Labour’s voodoo economics

“Voodoo economics” was the name given by George Bush Senior to his presidential rival Ronald Reagan’s economic ideas when the two were vying for the Republican nomination in 1980. Mr Bush’s scepticism proved well-founded. Now I don’t accuse Labour of promoting the same ideas – but there is the same sort optimistic logic and build-up of false expectations amongst supporters. Except that in Labour’s case it will be politically much riskier if they actually achieve power.

The original voodoo economics, or “Reaganomics” to its supporters, is associated with two ideas in particular. The first is “trickle down” – if the rich become wealthier then soon enough everybody else will benefit. So it’s OK to cut taxes on the rich – which would stimulate economic growth that benefits everybody. The other idea is known as the “Laffer curve”. If you cut taxes rates then in due course tax revenues increase because economic growth enlarges the tax base.

Reagan won the presidential nomination, and then the presidency for two terms. He wasn’t quite as  reckless as is often portrayed with tax cuts, but he did oversee more liberal economic policies that coincided with renewed economic growth. Mr Bush succeeded him in the 1988 election, and was then forced to raise taxes, in spite of his “read my lips” pledge against “new taxes”. He then lost out to Bill Clinton in 1992, who both raised taxes and oversaw a period of rapid economic growth. Trickle down was notably absent in this period, where median earnings in the US did not track overall economic growth; inequality rose sharply. There was no convincing evidence of the Laffer curve effect either, hence Mr Bush’s predicament. This still hasn’t stopped tax cutting being a central tenet of the US right’s faith.

So what is Labour’s voodoo? This is the idea that raising the wages of the lower-paid will generate sustainable economic growth, which in turn will generate tax revenues from which public services like the NHS can be funded. I’ve heard some such line of argument presented by Labour spokespeople over the last week. It replaces the classical Keynesian stimulus idea that the party had been peddling, until the the economy inconveniently grew and soaked up the slack needed to make such a policy work.

How might this idea work? Well I think it stems from the observation that productivity is weaker in Britain than in many other developed economies – notably France and Germany. So, if employers are forced to pay their workers more, they should be able to find ways of raising productivity to pay for it. And if they do that, the economy as a whole benefits, as well as the lower paid workers.  After all when Labour introduced the minimum wage under Tony Blair, the sky did not fall in. This isn’t nonsensical, but to put it generously, it is open to risk. Employers might indeed raise productivity, but they might well sack workers at the same time. In other words they would produce the same volume with fewer workers, rather than more with the same number. The result would be an increase in unemployment. And this is surely the most likely outcome. The examples of France and Germany are not encouraging: both have been haunted by high levels of unemployment to match their more generous levels of pay. East German pay was rapidly equalised after unification, for example, and the results were disastrous.

The truth is that nobody really understands why British productivity is so weak. Has it always been so, and simply exposed by the come-uppance of sectors like finance and oil which had disguised it? Is it based on poor skill levels, as employers tend to claim? Is it lack of capital investment forcing businesses into labour intensive operations? Or does it simply reflect the bargaining power of employers that will be sorted out as soon as the labour market becomes a bit tighter? I suspect that it is a combination of all of these factors.  Without knowing the causes of poor productivity, it is impossible to know whether any particular policy will work, or do more harm than good.

Of course Labour’s purpose isn’t to convince sceptics – it’s simply to confuse voters who are tempted to vote Conservative based on its economic record, and to give its core supporters some kind of fig leaf with which to cover the flaws in their treasured policy beliefs.

The problem will start if Labour win power, which, albeit probably as a minority, remains the most likely outcome of the election. As they push up the minimum wage and create a bureaucratic morass intended to encourage the use of the higher “living wage” and restrict the use of zero-hours contracts, they will not find the economy responds as they hope. Soon enough they will be forced to backtrack, if not on these policies then others, especially those involving taxation and public spending.

The Labour leadership remind me of the French Socialists under François Hollande. They developed a series of crowd-pleasing leftish policies, which helped secure them victory in 2012. Then the trouble started, and they were forced to backtrack. Their popularity fell into an abyss, to the benefit of the far right Front National. Something similar is building in British politics. Ukip, from the right, the Greens, from the left, and the Lib Dems from the centre are waiting to pounce on disillusioned Labour voters.