter-argument may simply be that it is unnecessary – with interest rates on government bonds at record lows anyway, the UK government could easily borrow for infrastructure investment by issuing bonds in the normal way (see Jo Michell).

In sum, governments of the left typically face a ‘capital’ dilemma. On the one hand, they wish to intervene in market processes – to change outcomes, redistribute incomes and maintain the welfare state.  Historically, though, they have had to ensure sufficient profitability in the private sector to provide adequate investment.  As we have seen, despite low interest rates and cash surpluses held by many companies, private investment remains low.  Interest rates could rise if the hitherto dormant ‘bond market vigilantes’ were to move out of UK government assets.  The business sector is also likely to be suspicious of a Corbyn government.  Public investment could partially make up for this and higher demand in the economy should encourage greater private investment anyway.  For all that, the terms of the partnership between an enabling state and a dynamic, innovative private sector on which Corbynomics will necessarily depend still need much fleshing out.