Dread of the financial markets is part of the Labour party’s DNA. This primal fear has been passed down the generations. Ramsay MacDonald, Clement Attlee, Harold Wilson and James Callaghan were all battle-scarred from their vain attempts to defend the pound.
Even though the signs point to a big Labour victory at the next election, the mood at the top of the party remains cautious. For months, Rachel Reeves has been on a charm offensive in the City, sending out a message to the bond dealers and currency traders that she will take no risks with the public finances.
Now the shadow chancellor has gone a step further. In a scaling back of the party’s green prosperity plan, Reeves has said the promised £28bn investment will not materialise until the second half of the next parliament. It had been assumed the commitment was from year one of a Labour government but, Reeves insists, fiscal stability comes first.
Reeves says circumstances have changed since Labour made its pledge two years ago, and she is right about that. Inflation is a lot higher and so are interest rates. It is not just mortgage payers who are being stung by higher borrowing costs: the government is as well.
What’s more, Liz Truss’s short-lived economic experiment last autumn has meant the markets now see the UK as a riskier bet. For a while, the return to financial orthodoxy under Rishi Sunak and Jeremy Hunt brought downmarket interest rates, but signs that inflation will prove harder to shift has caused them to shoot up again in recent weeks. For Reeves and the Labour leader, Sir Keir Starmer, the market turmoil is a double-edged sword. On the one hand, it makes a Labour win more likely; on the other it raises an obvious question for the party: if this is what the markets can do to a Tory government then what are they likely to do to us?
So Reeves intends to follow the example of Gordon Brown, who in 1997 stuck to the tough plans he inherited from Kenneth Clarke and faced down calls from his own supporters to spend more. This was not a universally popular decision on the left, where expectations were high after 18 years of unbroken Conservative rule. Reeves can expect the same reaction.
For a start, there is a big gap between Labour’s rhetoric and what it is actually planning to spend. The £28bn commitment amounts to a little more than 1% of annual national output and is far less ambitious than Joe Biden’s Inflation Reduction Act.
Nor is it all new money. The small print of Labour’s plan makes it clear the commitment involves taking whatever spending Starmer inherits from Sunak and ramping it up to £28bn. As things stand, the net increase in spending will be closer to £20bn. Even that assumes the new timetable is stuck to and not amended as a result of any future crises.
There’s a valid argument that even an additional £20bn of immediate extra spending would run into capacity constraints. Even the relatively modest increases Labour is planning would be a stretch for the UK if the spending came on stream immediately. There would be skills shortages, supply bottlenecks and a big surge in imports. After attacking the government for wasting billions of pounds in its response to the Covid pandemic, Labour will need to show that its green prosperity plan offers value for money. Not all state investments are good ones.
That, though, is not really what Labour is arguing. Reeves’s case for a gradual build up in spending is much more about hitting fiscal rules and keeping the markets sweet than it is about capacity constraints. Labour does not want to be in the position – as it was in the 1960s and 1970s – of borrowing heavily in the first two years of a parliament only to face a financial crisis that forces retrenchment as the next election approaches. That did for Wilson in 1970 and Callaghan in 1979. It may do for Sunak as well, since his government has got the economic and political cycles badly misaligned. Ideally, governments get all the bad news out of the way early in a parliament.
The problem with this approach is twofold. First, by the time Labour gets round to ramping up its green investment, other countries may well have streaked ahead. Second, and far more importantly, Labour is fully on side with the idea that time is running out to deal with the climate crisis. As Reeves herself pointed out, the Office for Budget Responsibility says that delaying action by a decade doubles the cost of transition.
Serious action requires serious investment, money on the scale that Biden is providing. It requires governments to make the case for different fiscal rules if the existing ones fail to make a distinction between borrowing that will provide a long-term asset and borrowing for current spending. It requires governments to make the case for green quantitative easing, on the grounds that if money can be created to cope with a financial crisis (2008-09) and a health crisis (2020) why should it not be created to cope with a climate crisis.
No question, there is a realpolitik argument for what Reeves has done. She would have a job making the case for turning on the green printing press in the current high-inflation environment. Truss has entrenched the idea that borrowing is bad and governments have to live within their means.
But adherence to financial orthodoxy has a cost. With a fair wind, in four years’ time Labour could be spending slightly more on greening the economy than the Conservatives are now. That’s not transformative. It is an attempt to have your cake and eat it.
