What should Labour's economic policy look like?

Since I accepted an invitation to be a member of Labour's Economic Advisory Council many people have asked me what Labour's economic policy will be. When I say I have no idea, they probably think I'm just being coy. But my answer reflects a reality which I think many people miss. The Labour leadership has to reach a compromise with the majority of the parliamentary party. Any other strategy involves self-destruction. So looking at the economic views of Corbyn and McDonnell, or what was suggested in the leadership campaign, will be an inadequate guide to the policy finally adopted.

Take, for example, the idea of "People's QE" that Corbyn floated as a possible policy during his election campaign. That involved funding a National Investment Bank using new money created by the Bank of England. Many economists, including the LSE's growth commission, like the idea of a National Investment Bank, and others would also agree there is scope to improve on QE, the Bank's money creation programme. However the Bank is unlikely to undertake any further QE over the next few years, so People's QE seemed to imply ending the Bank's independence. As there is still widespread support among economists for independence, pursuing this particular conception of People's QE would have been divisive. Perhaps as a result, in a Financial Times article in mid-October John McDonnell wrote that Bank independence was sacrosanct.

In that article he also announced setting up a group to look at the Bank of England's remit, and other groups may follow. So Labour's economic policy will gradually emerge from a combination of external advice and dialogue between the leadership and the parliamentary party.

Of course we can still speculate about what will emerge. Undoubtedly it will involve a more favourable view of the state than the current government. Even those who supported austerity back in 2010 now think Osborne is using the deficit as an excuse to shrink the state. I do not know of any economist who has backed his new fiscal charter, and I expect Labour to adopt fiscal rules that allow borrowing to finance higher public investment at a time when interest rates remain low. Such a rule could still be consistent with reducing government debt as a share of GDP.

A different view of the state does not just imply a larger state than Osborne currently plans, but also a more positive attitude towards the role of the state in promoting economic growth. This idea is exemplified by the work of Advisory Council member Mariana Mazzucato. In her book The Entrepreneurial State she shows that the most important factor behind iconic new technology like the iPhone is state directed applied research. The state should not just be an enabler of innovation, but a driver of it.

Elsewhere policy will respond to the successes and failures of the last Labour government. I was among a number of academics who contributed to a review of Labour's economic record in government, and there were many success stories. This tends to be forgotten because the Conservative Party with media help has succeeded in linking the recession and the need for austerity to the last Labour government's alleged fiscal profligacy. In reality the recession was the result of a global financial crisis, which in turn was by far the major factor behind the rising budget deficit. The idea that before the recession the UK was experiencing a debt-fuelled boom is also based on little more than a kind of backward induction following the recession.

There are two major areas where I expect economic policy to be rather different from the last Labour government. One is the regulation of finance: many economists would view policy changes since the global financial crisis as too little to prevent another crisis. A second is inequality. While the last Labour government did a great deal to reduce poverty (some of which, like tax credits, the current government is trying to reverse), they were famously relaxed about inequality, and in particular the incomes of the top 1 per cent. The issues are linked, because finance has driven a large part of the rising share of the 1 per cent.

It is here that Labour faces one of its most difficult challenges. Perceptions about lack of economic competence were critical in Labour's defeat in 2015. The issue of the deficit will have lost much of its power by 2020, but any policies to reduce inequality and increase financial regulation will be sure to be branded as unfriendly to business. Will these measures be seen by the electorate as damaging or enhancing Labour's economic credibility?