Home > General Politics, Labour Party News > Friedrich Hayek and the problem with Labour’s fiscal conservatism

Friedrich Hayek and the problem with Labour’s fiscal conservatism

Last week’s announcement on the 10p tax rate was most notable for the fact that it was embedded in Labour’s fiscal conservatism: the width of the income band within which people will be eligible for the 10p rate will depend on how much can be raised from the new tax on properties valued at more than £2m.

This ‘we cannot spend what we have not saved from elsewhere’ mantra of fiscal arithmetic is now at the heart of Labour’s economic policy, and is being firmly established as something that must not be questioned.  Thus all IPPR papers reflect the assumption that all initiatives must be ‘cost-neutral’, and policy seminars run by Progress and the like always work from the starting assumption that ‘tough .choices’ around spending will have to be made.

None of these papers and seminars seem to set out exactly how such fiscal conservatism policy will bring about economic growth.  This is an understandable omission.  Shuffling the existing quantity of money from one part of the economy to another more ‘growth-focused’ one, or through a process of ‘predistribution’ (either via tax or investment in education etc.) may have benefits in the longer term, but it does little or nothing of what Keynes put on the tin about the need to boost demand and thus investment to create a virtuous circle.

There are two explanations for Labour’s current policy speak.

First, the leadership may have a Keynesian plan up its sleeve, to be whipped out post-election, and that the toothless fiscal conservatism they now espouse is for show only, in order to demonstrate to a supposedly economically illiterate public that they are ‘responsible’ with the ‘nation’s finances’ (though these are not, as Chris points out, the same as the government’s).  Given Ed Balls’ background and previous espousal of Keynesianism, there may well be something in the notion that there is some kind of pact of silence in place.  If so, I can understand it, but I certainly don’t condone it; it would show a shoddy disregard not just for honest engagement with the electorate – itself a recipe for continued political disengagement as well as the continued embedding of fiscal conservatism as the policy norm - but would also reflect the almost total usurping of power by a narrow elite within the Labour party, despite all the showy promise of opening up policymaking to the wider party.

Second, the leadership may be genuinely convinced that redistribution and predistribution of existing resources is both safest (in terms of the bond vigilantes etc.) and sufficient to create growth.  In essence, it seems, Labour would be opting for an ‘at least do no harm’ strategy, accepting that there can and should be no quick fixes to the austerity-made mess in which we now find ourselves.

But I also wonder if this assumption that at least no harm will done by fiscal conservatism is actually justified.

If we think through how fiscal conservatism is actually implemented, we see how disruptive it can be too how the economy works overall.  If public services or investment can only initiated when sufficient money becomes available from elsewhere, and if this money only become available if the economy at least stays stable in real terms, then the risk to efficient investment becomes ever higher, and when doubts grow about whether investment (and consequent demand) will actually take place, any confidence fairies which might have been emerging gingerly from the shrubbery of austerity may soon take flight.  Investment becomes perceived as ever riskier because of the unknowns ahead, and the downward spiral continues into long-term economic malaise.

In fact Friedrich Hayek, hardly a fan of major public investment, saw something of the dangers associated with a cack-handed implementation of economic policy which doesn’t take account of the real dynamics of investment and confidence.  His proposals for the Denationalization of Money are primarily based, not as might be expected from later interpretation by the right, on the belief that states’ monopoly of currencies tends to lead inexorably to run-away inflation, and that inflation ruins economies by removing the value of assets.  His point about inflation (any level of inflation) is rather narrower, and focused on how the real economy reacts to it:

If the value of money is so regulated that an appropriate average of prices is kept constant, the probabilities of future price movements with which all planning of future activities will have to cope can be represented……..Though in this case the unpredictability of particular future prices, inevitable in a functioning market economy, remains, the fairly high long-run chances are that for people in general the effects of the unforeseen price changes will just about cancel out.  They will at least not cause a general error of expectations in one direction but on the whole make fairly successful calculations based on the assumption of the continuance of prices (where no better information is available).

Where the divergent movement of individual prices results in a rise in the average of all prices……the individual enterprise will have as little foundation  for correctly foreseeing the median of all the movements as for  predicting the movements of individual prices, it could also not base its calculations and decisions on a known median from which individual movements of prices were as likely to diverge in the  direction as in the other. Successful calculations, or effective capital and, cost. accounting, would then become impossible…….These skewed shifts of the distribution of price changes to one side of constancy which changes in the quantity of money may cause, and the resulting difficulty of foresight, calculation and accounting, must not be confused with the merely temporary changes in the structure of relative prices the same process also brings about which will cause misdirections of production (pp 71-73).

Hayek’s concern, then, is that the tendency to inflation creates, by its very nature, investment inefficiency and risk aversion.  Replace the need for businesses to be sure about price with the need for businesses to have some security around demand – whether that be higher or lower – caused by the government’s vacillation around it’s own investments – essentially it’s own reluctance to lead the way, and you have the same kind of recipe for long-term underinvestment as that set out by Hayek.

Indeed, you could argue that at least with the Coalition’s current brand of fiscal austerity – aimed as much as a long-term retrenchment of the state and the establishment of a permanent and sizeable underclass – we at least have some certainty about what to expect, and can plan accordingly – whether that be finding safe havens for corporate cash (thus maintaining low interest rates for firms which thriveon increased inequalities), the development of the foodbank industry or simply being poorer/developing survival modes on the margins.

What we seem to have with Labour’s current approach to policy is an unappetising alternative: either accept we’re being lied to for our own short-term good, or accept the consequences of Hayekian logic for our economic future.   There is still, of course, time to rescue the situation, by developing a credible economic policy based on a proper understanding of what money actually is.

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  1. February 18, 2013 at 1:13 pm

    Very clearly put. I share your concerns. Ed Ball’s Bloomberg speech in 2010 emphasises that there is no point in having the correct policy if the party/Keynes is ignored. Whilst, there is undoubtably a truth in that, there is also danger (and dishonesty) in over-adapting to the prevailing paradigm.

    I seem to remember that the LP similarly gave Blair the benefit of the doubt, in 97, and were appalled to find that was indeed ‘worse than that’.

    Trying to read between the lines of Balls’ recent statements doesn’t really help to discern his thinking and his enthusiasm for Mark Carney’s appointment seemed real enough. You may actually ‘know’ but my worry is that Balls confuses neo-keynsianism with Keynes. I believe that he studied with Gregor Mankiw at Harvard. The Mankiw who has been at the centre of a row with Harvard students who protested at his course only teaching ‘neo-keynesianism’.

    This ‘deficit dove’ approach contains the same crazy thinking about unemployment, deficits and debt as the neoclassical models.. only delayed until after ‘stimulus’ produces growth which is considered strong enough. It also kowtows to the supply-side nonsense rather than direct stimulus or jobs guarantee… and the imperative for gov’t to ‘borrow’ from the private sector. That certainly fits with the little that I know of the Balls’ approach to LP policy.

    It also seems significant that Mankiw was an advisor to Bush and is a Republican supporter.

    As you say, ‘If public services or investment can only initiated when sufficient money becomes available from elsewhere’ then we are heading down the spiral of decreasing demand and confidence… and affirming the austerity agenda of ‘there’s no money left.’ IMO the LP should at least be exposing the ‘deficit’ argument as a red herring and highlighting that if the private sector won’t invest, government must.

  2. paulinlancs
    February 18, 2013 at 1:27 pm

    Thanks Sue. I don#t know any more than you do about where Balls really stands, and it’s quite conceivable he doesn’t know yet – i have no problem with politicians learing/developing on the job.

    I’ve added in the link to the Blooomberg speech. I’d left it out as couildn’t for life of me remember when he’d said the key stuff you now refer to. Thanks

  3. Mike
    February 19, 2013 at 12:20 am

    Hopi Sen writes a lot about Fiscal Conservatism on his blog, but whenever someone tries to pin him down as to what he means by it, he wriggles away. I think both Carl & I tried to get to the bottom of it and failed. You could try. For instance, he’s simultaneously in favour of austerity and Keynsian stimulus until recovery. Then it’s the hair-strait-jacket with deficit-reduction targets that out-Osborne Osborne. I suspect it’s because he believes this is what the electorate want, the only way the electorate will trust Labour, because some polls say so. Because Labour are bloody useless at PR. Lately he’s discovered that Labour’s economic policy is “I agree with Vince Cable”, so Labour are now the SDP.
    I’m not clever like you people, but I reckon it’s time for the “traditional Labour voters” (people that voted Labour through the last couple of decades or more) to just walk away. That’s my plan.

  1. February 28, 2013 at 1:46 am

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