Dennis Leech argues that when it comes to paying for the pandemic, Labour should learn the lessons of the two world wars: austerity is not sound economics for recovery
Comparisons with wartime are appropriate because of the nature of the crisis: as in a major war costs are incalculable because so little is known about the enemy. The struggle has to continue as long as is needed. That suggests there may be important lessons to be learned from the economic history of the two world wars. Both were similar in that they resulted in massive increases in public debt, but there were also crucially important differences in the economic policies that followed that can teach important lessons for the Labour Party today.
When the virus has been tamed, there will have been a large increase in borrowing at the same time as reduced output, and the Labour Party will have to make a crucial choice: between continuing with Tory austerity or radically rebuilding the economy, between fiscal and monetary responsibility and the dynamism of a Green New Deal. In terms of the history of the party in government we can see there having been a choice between the fiscal prudence chosen by Ramsey MacDonald’s 1931 national government and the purposeful expansionism of Clement Attlee’s in 1945.
As in the 2008 financial crash, there is no alternative to spending whatever it takes. Scientists know so little about the virus that the consequences of uncontrolled spread are incalculable. There is no vaccine and its properties are not well understood yet. The best means of fighting it is by targeted public health measures of testing, tracing and quarantine. Until that has become possible, the only way is by observing strict social distancing and self-isolation.
In wartime men (and women) were taken out of economic production into the armed forces or war work. Between a third and a half of the workforce were directly being supported from the government budget. Their job was to fight the enemy; likewise today’s furloughed and self-isolating are taken out of production in order to fight the virus.
Before the outbreak of the First World War in 1914 total public debt was about £650 million; by the end of the war it had increased tenfold to £6.1 billion. It is not useful to compare nominal figures in pounds like this because of changes in prices and national income. Also of course we should remember that any government loan can always be paid off by a further loan because the UK government has never really had difficulty in borrowing.
We should also remember that the government is able to finance itself from the Bank of England. It is the overall scale of the debt that should be the subject of policy debates: how big it is relative to national income, most conveniently expressed by the debt/GDP ratio.
WW1 resulted in a massive increase in the debt ratio, from 24.5 per cent of GDP in 1914 to 133.8 per cent in 1919. After the war, much of government policy was focused on managing and reducing what was then considered a dangerously high debt level. Governments during the twenties and thirties repeatedly imposed austerity on the economy in the belief they were being fiscally responsible and supporting sound money. The second Labour government in 1931 was faced with a severe financial crisis and was told it had to make swingeing budget cuts. The prime minister Ramsey McDonald accepted the austerity argument, abandoned his socialist manifesto, formed a national coalition government and forced cuts through with Tory support against the opposition of almost the entire Labour party.
The effect was to deepen the depression, worsening unemployment while having little impact on the debt/GDP ratio – which by 1939, at 140.7 per cent, was actually higher than it had been at the end of the war.
During the almost six years of WW2 the debt ratio increased massively again, so that by 1946, just after the war, it had attained its highest ever level, at 242.3 per cent of GDP.
Despite inheriting this record debt ratio however, the postwar Labour government did not treat it as a burden but took a different approach from their predecessors. They applied new Keynesian economic thinking, learned from the bitter experience of the interwar period, in making their priority reconstruction and the achievement of full employment, through a socialist inspired expansion of the public sector. They focused on growing the real economy rather than paying back the debt.
The success of Labour’s post-WW2 economic radicalism was proof of the important principle that the level of government debt should never be made a priority over the promotion of full employment, and ushered in thirty years of prosperity. Meanwhile, without debt reduction being directly targeted as the main priority of government policy, the debt ratio came down steadily.
The two world wars were similar in that both resulted in massive increases in government borrowing, but they taught contrasting lessons in how the government should respond. After WW1 successive governments failed to achieve the debt reduction they sought and there was lost output. After WW2 the economy was put on a growth path that was sustained for many years by using government spending to maintain full employment and stimulate growth. In a sense there has been a natural experiment in economic policy over a period of thirty years comparing what we now loosely call neoliberalism with a mixture of Keynesianism and socialism. Yet looking back at it from today many policymakers seem to have forgotten the lesson that we learned then.
Before the Covid-19 pandemic hit us we had had ten years of austerity policies, imposed by Tory chancellor George Osborne in the wake of the 2008 crash. The recovery had been slow and living standards stagnated. Yet the debt ratio in 2020 was estimated to be about 83 percent, a figure that was still higher than the 64.0 percent it had been in 2010. So we can see once again that austerity does not work. In effect the government’s response to the 2008 crash was to repeat the mistakes of the 1920s and 1930s. Osborne made the elementary mistake of believing that the public finances of a country could be managed on the same principles as a household.
The Office for Budget Responsibility has estimated that the cost of the virus measures will mean the government will need to spend an extra £300 billion more than budgeted for, and that the debt/GDP ratio might increase to 115 percent by next year – a level comparable to that following WW1.
Faced with such an increase in the debt ratio, Keir Starmer’s Labour has a challenge. It must break with the neoliberal mindset as it did after the Second World War. That means rejecting the false narrative of so-called fiscal responsibility leading to austerity budgets. Instead, its policy should be managing the economy for green growth, full employment and prosperity.