Rachel Reeves is wrestling with a dilemma many of her predecessors have tried and failed to resolve. It defeated James Callaghan during his tenure as chancellor in the 1960s, and Denis Healey in the 1970s. Alistair Darling was another victim when, in 2010, he tried to juggle the need to show Labour could handle money (without spilling it down the proverbial plughole) with persuading his own troops that a more austere state could marry a generous welfare safety net with the requirement for long-term public investment.
Callaghan’s experience is probably the closest to what Reeves faces. Looking back, it’s possible to see how his mistakes could easily become Reeves’s.
From the moment he became chancellor, Callaghan was hobbled by the mess left by the previous occupant of No 11, Reginald Maudling. Encouraged by his prime minister, Harold Macmillan, Maudling went on a Truss-like spending spree. But the economic warning signals soon flashed red, forcing him to impose strict spending limits for the succeeding years.
Callaghan’s cast-iron “fiscal rule” was a pledge to maintain the value of sterling come what may. The high value of the pound made the nation feel rich, but almost 14 years of low productivity had left the economy less competitive than its neighbours. The lack of competitiveness increased the trade deficit, putting pressure on the pound (as more pounds were being sold to buy foreign currencies than the reverse).
In response, the Bank of England spent its reserves buying pounds to prop up the value. In a move that chimes with today, Callaghan forced departments to make spending cuts to limit government outgoings.
There are also present-day similarities with Callaghan’s determination to resist calls for a revaluation that would bring the pound into balance with the dollar. The Tory press accused Callaghan of reducing the value of people’s wages, just as it had in 1949 when Labour devalued sterling by 30%.
This was shorthand for Labour being unable to handle money and devaluation being a sign of a profligacy driven by its ties to the unions.
Much as today, senior economic advisers were telling Callaghan he would regret cancelling public investment projects to maintain austerity. Anthony Crosland, a former Oxford University economist turned Labour minister, was the most forthright figure inside the cabinet challenging the chancellor, but others with access at the highest level included the Cambridge economist Nicky Kaldor.
To solve the crisis they advocated lowering the exchange rate to allow industry a chance to export more, rather than reducing demand for imports by putting pressure on household incomes and reducing government spending. Think big and do what is needed to increase exports, they said.
Callaghan held out until 1967, when a combination of domestic and global events forced his hand. These included a dockers’ strike that stopped UK exports leaving the country, waning confidence among foreign investors – which put pressure on the central bank to print yet more money – and conflict in the Middle East.
Reeves is also contending with strikes, jumpy foreign investors and a flare-up in the Middle East. While she does not need to worry about propping up the pound, she is pursuing a policy of austerity to reduce the overall government deficit, for which the outcome is the same.
Crosland’s book The Future of Socialism is worth reading as a major revisionist text of the 20th century that still resonates in the 21st. He was a champion of equality and growth unhindered by the fear of failure displayed by so many Labour figures then and now.
An entertaining biography of her husband by Susan Crosland also captures much of the drive that would have made Crosland a critic of Reeves today as much as he was of Callaghan in the 1960s.
In October, Reeves will deliver a budget that will appeal to a constituency of people – and their money managers – who want to avoid taking any risks and conserve what they have already accumulated.
This group needs to be told that they must accept higher borrowing than they would like, and fewer tax breaks, because only then can the economy benefit from meaningful levels of public investment and higher productivity.
Looking back to the 1960s, we can see that after Callaghan to Crosland et al, the economy began to recover. But the investment it spurred only registered in the last year of the parliament, too late for the 1970 election. It shows that treading water to fulfil a Tory austerity pledge is a mug’s game.