The new economics of social democracy, or why our only viable option is for the state to spend more

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The Guardian's reported that Ed Miliband has said:

What has social democracy been about in Britain and in Europe perhaps since Tony Crosland? It is about tax and transfer social democracy. Crosland said 'use the proceeds of growth to make society better and fairer'.

It was, I agree.

And it isn't any more. That's obviously true. That's not because of the financial crisis. That's because we have reached the limits to growth. It is not possible to exploit our planet at the rate we have been and survive as a race. Whatever the reason we come to accept that, it's a fact.

That, however, does not spell the end of social democracy. Indeed, if anything this is the moment of greatest opportunity and challenge for social democracy. After all, the market has no solution to this scarcity because it treats the environment as an unpriced externality. If we follow that thinking, as we have been, then we head for oblivion - as so many on the right with their sole emphasis on immediate gratification seem to desire. The left - believing as it does that it is the duty of the state to intervene to set the rules for markets without which those markets cannot deliver anything close to an optimal solution for everyone, let alone market participants - are bound to have the upper hand in this debate. This then is our political ground to claim.

And claim it we can, but only if we realise that the choices facing social democrats have to change now. The old paradigm looked remarkably like this:

In Tony Crosland's time the world started at A and grew to B. Out of the growth represented by the outer ring part (C) went to the state to pay for the additional schools, hospitals and services that were desired and part (D) went to the private sector. Candidly, this was easy. It was a case of dividing the spoils. And that pretty much remained the case right through to the Brown / Blair era when many still thought growth would go on forever.

Except we now know it isn't. The situation for social democrats now is this:

There is no growth now. What we're demanding as social democrats now is a bigger slice of the same cake. And that, of course, seems like a harder thing to do. Except it isn't. In fact, it's what logically should happen, but that takes some explaining. Let me start with this from Larry Summers in the FT this week, from their Capitalism in Crisis series:

The nature of the transformation [in productivity and prices] is highlighted by the 50 fold change in the relative price of a television set of a constant quality and a day in a hospital over the last generation. While it is often observed that wages for median workers have stagnated, this obscures an important aspect of what is occurring. Measured via items such as appliances or clothing or telephone services, where productivity growth has been rapid, wages have actually risen rapidly over the last generation. The problem is that they have stagnated or fallen measured relative to the price of housing, healthcare, food, energy and education.

As fewer people are needed to meet the population’s demand for goods like appliances and clothing it is natural that more people work in producing goods like healthcare and education where outcomes are manifestly unsatisfactory. Indeed as the economist Michael Spence has documented, a process of this kind is under way: essentially all US employment growth over the last generation has come in non-traded goods.

The difficulty is that in many of these areas the traditional case for market capitalism is weaker. It is surely not an accident that in almost every society the production of healthcare and education is much more involved with the public sector than is the case with the production of manufactured goods. There is an imperative to move workers from activities like steelmaking to activities like taking care of the aged.

All of this makes complete sense. What does not is that Summers went on to say immediately thereafter:

At the same time there is the imperative of shrinking or least slowing the growth of the public sector.

This comment is completely baffling. More than that, it explains the crisis we're in because the issue we face is a simple one. As labour efficiency in manufacturing improves (and Summers gives some evidence of by how much it has improved in real terms) real labour rates in manufacturing rise, although the number of people employed falls. That's inevitable, and an observed fact. What are less understood are the other consequences that are described in the economic phenomena known as Baumol's cost disease.

What Baumol in effect says is that the wages of those whose productivity has increased will drag behind them the wages of those whose productivity has not increased. Baumol explained this by comparing workers in the motor industry in the 1960s, where productivity had massively increased real wages , with the classical musicians playing a Beethoven string quartet, where like it or not the same four players were still needed in the 1960s as they had been in the 1780s and playing it in half the time certainly did not add to the quality of the product. However, as he noted, the string players wanted wage increases to at least partly keep up with the car workers with the inevitable result that playing string quartets had in real terms got a lot more expensive than it had been in Beethoven's time, so state subsidies were now needed in very many cases simply to make sure that the best could keep on playing.

This is where we are now. As a matter of fact real wages in many parts of the private sector have risen over the last 30 or 40 years because of increases in productivity because that sector is fundamentally focused upon producing products or commoditised services that can be easily packaged and sold using technology. On the other hand, a great many of the services supplied by the state, whether they be healthcare, education, support for those in need, one-to-one advice, and so on, cannot be enhanced in this way. You cannot teach a class a 50 minute lesson in 30 min and you cannot do a 10 min consultation with a patient in 7 min without some significant compromise on the quality of service supplied occurring. Productivity gains in a great many of the activities undertaken by the state will therefore always, and inevitably, be low.  The claims of those who argue that these services are inefficient as a result and should be privatised as a consequence are just absurd: they're simply done in real time one to one, and that's a fact that will not change unless, of course, we want lower standard services (which privatisation does, invariably, deliver as a result).

And that fall in the quality or quantity of such services is dangerous for the economy as a whole since, as I argue in The Courageous State, services such as these are the bed-rock of our economy, our communal well-being and to the well-being of our private sector, which is built upon the foundation of such state provided services being available to those who work in the private sector and who can therefore afford the risks of doing so. We could not have a prosperous private sector unless the state provided these essential underpinning services for what it does. This is the essence of my theory of the cappuccino economy, explained in chapter 5 of that book.

Now to go back to the  diagrams, over the last 40 years we have financed government by making more 'stuff', mainly in the private sector.  That 'growth' in the amount of 'stuff' we consumed, fuelled by a combination of the abuse of the environment and productivity gains then 'trickled down' into increased public services. The result is the commonly held, but completely wrong, assumption the value is created in the private sector and the public sector is dependent upon the private sector for the generation of real worth. This, of course, is not true  (as anyone waiting in accident and emergency will tell you) but the perception remains in place precisely because productivity gains were undoubtedly made in the private sector that could not be replicated in the public sector, and so the myth persisted and continues to this day.

Now we have a fundamental choice to make. It's my suspicion that we are coming towards the end of growth. There are two good reasons for thinking so. The first is that we no longer wish to abuse our environment in the way we did. The second is that we are beginning to realise that we have enough ‘stuff'. There are only so many computers, mobile phones, sofas, and even cars that we need. Of course the distribution of that material well-being is inefficient, and even offensive on occasions at this point of time, with some being deprived of what they need whilst others have excess way beyond any reasonable requirements, but the point is that we do have sufficient to share to meet all reasonable material needs that anybody now has.

What is more, we seem to be increasingly aware of this fact and as a result are increasingly reluctant to be persuaded by advertising that we must go out and spend more on things that we know we don't need (see chapter 12 of the Courageous State for more on this). As a result it's my suspicion that the current increase in the savings ratios within the economy is not just arising from the fear of recession, it also reflects a real reluctance to spend on things people do not want. If true that has profound implications.

First of all, growth in manufacturing will be lower than in the past, and may even cease, barring the need to service an increasing number of people in some parts of the world. Secondly, that growth will not therefore provide the surplus to pay for the services we want out of productivity gains. And that means the model on which all political systems, and not just social democracy, has been based for the last few decades is, therefore, changing quite fundamentally. No wonder we have a political crisis!

If this critical point is properly understand then it follows that there is a need to change the criteria for decision-making in the economy as a whole and in the political sphere in particular in future. We will not pay for string quartets to be played out of the proceeds of growth undertaken at cost of the planet: we will instead have to positively decide that string quartets should be played because we think they have greater merit than the purchase of further digital music players for which there will be no content.  In other words, we will have to positively decide to reallocate resources from making 'stuff' to the activities where productivity gains may be limited but where as a community the value of the service supplied is critical to our well-being.

That is what is shown in the second pair of diagrams. If we wish to prosper we must educate our children (and our workforces). Health has probably the greatest contribution to the quality-of-life after the meeting of very basic needs such as food, water, clean air and shelter, and so its continued provision is essential.  But if we want the education, healthcare and other services we want, which are a fundamental basis for our succes as an economy and which we have more than enough trained people to supply then it is inevitable that we will have to allocate more resources to them in the future as a proportion of GDP since productivity gains in this sector are always going to be lower than in manufacturing and than in systematised private sector services. That's just a fact.

In that case Summers' argument that we recognise this fact and despite that cut the size of the state is utterly illogical - just as it is when the same argument is made by some people claiming to be on the centre left of politics. What he and they are actually saying is we must cut the supply of these essential services and the jobs associated with them to ensure that a continuing proportion of GDP can be dedicated to the production of goods and services in the private sector despite the fact that that sector will employ increasingly fewer people to make supply those products.

Or to put it another way, what they're actually saying is we must increase unemployment in what have been state run services so we can continue to keep the same proportion of GDP in the private sector even though that sector will also be shedding staff in its relentless desire to increase productivity. But that’s ludicrous.

First, the inevitable outcome of these policies will be growing unemployment. Both the state and private sectors will employ fewer people as a result of them. Unless those arguing for such policies assume the people made redundant as a result simply ‘disappear’ as a result (and they won’t) then inevitably that means we will have rising unemployment and that’s bounded to be associated with lower demand, and so a recessionary cycle.

Second, rewards will be  distributed increasingly unevenly as a result of such policies. The return to capital as a proportion of GDP will rise – and we’re seeing that happening now – whilst the gap in income between those in employment and those increasingly out of it will also rise. The inevitable result will be that fewer and fewer people might in the future have the means to buy the private sector products that this policy is intended to promote because too many people will be either unemployed or too poor as a result of falling real wages to ever buy the consumer goods the private sector will produce. The result will be a spiral of decline, matched by rapidly increasing unemployment and income disparity.

As a result it’s right to conclude that the second pair of diagrams aren’t correct. There is no choice that they represent as shown like this where we can simply decide to allocate a fixed pie in different ways:


Instead there is only this option:


We can fix GDP as a proportion of GDP as Summers and those arguing for the constraint of budgets and government activity and who say we must cut healthcare, education, pensions and welfare want. But we can’t do so without shrinking the economy as a whole for all the reasons noted above. Given the dynamic of the economy that’s inevitable. So we move from position A to position B, and so long as we try to maintain a static state sector we continue to see the economy shrink. That’s what is happening now.

Alternatively, we have the second diagram. State sector activity is allowed to grow from C to D and it puts to use the natural resources available to generate wealth within the economy that are currently going to waste. By for the most important of these, of course, are the people currently unemployed. And because they are now active the economy does at the very least continue to have the same overall value as before. The constituent elements of that value are different. We will have more state supplied services and less, proportionately, “stuff”. That “stuff” may need redistribution as a result if the benefits of material consumption are to be properly shared to ensure the vulnerable do not lose out, but this has always been a social democratic policy. But we do continue to have a strong economy, but one built on the supply of a growing proportion of communal services to meet the needs of the elderly, the young and the vulnerable, all of whom need personal services, all of which we can supply as we have the people available to deliver them if only we are willing to let them work. And if we do let them work then overall the private sector is bigger, I suggest, in the second diagram than the first even though it takes a smaller proportion of GDP.

This, I suggest is precisely why it is wrong to say there are now more limited resources for state spending: that's just not true if we want to avoid recession, let alone create sustainable growth. Those things can only happen by the state spending more. That's a simple economic fact, in my opinion.

The challenge for social democracy now is to say that this is the reality of the world we're now living in. We aren't living in a world where growth is inevitable, but we are living in a world where there is abundance for many, and there could be sufficient for all. However to achieve that situation where all have enough and the economy as a whole prospers we are completely dependent upon making decisions that correct the currently inappropriate allocation of rewards by the market because of its failure to take into account externalities, including its inability to properly value so many communal goods and services that only the state can supply efficiently.  That decision to reallocate resources to those services will, of course, require courageous politicians who are able to defend their positions and who are willing to say that they believe they have the judgement to make these decisions on behalf of communities, and who will request electoral mandates to deliver them.  That is what social democratic politicians are going to have to do in the future.

We're not, as Larry Summers seems to think, going to want politicians who argue that we must shrink the size of the state whilst recognising that it, and it alone, can effectively supplying so many of the services that are the subject of Baumol’s cost disease.

Why would we? We’d only want such politicians if we thought leaving people to die due to lack of care was acceptable, because die they will, whether from thirst (in hospitals and care homes where staff do not have time to help the elderly drink), hunger, cold or more besides. And we’d only want such politicians if we did not care for our young and vulnerable people. And we’d only do that if we valued “stuff” more than the well-being of these people. Advertising seeks to persuade us that is, in fact, the case: that we do want “stuff” more than we want a decent life for all. Social democrats have the job of arguing that’s not true and the evidence is, of course, on our side. Take for example the fact that so much of that advertising is for things that positively harm us as increasing obesity, amongst other things, demonstrates.

This task won't be easy. This demands a big change in the culture of our society. The idea of 'more' is deeply ingrained in us, but we will have to change in any event: the alternative is simply not sustainable.  More than that though, politicians will have to change as those that are needed will have to make difficult decisions.  Politicians have for a long time been able to free ride off the back of the economy and use its surplus to avoid the difficult challenges that politics is now going to face.

But face that challenge we must: we now are at the point where we have to decide whether things like education, health, a safety net for the old, protection for the disabled, the protection of the environment, the provision of housing for those who need it and all those other essential services that are critical to the well-being of our country as a whole are more important than generating higher wages for a reducing number of workers who are engaged in activities where productivity can be ratcheted by technology even though there are a fewer of those with significant income left to buy the products they make  and with the excess returns to capital that are generated increasingly dividing society between those who own the resulting profit and everyone else. And we have to decide whether we really put value on people first. That means we emphasise in our choices employing as many people as possible productively, using their skills to facilitate the well-being of others, and to help them through this process achieve their potential in vibrant economies which are, however, more dependent upon services than ever, and with a lower overall rate of consumption of material goods in proportion to total income which we will accept because are, overall, as a result better off, as the above diagrams show.

That possibility of people being better off as a result of this available choice to emphasise the provision of more services by the state that people need is the story that social democracy now has to sell.

As Polly Toynbee has said this week:

Hard times need create no "crisis of social democracy". In Attlee's postwar days of atrocious austerity, Labour produced its best policies – and so Miliband lays out reasons why fairness matters most when money is short. His "responsible capitalism" may look ever more essential by the end of this economically threatening year.

But that is true only if social democracy embraces the idea that this responsible capitalism is just one, albeit integral, part of the whole economy in which the state has at least as big a role to play and that it also understands that it is only when the state and responsible capitalism combine together to best effect to meet the needs of the people of this country that they in combination can help the people of this country achieve their own best potential for themselves.

And that’s what social democracy is really about.