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The Progressive Policy Think Tank

Labour pains on the economy: A brief explainer

John McDonnell hasn't suddenly become concerned about demand management per se, but he does want to make the case for increased borrowing for state-led investment.

The Labour leadership has got itself into a right mess over the government’s fiscal charter. Some of this is just the result of political mismanagement and chronic mishandling of the media. But there are intellectual reasons for it too.

Contrary to what Diane Abbott said on the BBC Today programme this morning, shadow chancellor John McDonnell has not argued the classic Keynesian case against austerity. In his speech to the Labour party conference last month, he attacked austerity on the grounds of distributive justice: instead of cutting public services and tax credits, the government should reduce the deficit by increasing taxes on corporations and the wealthy. He did not argue that deficit reduction was taking demand out of the economy. He warned about risks to sustainable growth posed by developments in the global economy, and underlying structural weaknesses in the UK economy, but his primary reasons for opposing austerity were that it was socially punitive and distributively unjust.

This allowed him to argue that he was not a 'deficit denier' – just that he had a different and fairer plan for reducing the deficit. He too would 'balance the books'.

However, he appeared not to have noticed that George Osborne’s fiscal charter requires the government to run a surplus on total managed expenditure, not just current expenditure – so signing up to it, as he pledged he would to the Guardian on the eve of the Labour conference, would prohibit borrowing for investment. This is why he has now done a U-turn: not because he has become concerned about demand management per se, but because he wants to make the case for increased borrowing for state-led investment.

This isn’t simply a reheating of Ed Balls’ position before the last election. Balls certainly wanted to increase capital investment, but he wanted a smoother path of deficit reduction than the government was then planning, and he didn’t want to pledge the significant tax increases that would be necessary to alleviate cuts to departmental spending or social security, as McDonnell does. (Indeed, the chancellor’s summer budget went some way towards adopting the Balls plan by increasing taxes and smoothing out the trajectory towards a surplus, but didn’t exclude capital investment from the new fiscal rules.)

McDonnell’s intellectual position appears to be grounded in work by economists who write for Socialist Economic Bulletin. Their view, spelled out in a series of blog posts, is that only investment generates economic growth, and that only the state – and not private capital – can secure the necessary levels of investment. They advocate borrowing for investment, but not for financing consumption over the cycle (much as did Gordon Brown’s 'golden rules'). They explicitly reject structural deficits and Keynesian demand management, in favour of state-led investment strategies. When McDonnell gives the Labour response to the government’s fiscal charter, I expect this to form the core of his argument.