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Notes on a resilient social democracy

A key tenet of 20th-century social democratic thinking was that capitalist economies are inherently unstable and prone to cyclical crises.

Unlike the Marxist left, social democrats did not believe that these crises would eventually prove terminal for capitalist relations of production. Instead, they argued capitalism could be regulated through demand-management to reduce the incidence and impact of recessions, steered towards stronger growth performance through public ownership of leading sectors, and constrained in order to protect spheres of social existence like education and health from commodification.

The post-war Keynesian settlement was broadly successful in achieving these aims. Full employment was secured, public services were expanded, and deep cyclical crises were avoided. Systemic financial crises were almost entirely abolished, as the following graph (from a presentation to the recent Institute for New Economic Thinking conference in Berlin) indicates:

Figure 1

Financial crises through history

Yet once the post-war consensus had collapsed under the pressure of stagflation and the profit squeeze of the 1970s, social democrats largely lost their focus on the prevention and mitigation of capitalism’s recurrent instability. In particular, Third Way and New Democrat revisionists accepted the basic macro-economic policy framework inherited from the Reagan/Thatcher era, choosing to make markets work more effectively for the public interest through supply-side reforms and tax-and-spend redistribution. This was the period of the Great Moderation in which inflation targeting and judicious investments in skills, R&D and labour activation looked set to deliver continuous Goldilocks growth: neither too hot nor too cold. Indeed, this is pretty much what happened in the UK until the global financial crisis struck in 2008 and the underlying problems of the model (current account imbalances, asset bubbles, fiscal weaknesses and so on) were exposed.

So what would a social democratic agenda with a renewed focus on resilience and stability look like today? Reform of the financial sector and measures to prevent asset bubbles are clearly first order priorities (although the real question for social democrats is whether they have anything distinctive to say on these issues). Medium- and long-term fiscal prudence must also be a core component, which is perfectly consistent with short-term measures to stimulate economic growth. Fiscal sustainability must involve clear prioritisation of public spending, with a focus on public services that promote full employment, such as childcare. High employment rates are critical to sound public finances.

Tax reform is needed to improve the resilience of the tax base. As I’ve argued elsewhere, the UK’s deficit rose as sharply as it did during the recession because the tax base was overly reliant on volatile revenue sources such as stamp duty, corporation tax from the financial sector, and wealthy individuals. Breadth and resilience are more important that progressivity per se in the tax take.

Volatile taxes reflect the structure of the UK’s economy and its over-reliance on the City, debt-financed consumption and the south-east. Rebalancing the economy is now common currency, although there is little evidence of it happening and it is important to be realistic, in particular, about the potential for reform to generate increases in manufacturing employment. Nonetheless, there are a range of measures that can be taken to drive investment to new sectors, revalorise innovation and industrial performance, shift infrastructure spending northwards, and so on.

A key area that has only been tentatively explored on the British centre-left, however, is that of keeping people in work during future recessions. The flexibility of the UK labour market, alongside tax credits to top up lost wages, has been relatively effective at minimising the recent rise in unemployment, given the size and duration of the recession and recent economic stagnation. More should be done, through job guarantees, to tackle long-term unemployment. But could the UK learn lessons from other countries about how to prevent wider job losses through short-time working arrangements?

This is important for two reasons. First, interesting new academic evidence from the US (The Trend is the Cycle: Job Polarization and Jobless Recoveries, by Nir Jaimovich and Henry E. Siu) has pinpointed how job polarisation – the loss of routine middle-tier white and blue collar jobs – has occurred primarily during recent downturns and subsequent jobless recoveries. Economists normally conceive of the hollowing out of the labour market as a gradual secular trend rather than an episodic process. But Jaimovich and Siu argue, in summary, that:

‘Jobless recoveries are evident in only the three most recent recessions, and they are due entirely to jobless recoveries in routine occupations. In this group, employment never recovers beyond its trough level, nor does it come anywhere close to its pre-recession peak.’

One conclusion we might draw from this research is that it is vital to prevent redundancies during recessions, rather than to rely exclusively on job activation strategies for those who have already lost their jobs. Macro-demand management is the central policy tool, of course, but is there a role for short-time working policies? Labour flexibility allows adjustment in hours, as well as reallocation of workers between firms and sectors, while the tax credit system can act as an automatic stabiliser for those whose wages fall through reductions in working time. But the UK lacks a coordinated policy for short-time working, of the kind used on the continent, notably in Germany.

Germany’s labour market performance has been exceptional in recent years, as the following demonstrates:

Figure 2

Unemployment, Germany vs Europe (%)

The health of the German labour market reflects long-term structural reforms undertaken by the Schroeder government, as well as considerable wage restraint from German trade unions over many years. But during the financial crisis, the German government and its social partners brought highly effective short-time working policies into play, through which employers could draw down subsidies to top up wages for workers put on reduced hours, rather than make them redundant.

Research suggests that the use of working time accounts, short-time working and similar instruments to reduce working time saved some 1.2–1.5 million jobs in Germany, of which about 300,000 to 350,000 jobs were due to publicly supported short-time working arrangements (the rest were the result of initiatives taken by companies, such as the reduction of overtime, the amortisation of credit time or build-up of debit time in working time accounts, and the withdrawal from previously agreed longer working times). This is a very impressive record.

Interestingly, the centre-right Swedish government announced in its budget statement earlier this week that ‘initiatives have already been taken together with the social partners to create a system for short-term employment which can be activated the next time an exceptionally sharp downturn of the kind experienced in 2009 affects Sweden’.

The Scandinavians learnt the hard way in the 1990s that they had to secure their economies against future financial crises and the fiscal impact of deep recessions and high unemployment. Their current policy frameworks are consequently built on prudential foundations. While the UK lacks the corporatist architecture found in continental labour markets, it should nonetheless begin to prepare for the next recession, and start to develop a short-time working policy that can be implemented for leading firms and key sectors. In turn, this should form part of a comprehensive social democratic rediscovery of the virtues of prudential planning.

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