Will Corbyn Face Another IMF Crisis?

A Labour government led by the party’s radical left is closer to power than at any other point in Britain’s history. Yet the folk devil of a profligate Labour party frittering away the nation’s wealth remains embedded in the British unconscious. It was this folk devil which the press drew upon in its characterisation of the 2017 Labour Manifesto as a ‘return to the 1970s’. When the Conservative Party was on the crest of power in 2009, then-opposition leader David Cameron liked to demonstrate the severity of the nation’s crisis by invoking the spectre of year 1976, when the IMF bailed out a supposedly bloated, prodigal Labour government, as the value of the pound fell. Cameron was linking this exchange rate crisis with a purported crisis of public debt. His plans for austerity would, he argued, avoid going cap-in-hand once again to the International Monetary Fund for financial assistance, as Labour Chancellor John Healey had once been forced to do. Since then a lot has changed, not least because a radical Labour leadership has put the final nail in the coffin of austerity’s public credibility. Yet while the seeming necessity of public sector budget cuts has been displaced in popular common sense, there is still a pronounced fear that outright fiscal expansion could return the country to the abyss. But these fears are clouded with confusion over two questions – what really happened during the IMF crisis, and is it in any way comparable to the position a Labour government would find itself in today?

In 1976 the United Kingdom received a loan of $3.9 billion from the IMF in return for £2.5 billion of public spending cuts. The loan was sought by the Labour government in the context of repeated runs on sterling. Global money markets had repeatedly lost faith in the pound during the postwar era, with sell-offs coming at an increasing rate since the early 1960s. What made such lack of confidence in the pound potentially catastrophic was the existence of large “sterling balances” (or international reserves of the pound) held by many of Britain’s former colonies. The various international holders of sterling could easily be led to sell off their reserves in anticipation of a possible devaluation of sterling by the government brought on by persistent inflation. The pound’s exchange rate was therefore under constant threat. The cause of this weakness of sterling is often explained as a result of “structural” features of an “uncompetitive” UK economy. As Richard Roberts puts it in his recent book When Britain Went Bust: The Crisis of 1976, “The runs on sterling stemmed from a set of economic weaknesses, policy priorities and structural features that gave rise to repeated balance of payments deficits that prompted sell-offs by overseas holders fearful of a devaluation as the solution to the disequilibrium.”

British governments of the 1960s and 1970s fought to defend the pound while at the same time attempting to guarantee full employment and high rates of growth using broadly Keynesian macro-economic policies. The conventional explanation for Britain’s competitiveness crisis during the 1970s revolves around high wages – a result of full employment policies – and consequent runaway inflation. The argument goes that because the labour system was too rigid, government efforts to stimulate the economy through demand management did not lead to increased domestic investment by private firms but resulted in growing imports and a deteriorating balance of trade. Instead of spending in the pricey British economy, investors and consumers supposedly took their cash abroad; so higher wages weren’t going to stimulating our manufacturing, but manufacturing overseas. One way for a government to overcome a situation where its products are more expensive – and therefore uncompetitive – is to devalue its currency in order to make its exports cheaper. This can sometimes get out of hand; where markets perceive a threat of devaluation, they will want to get rid of the country in questions’ currency because it is primed to lose value. (Broadly speaking, the more sterling available on the market, the lower its price). This is to say – runs on the pound took place because international holders of sterling anticipated a devaluation to counteract these competitiveness problems, and so tried to sell sell sell before the price plummeted. And if you have an economy heavily reliant on imports, then you run into serious problems if your currency can’t buy as much of those cheap overseas goods. Here conventional economic assumptions about competitiveness seem to imply that expansion of the public sector to support the economy artificially boosts wages and renders exports less competitive.

The IMF is one of the key institutions set up in the Bretton Woods era to manage the new system of global finance under the hegemony of the dollar. When sell offs-of sterling occured in the past, it was a regular lender to British governments. British foreign reserves nowhere near matched the volume of sterling that could theoretically be sold off, so loans from the IMF were vital in allowing the British government to stabilise the pound exchange rate by buying up hoards of sold-off sterling. After 1971 the United States, which was suffering its own competitiveness crisis, ditched its guarantee to exchange the dollar for gold at a fixed rate, and soon after a system of floating exchange rates emerged. This saw renewed attempts of the UK to manage the exchange rate of its currency despite its economy under-performing relative to newcomers such as Germany and Japan.

With the onset of the oil crisis in 1973, the UK balance of payments deteriorated rapidly, reaching a peak of £3.4 billion in 1974. Labour came to power in the second election of that year with a tiny majority and a nervous party leadership. A further changeover in 1976, when Prime Minister Harold Wilson resigned and was replaced by his Chancellor James Callaghan, did not help matters. The Labour Party was being torn in two directions, with a radical grassroots pushing for left-wing, democratising reforms to the faltering post-war system and a leadership which was increasingly keen on monetarist, supply-side economics. Both Wilson and Callaghan shared an enthusiasm for “voluntary wage restraint” by workers, as promised in the so-called Social Contract between Labour and the Trade Union Congress (TUC). They believed wage restraint was a major electoral asset, with its power to curb inflation and restore confidence in the pound. Professor Christopher Rogers of the University of Warwick argues that, “The Treasury and the Labour Government used marked rhetoric and IMF conditionality in order to depoliticise the consequences of retrenchment in a strategic way.” In other words, Callaghan and his new Chancellor Dennis Healey were persuaded that some level of fiscal retrenchment was necessary in order to restore confidence in the pound, and the IMF was the means to implement cuts that they had decided were necessary anyway. Wage moderation and cuts to the public sector – were supposed to reduce inflation and therefore send a signal to the markets that the government would not need to devalue sterling. Moreover, their decision paved the way for the rise of monetarism, in which demand management was forgotten, and replaced by management of the money supply to fight inflation.

There was a significant decline in inflation from 25.9% in 1975 to 14.7% in 1976, as a result of voluntary wage restraint, recession, and cuts already agreed to by the cabinet. Nonetheless, the government argued for the necessity of still more dramatic fiscal retrenchment. Rogers argues that, despite its public arguments to the contrary, the Treasury was actually in favour of managed depreciation of the pound to restore competitiveness, even as it publicly argued that the weakening exchange rate threatened Britain with default. The Treasury first tried to balance the political impact of this monetary management by promising no further cuts to public services, but once negotiations with the IMF over the loan conditions began, and it became clear that those promises would be impossible to keep. The threat of total economic failure was used to dissuade government ministers from backtracking. This culminated in Callaghan’s famous speech to Labour conference, in which he argued that “we used to think you could spend your way out of a crisis… I tell you in all candour that option no longer exists”. It was drafted by the monetarist media commentator Peter Jay.

Thus the government’s supposed humiliation of having to resort to the IMF was a more complicated process of adjustment by a Labour leadership that had grown sceptical of Keynesian demand management and wanted a non-socialist way out of the quagmire. Despite various proposed alternatives from social-democratic and left factions within the cabinet, most notably Tony Benn’s Alternative Economic Strategy of import controls and a democratised economy based on sustainable industrial growth, the atmosphere of heightened tension saw the Treasury and the Prime Minister win out. They argued that the only alternative to the IMF was economic chaos which would see Labour booted out of office, and the installation of a Conservative administration bent on even deeper cuts to social spending – an argument which rapidly acquired a dark irony following the election of the Thatcher government in 1979. From then on, governments would dedicate themselves to busting inflation through monetary controls and abandoning the goals of high wages and full employment.

Was the IMF deal unavoidable? Ultimately, the Labour government accepted the death of Keynesianism, and refused to countenance the launch of a new kind of industrial policy which could have presented an alternative to the monetary strategy presented by the IMF; a way of diverting the impacts of higher wages into fuelling the domestic economy. Simon Wren Lewis, who was at that time a junior economist at the Bank of England, remembers it as a foreign exchange crisis rather than one of public debt sustainability. As so often with Keynesian economists, he puts the failures of the government down to technicalities: the relative newness of floating exchange rates meant the technical knowhow simply wasn’t available to the government, and the management of the exchange rate assumed disproportionate priority in the minds of policymakers. With inflation high, the IMF loan was “useful” for meeting external debt obligations without devaluing sterling and bulldozing the currency’s exchange rate. Yet the evidence that the government was subtly allowing some depreciation of the pound – all whilst warning of its deleterious effects – allows for alternative readings. Rather than reaching a technical limit to its power or expertise, the government made an active decision to defer to the authority of the IMF and to remove economic policy decisions from democratic oversight. Healey later wryly claimed that the IMF loan was a “Pyrrhic defeat”, allowing him to pursue policies he had already decided were deeply necessary.

As mentioned above, Britain’s competitiveness crisis is conventionally seen as a result of a ‘wage squeeze’ on profits by organised labour operating in ‘inflexible’ labour markets. Roberts argues the crisis was a result of “poor productivity due to labour, management and investment factors, high labour costs due to the bargaining power of trade unions, and relatively high inflation.” But it was not Britain alone which suffered from a crisis of competitiveness in the 1970s. Rather, the competitiveness problem which gripped Britain was – as a former world leader and owner of a former global reserve currency – a more acute form of the competitiveness problem which gripped all advanced economies during the period. Robert Brenner, in his book The Economics of Global Turbulence, 1945-2005 , argues that the long downturn of the 1970s was not a result of militant labour demands but of contradictions within the competitive structure of capitalism per se. Because individual capitalist firms are forced to compete with one another for market share, they have to cut costs through technical and technological innovation. This individual blessing is also the system’s collective curse: as firms with high fixed capital investments grow they become reluctant to abandon existing production lines, despite the fact that smaller, lower cost firms from cheaper economies can undercut them. As relatively under-developed economies catch up with the most advanced, the profit rates of the advanced economies fall. Capitalist competition creates systematic over capacity and low profit rates in advanced economies, leading to low levels of investment, low productivity, and eventually falling real incomes. Brenner inverts the logic of Adam Smith’s ‘invisible hand’ principle: rather than being the engine of mutual prosperity, the pursuit of individual self-interest undermines the system as a whole. Brenner argues that there was no system-wide ‘wage squeeze’ on profits in the 1970s, but rather a sharpening of inter-capitalist competition, which led to policy attempts by governments in the advanced economies to shake capital free from low-profit productive sectors. The main effect of the end of the Bretton Woods system of fixed exchange rates was a weakening of the dollar, which allowed the US economy to regain some of its footing relative to other advanced economies. Britain would not devalue sterling in the 1970s and, through deflationary policies, helped to pave the way for the Thatcher-Reagan supply-side revolution of the 1980s. Deflation and tight public money became the means by which advanced economies reduced prices and attempted to restore competitiveness throughout the 1980s and 1990s. Moreover, by depoliticising economic policy and deferring to the IMF, the seeds of anti-democratic neoliberalism were sown. Neoliberalism did not simply gift political power to markets, rather it took economic policy out of the hands of democratic states and invested it instead in technocratic institutions. Yet even as neoliberalism took over from the old Keynesian productive capitalism, the productivity crisis remained.

The policy platform developed by Labour under Corbyn offers the first signs of a left-economic answer to the long productivity crisis of British capitalism. For both the Labour left and the Labour right, the spectre of 1976 looms large. Yet even for those who are sceptical of the policies of the present Labour leadership, a full-blown exchange rate crisis of the kind which would require IMF intervention remains unlikely. As Richard Roberts argues, governments today are much more “adept” at floating the pound. No recent government manages the currency today as it sought to do between 1972 and 1992 (the era of the Exchange Rate Mechanism crisis). British government debt is now a much safer bet and maturities are longer. Inflation is of course a far-cry from its mid-70s peak (even after import price hikes since Brexit). Britain’s central bank, the Bank of England, can act as lender of last resort to the government even if there is a spike in yields on government debt. Meanwhile, the Labour leadership has been careful to avoid association with the various myths of fiscal laxity. One central plank of its economic platform has been not to borrow for day-to-day spending but only for “long-term, patient investment” as Shadow Chancellor John McDonnell puts it. A financial transactions tax, proposed in the Labour manifesto, would start to undo some of the most dangerous effects of financialisation, encouraging productive investment in the private sector and undoing some of the power of global financial markets to strangle the economy. It is far from certain that such “unprecedented” intervention by the government in the private sector would be enough to reverse decades of productive decline in Britain, but it would be a start towards a fairer, more redistributive economy.

If elected, and if it stumps up the promises outlined in current policy thinking, the current Labour party would likely be the most politically radical government to ever lead an advanced western economy. It was the radical economist Michal Kalecki who, in his essay ‘Political Aspects of Full Employment’, first observed how the limits of government policy were not economic in the strict sense but political. While there was in effect no fixed limit to the government’s ability to increase employment, eventually the organised power of the working class under conditions of full employment would become a threat to capitalist class interests. Kalecki argues that, under conditions of permanent full employment the “social position of the boss would be undermined, and the self-assurance and class-consciousness of the working class would grow.” The threat of revolt by the bosses was not down to a simple mechanical pressure on returns to capital through spiralling wage growth, but was a political effect of an empowered working class movement clamping down on capital’s supposed freedom. Corbynism is not a threat to capitalism in the simple sense of it being economically damaging. Rather it is a political threat to the power of capital. And it is on the terrain of politics in the broadest sense – from the social movements to the political parties of an emaciated liberal democracy to the broadly traditionalist civil service and on to the organised power of workers and capital – that the battles will really be fought. In 1976 the Labour leadership was bending towards monetarism and austerity; today, thanks to the actions of a reborn British left, it is bending in a very different direction the ultimate destination of which remains uncharted.

It has become commonplace to argue that the 1970s was the decade in which politicians surrendered power to the markets. Yet, the case of 1976 shows that political elites operating at the heart of the state as well as through central banks and international institutions remained as powerful as ever – it was not so much a capitulation as a confluence of interests. The belief that the power of politics could no longer match the power of markets had also led to the assumption that attempts by government to intervene in markets all end in disaster. As we have seen, the conventional account of Britain’s competitiveness crisis holds that investors and consumers sent money abroad rather than invest in the pricey and uncompetitive British economy. A revived version of the ‘crowding out’ theory, by which a growing public sector deters private investment, was used to justify austerity as the way to avoid a so-called investment strike. In open economies in which global financial markets are highly integrated, it is commonly held that capital flight is caused by an active state intervening in the economy. But as we have seen, it was not overpaid labour or an overgrown state which caused the crisis of competitiveness of advanced capitalism in the 1970s, but rather the entry of cheaper economic units onto the unevenly developed capitalist world market.

Setting the particularities of the British exchange rate crisis of the 1970s aside, would a radical government with a Keynesian programme for stimulating aggregate demand through public investment inevitably struggle against capital flight or an investment strike? In a purely mechanical world, probably not. Publicly coordinated investment could spur the private sector, reducing uncertainty about the future. A Labour government would act to wean the economy off low-paid, low productivity service sector jobs and towards high-tech, high-productivity green jobs. But as we have seen, we do not inhabit a world where economics is divorced from politics. It is likely that a future Labour government would encounter political resistance on a scale comparable to that levied on Greece’s Syriza government in the early days of its administration. Syriza arrived in government armed with a similarly moderate programme to reflate demand in the Greek economy, yet specific political decisions helped force that government into a corner in its debt negotiations. In particular, Mario Draghi’s decision to stop the purchase by the European Central Bank of Greek bonds forced the Syriza government into using more expensive Emergency Liquidity Assistance and placed a sword over their heads during talks with the Troika. A Labour government in Britain would have obvious advantages over Syriza. The British economy is larger and not bound into the strictures of the single currency. It is likely that a government of the left would be met with some degree of capital flight – yet the gamble of a left-Keynesian government would be that the multiplier effect of targeted public investment and the increased consumption power of the working class from wage rises would offset the movements of mobile capital out of the country. Shadow Chancellor John McDonnell has reportedly set up war game style strategy planning to think through how such moves by capital could be anticipated and countered. His team of war-gamers will surely be contending with the prospect of some restrictions on capital movements and ways to offset a plummeting pound. Any major intervention or significant alteration of policy in a modern economy will provoke such a response. But the fate of a future Labour government will not ultimately be determined by the ‘confidence’ of impersonal markets. Nor will it, as some argue, inevitably end in a stand-off between the inexorable forces of capital, and the well-meaning ideologues who intervene to their peril in its operation. Ultimately, the outcomes will rest on a political struggle between the forces who want to press ahead with the programme and those who want to retreat from it. Key groups with real political power will press for the full-scale abandonment of the programme and will use the levers of neoliberal power to halt the government in its tracks. Any rise in inflation or any policy that jeopardises the freedom of capital will be used to cultivate an air of chaos around the government. Whatever the result of the Brexit negotiations and the state of the British economy after exit is finally completed (retaining Single Market membership or not), it will again be used to undermine the programme. The government’s allies will not even necessarily be in the cabinet – but on the streets. This is why it is so important to organise people now and to be ready to face those political battles when they come.


Published 8th October 2017

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