The pillars of a new economy

The election of Jeremy Corbyn to the Labour leadership owed much to his brave assertion that austerity is the wrong response to recession and that a successful economic policy should address the goals of improving our productive capacity and a fair distribution of the fruits of economic success.

Whether or not those assertions convince the wider electorate (and there is no reason why they should not), the mere fact that they have been made has changed the shape of the debate about both politics and economic policy. It has encouraged the growing emergence of a new mainstream consensus that at last offers a real alternative to neo-classical and ‘free market’ orthodoxy.

For those who welcome and support that development, however, there remain issues to be worked through. If we are to secure an economic future that relies on more than asset inflation and an unsustainable consumer boom, we first need a new approach to monetary policy so that the power of government can be used to stimulate much-needed investment in greater productive capacity and full employment. Second, any strategy for sustainable growth and increased investment will be frustrated unless the main inhibition to any policy for growth – the damaging and long-term loss of international competitiveness suffered by British industry – is overcome. This pamphlet addresses both of these central issues.

The main purpose of monetary policy has been seen for decades as simply the control of inflation. That function has been contracted out to the Bank of England and is accordingly beyond the reach of democratic accountability. Even in terms of this limited goal, however, it has created a major distortion. By far the greatest proportion of the money in our economy – estimated by the Bank of England at 97 per cent – is created by the commercial banks out of nothing, most of it lent out on mortgage, thereby encouraging asset inflation and consumption rather than productive investment. If it is acceptable for the banks to exercise this power for their own private purposes, why should the government not use it for wider public purposes?

The government’s role in monetary policy, however, has been limited to the ‘quantitative easing’ (or, more pejoratively, ‘printing money’) that was undertaken as a panic response to the imminent collapse of the banking system following the global financial crisis. The willingness to take that action, however, surely raises the question as to why £375bn of new money can be safely provided for the purpose of bailing out the banks but should not even be contemplated for any other purpose.

Other countries, and at other times, have understood the great advantages of using monetary policy to provide investment finance for productive purposes; we should learn from their example. The post-war Japanese economic miracle, for example, was largely founded on an application of the Keynesian insight that new money provided for investment purposes cannot be inflationary if it is matched by a corresponding increase in output over an appropriate time scale.

Quantitative easing, appropriately directed to productive purposes in line with an agreed industrial strategy, would provide the stimulus and capacity for investment that British industry (whose current net investment level is approximately nil) desperately needs. But the demand for that investment finance is unlikely to materialise, for as long as British industry remains as uncompetitive as it has been for decades.

The evidence for that loss of competitiveness, while resolutely ignored by our policymakers, is unmistakable – a perennial trade deficit, a shrinking share of world markets including our own, a manufacturing industry that is struggling even to survive, let alone prosper, and the constant need to balance our payments by borrowing from overseas and selling our assets.

We hardly bother even to ask why this should be so. Yet the answers are staring us in the face. British industry is uncompetitive because we insist on charging more for our goods and services than the international market will bear. The most important determinant of international competitiveness is the exchange rate; it is the rate for sterling that translates all our domestic costs into international prices. At its current rate, it guarantees that British products are priced out of international markets.

Conventional wisdom tells us that the exchange rate is set by the market, but that is flatly contradicted by, among other things, the Japanese experience. A determined government can engineer a substantial devaluation (in the current Japanese case, by 48 per cent) if it takes appropriate action. That action, as in the Japanese case, will often take the form of an expansionary monetary policy and the government-authorised creation of new money.

The solutions to the two fundamental requirements of increased productive investment and improved competitiveness can therefore be seen as complementary. The policies required for one reinforce those needed for the other and make up a credible and coherent whole. A strategy built on these twin pillars would revolutionise our economic prospects.

Read Bryan Gould’s new Fabian Ideas pamphlet Productive Purpose: Investment, competitiveness and the new economy