Mark Carney is saying invest your money, but there are still risks

Governor has given the green light with continued low interest rates, but markets, inflation or a housing bubble bring caution

Larry Elliott, economics editor
The Guardian, Wednesday 7 August 2013 14.25 BST

Mark Carney, governor of the Bank of England at the quarterly inflation report.

Get out there and spend. Feel free to take the plunge and buy that house. Go ahead with plans for new investment mothballed since the recession.

That, in short, was the message from the Bank of England to consumers, property hunters and entrepreneurs on Wednesday. Why? Because unless something unexpected happens, official interest rates are staying where they have been since early 2009 until 2016 at the earliest.

Such a long period of cheap money would be unprecedented. The Bank of England has never had interest rates this low in its 319-year history and is on course to keep them pegged at 0.5% for longer than it took the allies to win the second world war, longer than the French Revolution between the storming of the Bastille and the topping of Robespierre, and longer than it took the Beatles to record everything from Love Me Do to Abbey Road.

Quite a period, and evidence of just how fragile Threadneedle Street thinks the economy remains following the deepest recession and the slowest recovery in recorded history.

The financial crisis has left deep scars on the UK. This was an economy, after all, which became chronically dependent on the casino activities of the City and an over-heated property market. Matters have been made worse by the debt crisis in the eurozone, which has hit exports, and by the government’s deficit reduction plan.

That has left the Bank of England with responsibility for keeping the economy going and, fearful that recent signs of green shoots could be nipped in the bud by unwarranted suspicion that it would soon tighten policy, the Bank provided guidance on how it intends to play things.

Monetary policy is now unashamedly pro-growth and deep into uncharted waters. It has raised the inflation target to 2.5% in all but name and is effectively operating the sort of twin mandate system used by the US Federal Reserve in which growth and price stability carry equal weight.

Having experimented with quantitative easing, the Bank is now trying forward guidance: sending messages out about how it intends to conduct policy in the future. Unemployment as measured by the internationally agreed labour force survey measure of joblessness, will have to come to 7% before the monetary policy committee will even consider raising interest rates or starting to sell back to the financial markets the £375bn of government bonds it has bought under the QE scheme.

Unemployment on the LFS measure is currently 7.8%, and according to the Bank’s forecasts will not hit 7% until 2016. Conveniently for George Osborne, that means well after the next general election. Carney was hand-picked by Osborne to replace Mervyn King and the chancellor must have been well pleased with his first big public outing.

The new governor made it clear that he considered the strong data in recent weeks no big deal: “There is understandable relief that the UK economy has begun growing again. But there should be little satisfaction.”

Even after raising its forecast for growth this year to 1.4% (from 1.2%) and to about 2.5% next year, the outlook is for weak post-recession expansion by historic standards.

The MPC wants to see this recovery fully embedded and believes that there is plenty of scope for expansion while keeping inflation to 2%. But the plan to keep monetary policy ultra-loose is not a hard-and-fast promise and there are three circumstances (or knockouts) in which the MPC would consider action before the 7% threshold is reached.

The first would be if inflation 18-24 months ahead was expected to be more than 0.5 percentage points above its 2% target.

This, though, is much less of a “knockout” than it looks. The Bank invariably says inflation will be back to 2% within two years, and did so even when it was running above 5%.

The second knockout – that action would be contemplated if medium-term inflation expectations slip their anchor – is also a bit fuzzy since it will depend on the subjective judgment of the MPC.

Finally, the MPC would rethink its policy stance if it thought an abundance of cheap credit was fuelling an asset-price boom that could not be controlled by the bodies charged with regulating the City – the financial policy committee and the Prudential Regulation Authority. Even so, it would probably want to see whether imposing specific capital requirements for lending to certain sectors of the economy (such as real estate) would work first.

So, in reality policy is not going to change anytime soon, despite the risks.

The Bank believes there is plenty of spare capacity in the economy following the slump but it doesn’t know exactly how much. If there is less than it thinks, faster growth will quickly feed through into higher inflation. Nor does it really know whether there is a stable relationship between inflation and unemployment in the UK, in the way there appears to be in the US.

Nor can it confidently predict how the financial markets will respond to the news that monetary policy will remain unchanged for another three years at a time when other central banks – the US Federal Reserve for example – will be tightening. Sterling looks vulnerable to a tumble on the foreign exchanges, thereby stoking imported inflation.

Finally, there is the risk that when policy is tightened it will need to be tightened aggressively. Britain’s predilection for booms and busts in the past 40 years means that a good, old-fashioned housing bubble, with its attendant balance of payments deficits, cannot be ruled out.

The Bank, though, considers this to be a risk worth running. It has plenty of experience of recessions caused by over-heating and knows how to deal with them. But the slump of 2007-09 was different. Normal policy tools weren’t effective in a downturn caused by global financial systems failure. That’s why exceptional measures were deemed necessary. And are still deemed necessary, whatever the side effects may prove to be.

UK workers feel pain of years of falling wages

August 6, 2013 12:01 am

By Jim Pickard and Elizabeth Rigby
Real wages have fallen in 36 of the 37 months since David Cameron became prime minister, according to new data. The figures suggest the average worker will have lost the equivalent of £6,660 in that period.
Labour unveiled the data on Monday in an early attempt to draw a battle line in the 2015 general election campaign, with the cost of living expected to be a key area of debate.

“Cameron likes to talk about the global race but there has been a race to the bottom when it comes to wages,” said Chris Leslie, shadow Treasury minister. “Workers are, on average, earning today the same as they made in 2001.”
Some ministers are privately hopeful about the prospects of economic recovery after recent positive data, including Monday’s encouraging services PMI figures.
Yet households are likely to remain under pressure with more public spending cuts, or tax rises, expected to deal with more than £1tn of public debt.
Against that backdrop, few expect the issue of living standards to suddenly disappear as an electoral issue even if gross domestic product rises.
David Cameron has called the cost of living “the most important issue to families up and down the country”.
Ed Miliband, Labour leader, has promised that May 2015 will be a “living standards election”.
As such, the search is on for all the political parties to find ways to help consumers at no cost to taxpayers: for example by forcing companies to improve their transparency and provide cheaper services.
Jo Swinson, business minister, will on Tuesday announce plans to give online shoppers more time to return goods, while also giving the public greater protection from rogue traders.
George Osborne, chancellor, said the Treasury’s proposed childcare package would “help those on tight family budgets” as it launched a consultation on plans to offer tax breaks worth up to £1,200 per child to families where both parents work.
But the Resolution Foundation, a think-tank, said only a “tiny fraction” of the new money would go to the lowest paid. “It’s crucial that the government adapts its scheme to help the poorest working families,” Resolution said.
Labour has drawn up rival policies designed to give consumers better value for money, including “strict caps” on rail fares, forcing energy companies to put all over-75s on their cheapest tariff and capping interest rates charged by payday lenders.
The reason the cost of living is high is because Labour crashed the economy
– Mark Hunter, Liberal Democrat MPr
The party said on Monday that the UK had seen the biggest fall in workers’ income in any country in the Group of Seven leading economies since the general election. A YouGov poll for The Times newspaper on Monday found that 58 per cent of workers believed their pay would fall in real terms over the next year.
Few of Labour’s policies, however, would have any direct impact on the level of wages paid by the private sector – with Mr Miliband only tentatively supporting the idea of a higher “living wage”.
Mark Hunter, a Liberal Democrat MP, said the coalition had helped workers by raising the threshold where they started paying income tax.
“The reason the cost of living is high is because Labour crashed the economy,” he said. “For them to criticise the coalition for cleaning up their mess is utterly hypocritical.”
The issue of pay and workplace rights has come into sharp focus with the revelation that 1m British workers are on “zero-hours contracts”, which often provide no holiday or sick pay.
Vince Cable, Lib Dem business secretary, said he would consider changing the rules for workers who were only allowed to work for one employer. “We could move forward with recommendations to consult on legislation,” he suggested.
Chuka Umunna, shadow business secretary, will hold a summit this month to seek to establish more facts about the trend for zero-hours working. “We want to take an evidence-based approach to this, get people around the table, both employers and those on these contracts,” Mr Leslie said.
“In some circumstances there may be justification for this. But when you think of the pressure people are under, how can you plan ahead for your family if you don’t know what income you’ll get from week to week?”
 . . . 
Policy battlegrounds
Banks
The coalition is introducing new rules in September to make it easier for customers to change banks in an attempt to boost competition. Labour has promised action to cap the cost of credit, especially in relation to payday lenders.

Housing
The £130bn Help to Buy scheme will, from next year, underwrite the mortgages of homebuyers with small deposits. Labour would borrow billions to build new social housing and tackle abuses in the private rental market by introducing a national register of landlords.

Transport
Fuel duty has been frozen for two years at a cost of £6bn. Ministers want to spur competition by forcing service stations to display fuel prices on motorway signs. A rise in train fares of inflation plus 3 per cent was reduced to RPI plus 1 per cent. Labour would apply “strict caps” to fare rises and backs a new legal right for passengers to be offered the cheapest ticket.

Wages
Labour has highlighted a fall in real wages and the rise of insecure zero hours contracts. The opposition has promoted the living wage, currently paid by some employers in London, but has stopped short of committing to introduce it nationally. Ministers say the minimum wage has kept going up – it is now £6.19 – and an increase in the income tax threshold to £10,000 will ease pressure on low earners.

Energy
David Cameron promised to force energy companies to put all customers on their lowest tariff. Under the guidance of regulator Ofgem the market is being simplified, albeit to a lesser extent than the prime minister proposed. Labour would abolish Ofgem and create a “tough new energy watchdog” to pass on price cuts when the cost of wholesale energy falls.
Copyright The Financial Times Limited 2013.

Zero-hours contract workers – the new reserve army of labour?

Karl Marx would see zero-hour contracts for what they are: rank exploitation – the type of working conditions that spawned trade unions in the first place

It is a pity Karl Marx was not around last week to comment on the news that 90% of the workers at Sports Direct are on zero-hours contracts. The author of the Communist Manifesto would also have had plenty to say about the news that the official estimates of those working in this form of casualised labour had shot up by 25%. It would have amused him to hear that even Buckingham Palace – the very symbol of the ruling class – had got in on the act.

It is safe to say Marx would have cavilled with those who see zero-hour contracts as an expression of Britain’s economic strength, a demonstration of flexible labour markets in action. He would have thought “reserve army of labour” a better description of conditions in which workers were expected to be permanently on call for an employer.

The Office for National Statistics said last week that 250,000 people were now on zero-hours contracts – a 25% increase on its previous estimates but still small in relation to the 30 million people employed in the UK. The estimate is, however, disputed by some labour market experts who point out that more than 300,000 care workers are on such contracts. What is certain is that the total is on a steep upward curve; it may be as high as one million and growing.

Bodies representing employers say zero-hours contracts should be welcomed since without them unemployment would be even higher. Better, they say, that people should be working 20 hours one week and no hours at all the next rather than be on the dole.

Seen in this light, Vince Cable – who is conducting a review of the contracts – should be thinking of further deregulation of the labour market rather than contemplating measures that might reduce this “flexibility”. He could, for instance, repeal the 1874 Factory Act that banned children under 10 from working in a manufacturing plant. He could rethink the 1847 10-hour Act that said children should not work for more than 10 hours a day. He could be really bold and say that Parliament erred in 1841 when it voted in favour of the Mines Act that prevented a child under 10 from working underground in a pit. Because, let’s face it, all this legislation represented regulation of the labour market that made it less “flexible”.

It’s only fair to say that some employees are content to be on zero-hours contracts. Some students, for example, want to combine work with study and are willing to turn up when summoned. That’s also true of older workers topping up their pensions with a bit of irregular, part-time work.

That said, there is an early 19th-century feel to zero-hours contracts. It is as though Britain has gone back to the future, returned to an age where the employer had the whip hand and where the rights that workers enjoyed under the feudal system had been removed.

Research by the Resolution Foundation thinktank shows that those on zero-hours contracts earn less than those on staff or on fixed-hours contracts. They have no rights to sick pay. Holiday pay is often refused. And there is plenty of anecdotal evidence to show that if they turn down work when it is offered – even if it is to take a child for a medical appointment – they will be pigeon-holed as not suitably “flexible”. The choice to refuse work is, in reality, no such thing.

These were the sorts of labour market practices that gave rise to trade unions in the first place. Back then they had a name: exploitation.

Many big employers are wary of zero-hours contracts and there are sound economics reasons for their refusal to do so. The first is the risk of reputational damage. There have been plenty of examples in recent years of firms that have suffered from a consumer backlash against business practices deemed to be unethical or anti-social, and in an age when social media campaigns go viral the damage can be instant and severe.

The second is that in an economy increasingly dominated by the service sector, many firms want their employees to be loyal, motivated and customer-friendly. They believe that the chances of recruiting and retaining the best staff improve when employees are paid higher wages and have greater job security.

Public sector employers, in particular, should be aware of the risks. The growing use of such contracts in care homes is the consequence of an ageing population and the drive to cut costs. This is a combustible mixture, and it doesn’t take much imagination to envisage the likely outcome: more cases of neglect and cruelty.

Finally, there are the big picture consequences of casualised labour. For the individual firm, cutting costs through zero-hours contracts may make perfect sense. Firms only employ labour when they need it, so that the cost of employing an additional worker is equivalent to the extra output produced. Lower wages equals higher profit, leading eventually to higher investment and an increase in employment.

The issue is whether this equation works at an economy-wide level, the Keynesian doctrine is that driving down wages leads either to falling aggregate demand (leading to lower profits and pressure for even lower wages), a higher government bill for tax credits or increased individual debt.

In the 30 years that followed the second world war, the social democratic model held sway. It was a time when governments followed full-employment strategies, trade unions were strong, and when governments believed that rising real wages and job security were good for capitalism.

The mood changed in the mid-1970s, and in the subsequent decade high levels of unemployment, curbs on trade unions, deregulation and globalisation combined to shift the balance of power in favour of employers.

So what happens now? In one sense, a controlled experiment is under way. If the free marketeers are right, then companies such as Sports Direct will thrive while Tesco will not. Similarly, those countries that have “flexible” labour markets such as the UK will do better than those countries that cling on to social democratic values.

Marx would have seen zero-hours contracts as the continuation of a long historical trend, stretching back to the mid-1960s when the profitability of western manufacturing firms started to fall. From that moment, he would say, the search was on for measures to boost profits, and this has manifested itself in a number of ways: by direct attacks on organised labour; by the increased financialisation of the economy; by the search for cheap raw materials whatever the environmental cost; and by asset bubbles. Accordingly, zero-hours contracts are the response to tougher conditions facing firms as a result of the financial crisis. Reversing that trend will require more than legislation: it will mean tackling one of the root causes of that crisis: the imbalance of power in the labour market.

LSE British Politicast Episode 2: Austerity Economics and Central Banking

LSE British Politicast Episode 2: Austerity Economics and Central Banking

Posted: 31 Jul 2013 04:00 AM PDT

In this episode, we focus on austerity economics and the role of central banks in times of financial crisis. The UK coalition government embarked on a programme of spending cuts when it came to power in 2010. Since then many economists and academics have argued that the intellectual justification for austerity has crumbled and it is a self-defeating strategy in bad economic times. Mark Blyth, Professor of Political Science at Brown University in the US, takes this view in his new book Austerity: The History of a Dangerous Idea. He discusses why he thinks austerity is merely a form of self-harm. We also hear from Claire Jones, economics reporter at the Financial Times about the role of central banks, particularly that of the Bank of England, in the age of austerity.LSE British Politicast Episode 2: Austerity Economics and Central Banking.

 

FUTURE SHOCK: GOVERNING AS ONE NATION LABOUR

1. Future Shock examines the powerful forces of political opposition that a Labour government could face after the next General Election as it grapples with slow growth, the legacy of austerity and tensions over the E.U. It argues that Labour has to foster a powerful social movement if it is to successfully drive radical reforms.

http://clients.squareeye.net/uploads/compass/documents/Future%20Shock.pdf.

There is an alternative’ – Ed Balls’ speech at Bloomberg 2010

The case against the ‘growth deniers’ – how Labour can win the argument that there is an alternative

Download a PDF of the speech here

Watch highlights here

INTRODUCTION

I am very grateful to Bloomberg for giving me the opportunity to come here this morning to respond to the bullish speech given from this same platform by George Osborne 10 days ago.

That speech is the clearest articulation of the Cameron-Clegg Coalition strategy for this parliament.

In it, their Chancellor repeated his claim that fiscal retrenchment through immediate and deep public spending cuts to reduce the fiscal deficit would build financial market confidence in the UK economy, keep interest rates low and secure economic recovery by boosting private investment.

And the Chancellor once again declared that his was the only possible credible course ahead – dismissing anyone who doubts that fiscal deflation on this scale and at this delicate stage in the economic cycle is necessary or wise.

I was in America when I read about the speech, travelling across New England.

And after seeing first hand the worried and increasingly pessimistic mood in the US – in the media and in conversation with friends – it jarred to read the British Chancellor saying he was “cautiously optimistic about the economic situation”.

The prevailing attitude I saw in America was not optimism but fear.

Every newspaper I read highlighted people’s worries about their business, their jobs or their home and the growing concerns of US policymakers and business leaders and financial analysts at the emerging signs of a double-dip recession – and not just any recession.

They fear what Americans – especially on the Eastern seaboard – like to call a ‘Perfect Storm’.

A perfect storm where continued de-leveraging by banks and the private sector meets premature fiscal retrenchment from governments and a drastic tightening of consumer spending… as tax rises, benefit cuts and rising unemployment hit home.

And it is these fears – not just in the US but round the world – which in recent days have caused equity markets to fall sharply, bond markets to surge, well summed up by Wednesday’s Financial Times front page headline ‘Market jitters over growth’.

This is a risky and dangerous time for the world economy. History teaches us that economic recovery following a large-scale financial crisis can be slow and stuttering.

In the US, the debate is not about fiscal tightening but whether further stimulus is needed to prevent a double-dip. And the world will be watching closely when Federal Reserve Chairman Ben Bernanke speaks this afternoon in Jackson Hole to see what message he sends about the future course of US monetary policy and whether he can revive flagging confidence in the US recovery.

Here in Britain we have seen, in recent days, MPC member Martin Weale warn of the risk of a double-dip recession as a result of the current fiscal tightening.

But whether our economy continues to recover or slips back into sustained slow growth – even recession again – is not just a concern for Treasury ministers and financial analysts.

Whether our leaders make the right calls now on growth and jobs, the deficit, public spending and welfare reform will determine the future of our country for the next decade or more and shape the kind of society we want to be.

I do believe we face a choice as a country – on the economy and the future of our public services and the welfare state.

And today I want to respond to what I believe was a fundamentally flawed speech ten days ago:

– wrong in its analysis of the past;

– reckless in its diagnosis of the current situation; and

– dangerous in its prescription for the future.

This week’s IFS analysis of the June Budget has confirmed what we already knew – that the Coalition’s economic and fiscal strategy is deeply unfair.

In this speech I will argue that it is also unnecessary, unsafe for our economy and unsafe for our public services too.

Of course we need to deal with the deficit and there is no doubt that we must cut waste where it is found. There is no dispute about that.

We do need a credible and medium-term plan to reduce the deficit and to reduce our level of national debt – a pre-announced plan for reducing the deficit based on a careful balance between employment, spending and taxation – but only once growth is fully secured and over a markedly longer period than the government is currently planning.

I believe that – by ripping away the foundations of growth and jobs in Britain – David Cameron, Nick Clegg and George Osborne are not only leaving us badly-exposed to the new economic storm that is coming, but are undermining the very goals of market stability and deficit reduction which their policies are designed to achieve.

Far from learning from our history it is my fear that the new Coalition government is set to repeat the mistakes of history – and that George Osborne’s declaration of ‘cautious optimism’ on this platform a fortnight ago may go down in history alongside Norman Lamont singing in his bath.

But it is not too late to change course.

So today I will set out the building blocks of an alternative economic strategy that is rooted in economic history and analysis as well as our country’s shared values.

POLITICS, ECONOMICS AND HISTORY

First, let me say why I think it is so important for me – and indeed every other candidate who seeks to lead the Opposition – to stand up now and challenge the current consensus that – however painful – there is no alternative to the Coalition’s austerity and cuts.

Because as someone who was at the heart of the decision on whether Britain should join the Euro, it seems incredible to me that such fundamental and far-reaching economic decisions are being taken by the coalition government with so little debate and – let us be clear – with no mandate from the British people for their rise in VAT or immediate and deep spending cuts.

Yes, there is plenty of discussion up and down the country about where the axe should fall on public services – as my opposite number Michael Gove has discovered.

There are intense disputes, not least within the Conservative Party, about whether welfare reform can deliver the impact and savings claimed by Iain Duncan Smith.

And there are very important arguments taking place about the universality of benefits, and the age at which pension-related entitlements should kick in.

These are all important debates.

But the fundamental questions we face now – Is it right to be cutting billions of pounds from public services and taking billions of pounds out of family budgets this financial year and next? what will that do to jobs and growth? and ultimately, what will that mean for the deficit? – are almost ignored.

Yes, there are some important warning voices – Anatole Kaletsky, Paul Krugman, Lord Skidelsky, David Blanchflower to name a few – who have written powerful critiques on the comment pages of the broadsheets.

But for the most part, the political and media consensus has dictated that the deficit is the only issue that matters in economic policy, that the measures set out in the Budget to reduce it are unavoidable, and that there is no alternative to the timetable the Budget set out.

Interviewers look aghast when I tell them that cutting public spending this financial year and pre-announcing a rise in VAT is economically foolish, when growth and consumer confidence is so fragile. ‘But what would you cut instead?’ they demand.

So strong and broad is this consensus that a special name has been given to those who take a different view – ‘deficit-deniers’ – and some in the Labour Party believe our very credibility as a party depends on hitching ourselves to the consensus view.

I am not one of them.

The history of British policymaking in the last hundred years has taught us that on all the other occasions when major economic misjudgements were made, broad-based political, media, financial and popular opinion was in favour of the decision at the time, and the dissenting voices of economists were silenced or ignored.

In 1925, Chancellor Winston Churchill decided to return sterling to the ‘gold standard’ on the grounds that there was no credible alternative which the financial markets would support and that a return to gold would boost confidence and private investment.

He was supported by the broad mass of economic opinion – including the Governor of the Bank of England, Montagu Norman and the leadership of the Labour Party. Only John Maynard Keynes stood out against the consensus at the fateful 11 Downing Street dinner where Churchill made the decision.

But Keynes famously lost the argument and, as he correctly predicted in The Economic Consequences of Mr Churchill, the result was deflation, rising unemployment, the general strike and then Conservative election defeat.

In 1931, two years after the biggest financial crisis of the last century, Labour Prime Minister Ramsay MacDonald said spending cuts were unavoidable to slash the deficit, ease pressure on sterling and satisfy the markets, in the hope of triggering a private sector led recovery.

He wrote: “We are compelled to devise special measures to meet the temporary difficulties. The critics will have to face facts and deal honestly with the interests of the country.”

Labour MPs rebelled, and MacDonald formed a national coalition government with the Conservatives to drive the plan through with broad media support.

Again, Keynes stood outside this consensus, writing that: “Every person … who hates social progress and loves deflation … feels that his hour has come and triumphantly announces how, by refraining from every form of economic activity, we can all become prosperous again.”

And the result of MacDonald’s plan?

The promised private sector recovery failed to materialise. Unemployment soared. Debt rose. Britain faced years of low growth. The parallels with today’s situation are striking.

Again in 1949 and 1967, the decisions of the then Labour governments to resist and delay inevitable devaluation was widely supported by both the press and the Conservative opposition.

In 1981, Geoffrey Howe and Margaret Thatcher told the country: “There is no alternative” as they proposed dramatic hikes in interest rates and taxes to tackle inflation and strengthen the public finances, even as 364 economists famously wrote to The Times newspaper to criticise the plan.

And the consequences? The deepest recession since the Second World War, massive social unrest, five years of rising youth unemployment, 3 million jobs lost in Britain’s manufacturing industries and whole communities scarred for a generation.

And finally in 1990, Margaret Thatcher and John Major decided to join the European Exchange Rate Mechanism in the face of heavy financial market pressure, a decision supported by the CBI, the TUC, the Governor of the Bank of England, the leadership of the Labour Party – and widely acclaimed by the press.

Again, there were one or two voices – Alan Walters on the right, Bryan Gould on the left – who stood against the tide, but they were largely ignored.

And the result? Interest rates stuck in double figures as the UK suffered the longest recession since the war.

So the first lesson I draw from history is to be wary of any British economic policy-maker or media commentator who tells you that there is no alternative or that something has to be done because the markets demand it.

Adopting the consensus view may be the easy and safe thing to do, but it does not make you right and, in the long-term, it does not make you credible.

We must never be afraid to stand outside the consensus – and challenge the view of the Chancellor, the Treasury, even the Bank of England Governor – if we believe them to be wrong.

But there is a second lesson too – which is also very pertinent at the present time for the Labour opposition and those of us who aspire to be the next Labour leader: it’s not enough to be right if you don’t win the argument.

For – as Keynes found in 1925 and 1931 and Alan Walters found in 1990 – being right in the long run and well-judged by history is no great comfort.

Up to now, this is Labour’s current predicament. Only last week the Guardian ICM poll reported public support for Coalition action to cut the deficit.

Of course, the impact of immediate cuts to public spending on jobs and the recession has not yet fed through. And while it is one thing for the public to support deficit reduction when they are told that it will come from cutting “waste” in public spending, it is quite another when the cuts mean local school building projects stopped, or a new local play facility cancelled.

As the impact of deflation on jobs and the economy feeds through over the coming months, and the reality of the Government’s cuts programme, tax rises and benefit cuts begins to bite, I have no doubt that public opinion will become increasingly concerned.

But, in my view, to sit back and wait for the pain to be felt is a huge trap for Labour.

Because in the meantime, the clear strategy of the Coalition Government is to persuade the public both that there is no alternative, and that – however much George Osborne boasted of his own fiscal austerity before this audience – all their decisions are the fault of the previous government.

In my view Labour cannot sit back and allow this to happen.

Leadership is about changing and leading public opinion rather than being driven by it.

That is why I say it is time for Labour to take on and win the argument with David Cameron, Nick Clegg, George Osborne and others who share their views.

Not through warm words and wishful thinking.

And not only by highlighting that the VAT rises and benefit and spending cuts are unfair – because if the Tories can persuade people they are both unavoidable and Labour’s fault, we won’t win that argument either.

The last Labour government succeeded when we combined our values with economic rigour, when we were both radical and credible in our approach.

When I made the case for Bank of England independence, sticking to Tory spending plans in 1997, not joining the Euro, or raising tax to pay for the NHS I did so based on sound analysis – and we won the argument over time.

That is why we need now to win the argument for an alternative economic plan that is rooted in economic history and analysis, as well as our values and principles.

And I am clear that we cannot start waging the argument for a credible alternative path for growth, jobs, continued recovery and the eventual reduction of the deficit without first setting out why we believe the new government has got it so fundamentally wrong.

That is why it is vital that we first show that the Tory cuts are not just unfair, but both unnecessary and economically-unsafe.

THE OSBORNE BLOOMBERG SPEECH

So let me turn to George Osborne’s speech and his triumphant espousal of the current consensus.

In his speech he makes four main claims:

– that the current economic situation – and the decisions he says he must now take – are all Labour’s fault;

– that the demand from the international money markets for fiscal consolidation is so strong that Britain and other countries must cut the deficit to avoid a ‘Greek-style’ financial crisis;

– that – as a direct result of his deficit reduction plan – Britain is re-entering a period of sustainable growth, with the private sector, in his words, “confounding predictions that [it] cannot generate jobs”;

– and that anyone who argues for a slower, less steep plan for reducing the deficit is a ‘deficit-denier’ who would ‘wreck’ recovery.

1. ‘All Labour’s fault’

So first, is the current economic situation all Labour’s fault, the consequence irresponsible levels of public spending and borrowing in the early part of the last decade?

And Labour’s fault too for increasing the fiscal deficit during the financial crisis by nationalising the banks, cutting VAT and boosting public spending.

First, no matter how George Osborne seeks to re-write history for his political ends, it is a question of fact that we entered this financial crisis with low inflation, low interest rates, low unemployment and the lowest net debt of any large G7 country – and the second highest levels of foreign investment too.

Yes, we borrowed in the last decade to invest in the transformation of our public service infrastructure – and rightly so – but where we needed to raise money to pay for increased current spending on nurses, doctors and the New Deal, we raised the taxes to pay for them – the NI rise for the NHS, the windfall tax on the privatised utilities. And when handed the windfall from the sale of the 3G mobile spectrum, we used it to pay down the national debt.

Of course we did not get everything right. We should have ignored Tory and City claims that we were being too tough on financial regulation and been much tougher still. And there is no doubt that house price inflation was rising too fast in 2007 – despite the actions we took to implement the Barker report.

But in the main I believe that our decisions were far-sighted and responsible, which was why we were the government that made the Bank of England independent and the only government in British history to maintain and meet our fiscal rules for more than a decade. The increase in the trend growth rate was confirmed by the National Audit Office. And there was no significant structural deficit in the public finances until the collapse of tax revenues from the City of London in 2008.

Moreover, even despite that loss of revenues, our low debt position, our low inflation and low interest rates meant that we were the only government in post-war British history which – faced with recession and deflation – had both the will and the means to fight it through a classic Keynesian response.

Everything we did was intended to pump money into the economy, protect jobs and support household finances: stopping the banks collapsing; subsidising mortgages; cutting VAT; funding new apprenticeships and job opportunities; giving people cash incentives to buy new cars; supporting viable businesses; postponing tax payments; bringing forward public spending; quantitative easing by the Bank of England.

And as a result, we came through that storm without seeing the spiralling rates of inflation, interest rates, unemployment and repossession which have accompanied previous British recessions.

Not only that, but our actions led the world to follow suit, stopped the collapse of the global banking system, and took us back from the brink of depression.

And the effects of our actions are clear to see from the data on jobs, growth and the public finances from the first half of this year, before George Osborne’s ‘Emergency Budget’:

– faster than expected economic growth in the second quarter of the year;

– unemployment falling not rising;

– and public borrowing now markedly lower than Alistair Darling forecast back in March.

But rather than continue with a strategy that was working, George Osborne is doing the exact opposite.

As the second storm looms on the horizon, everything he is doing is designed to suck money out of the economy and cut public investment, while his tax rises and benefit cuts will directly hit household finances at the worst possible time. It is the exact reverse of the policy which allowed Britain and the rest of the world to weather the first storm.

George Osborne was fond of saying – wrongly – that the Labour government had failed to fix the roof while the sun was shining. What he is now doing is the equivalent of ripping out the foundations of the house just as the hurricane is about to hit.

2. ‘Satisfying the markets’

So what of George Osborne’s second contention – strongly supported by Nick Clegg – that the demand from the international money markets for fiscal consolidation is so strong that Britain and other countries must cut the deficit to avoid a ‘Greek-style’ financial crisis?

On this platform, the Chancellor went so far as to say that “the biggest downside risk to the recovery” was a loss of market confidence and a sharp rise in market interest rates. And he claimed that this risk had now been averted as a result of his Budget package for deficit reduction.

I do not have to tell this audience that what matters for credibility is not how tough politicians talk, but if their plans work and can be delivered.

Above all, stability requires a credible medium term path for fiscal sustainability and stable growth. What undermines confidence is uncertainty over whether a sudden fiscal adjustment is deliverable and over the impact it will have on consumer and investor confidence.

Time and time again in recent years, we have seen the markets lose confidence – usually in emerging market economies – because they see fiscal adjustment plans which look tough but lack credibility and end up being self-defeating. A vicious circle begins of slower growth, investor flight, further reduced projections for growth, a worsening fiscal position, and further loss of market confidence.

Hence Spain’s decision, announced earlier this month by Prime Minister Zapatero, to reverse cuts in infrastructure spending and put back in place some projects that were suspended – a decision designed to support growth, jobs and confidence.

In Greece the markets have looked at the draconian spending cuts that the rest of Europe has demanded from the Greek government, seen the resulting general strikes and riots in the streets, decided that those spending cuts are undeliverable, that the Greek economy will struggle to grow within the Euro area, and have lost confidence accordingly.

The Greek crisis may have started with concerns over the government’s ability to service its debt, but it is now a more fundamental question about whether its economy can grow and its society can remain stable.

By contrast – outside the Eurozone and with long-term real interest rates at record lows for both 10 year and 30 year bonds – Britain faces no difficulty servicing its debts as recent debt auctions have demonstrated – and the term structure of our debt is long thanks to the brilliant work of the Debt Management Agency.

As US economist Brad DeLong said last month:

“History teaches us that when none of the three clear and present dangers that justify retrenchment and austerity – interest-rate crowding-out, rising inflationary pressures on consumer prices, national overleverage via borrowing in foreign currencies – are present, you should not retrench.”

And yet in recent months, as Britain has followed the rest of Europe down a reckless commitment to immediate deficit reduction, we are now seeing very real worry in financial markets as fears of stagnation or even a double-dip recession grow.

Before the general election we were told regularly by the Conservatives – and also by some newspapers – that the UK economy was at grave risk of being ‘downgraded’ by the international credit rating agencies because the deficit was not paid down fast enough.

Last week Moody’s raised the prospect of downgrades for economies across Europe – including the UK – for precisely the opposite reason: because of the threat of lower growth and higher unemployment on deficits.

The fact is that savage cuts that hit the economy or are politically undeliverable won’t achieve sustainable deficit reduction or build market confidence. A slower, steadier plan, which does not put jobs, growth or services at risk, is more likely to succeed and have market credibility.

3. ‘The prospects for growth’

Which brings us to the issue of George Osborne’s cautious optimism.

In the Bloomberg speech, his third, and definitely his boldest contention, was that – as a direct result of his deficit reduction plan, and indeed impossible without it – Britain was re-entering a period of sustainable growth.

He said:

“The much-needed rebalancing of our indebted economy – away from government and towards the private sector, away from consumption and towards business demand, away from imports and towards exports – is beginning.”

I would like him to point to the precedent from British economic history which says that, with slowing growth in our main trading partners and companies de-leveraging, it is possible for public sector retrenchment to stimulate private sector growth and job creation.

The 1930s and 1980s proved the opposite. And indeed, the new government economic forecaster, the OBR, has admitted the cuts will depress jobs in both public and private sectors – starting with the loss of jobs building new schools.

The data for the second quarter for GDP may have been strong, but the signs are not encouraging for the second half of this year.

Even in the days since the Bloomberg speech, we have seen increasing signs of economic slowdown in Britain, and UK consumer confidence, business optimism and mortgage starts are all down.

For all George Osborne’s talk of ‘deficit-deniers’ – where is the real denial in British politics at the moment?

We have a Chancellor who believes that he can slash public spending, raise VAT and cut benefits – he can take billions out of the economy and billions more out of people’s pockets, he can directly cut thousands of public sector jobs and private sector contracts, and none of this will have any impact on unemployment or growth.

Against all the evidence, both contemporary and historical, he argues the private sector will somehow rush to fill the void left by government and consumer spending, and become the driver of jobs and growth.

This is ‘growth-denial’ on a grand scale.

It has about as much economic credibility as a Pyramid Scheme.

For George Osborne read Bernie Madoff: he’ll take your money and take your job, but don’t worry – if you wait long enough, he promises you’ll get it all back from someone else.

4. ‘There is no alternative’

Then – having blamed the Labour government for his cuts plan, and insisted the markets are guiding his hand – George Osborne went on to make a further bold claim.

I have argued that the Coalition’s plans for rapid deficit reduction now are not just unfair but also unnecessary and economically very risky indeed.

The Chancellor says that there is no alternative to his timetable for deficit reduction, and that anyone who argued for a slower, less steep plan for reducing the deficit was a deficit-denier, someone who wanted to “wreck the economy” and condemn it to “ruin [and] disaster”.

George Osborne includes in his charge Alistair Darling and David Miliband, who have suggested the lesser plan of halving the deficit over four years.

I told Gordon Brown and Alistair Darling in 2009 that – whatever the media clamour at the time – even trying to halve the deficit in four years was a mistake.

The pace was too severe to be credible or sustainable.

As both history and market realities teach us, the danger of too rapid deficit reduction is that it proves counter-productive:

– tipping us back into recession, unemployment rising and the deficit and debt getting worse into the medium-term.

– and requiring cuts to public spending which would hamper our long-term economic future by cutting university places or scientific research and development; or be deeply unfair, dismantling the very basis of the NHS and universal welfare state that the Attlee government established.

Yet George Osborne is planning to go £40 billion further and faster this year than even Alistair Darling’s plans.

If I have explained this morning why I disagree with the Cameron-Clegg strategy and why I believe their economic plan is a prescription for disaster, it does beg the question: what is the alternative?

It was never enough for Keynes just to rail against the government of the day and their ill thought out plans. He wanted to argue the better course of action.

So it is Labour’s responsibility to set out a clear plan for growth, a more sensible timetable for deficit reduction, and a robust explanation of why that will better support our economy and public finances.

Even halving the deficit over four years represents comfortably the biggest and fastest cut in the deficit since the period after the Second World War, but without the peace dividend to fund it.

In a recent article in the Financial Times, the historian Niall Ferguson wrote:

“People are nervous of world war-sized deficits when there isn’t a war to justify them.”

But this is precisely the case I made to Gordon Brown and Alistair Darling last year – we have just experienced the biggest global financial crisis in a century, an event as momentous in historical and financial terms as war, famine or a natural disaster.

Our economies were saved from catastrophe only by government intervention to nationalise banks and to absorb huge financial liabilities from the private financial sector. To attempt to repair the damage of such an event and return the national debt to its previous level in just a few years is not only dangerously incredible in the eyes of financial markets but places an intolerable burden on current users of public services.

Just think if Clement Attlee’s government at the end of the Second World War had decided that the first priority was to reduce the debts built up during the war – there would have been no money to fund the creation of the NHS, no money to rebuild the railways and housing destroyed in the Blitz, no money to fund the expansion of the welfare state.

All the things the Labour movement is proudest of about that post-war government would have been jettisoned.

And why weren’t they?

Because they recognised that when a country has been through an once-in-a-generation event – like the Second World War – where the costs involved are a second thought next to equipping the armed forces and saving people’s lives, homes and freedom – then the government needs a once-in-a-generation approach to the resulting debt: a slower, steadier pace of reduction which meant they could also fund the improvements in health, education and welfare that the post-war generation demanded and deserved.

So when George Osborne says that there is no alternative to their timetable and that anyone who disagrees is a deficit-denier, I say this:

If it was possible for our post-war government to have the wisdom and foresight to recognise the benefits of a slower, steadier approach to reducing an even bigger debt, then it does not behove you to close off all debate.

As for the argument that by taking a longer period to repay the debt, we unfairly burden future generations, Nobel prize-winning economist Paul Krugman puts it well:

“People who think that fiscal expansion today is bad for future generations have got it exactly wrong. The best course of action, both for today’s workers and for their children, is to do whatever it takes to get this economy on the road to recovery.”

That is why – on the grounds of prosperity and fairness – I believe Labour does need a credible and medium-term plan to reduce the deficit and to reduce our level of national debt, but only once growth is fully secured and over a markedly longer period than George Osborne is currently planning.

For the medium-term, a credible and pre-announced plan for reducing the deficit needs a careful balance between employment, spending and taxation.

We need to do more to raise taxes fairly – such as starting the top rate of tax at £100,000 and reversing the cancelled part of the NI rise. I support an international transaction tax and think David Miliband is right to propose a new wealth tax on the largest estates.

And we will need to set out tough spending cuts in some areas, as I did in the schools budget where I identified in detail the savings which could be made in school and non-school budgets alike while protecting frontline service delivery.

But by far the biggest influence on deficit reduction and the balance between taxation and spending is economic growth and the number of taxpayers in jobs paying their fair share.

That is why the priority this year and next must be growth and jobs.

The Coalition should act quickly and aggressively to reverse George Osborne’s cuts in support for the economy, and his increases in household bills.

We need to reinstate vital investments now which support jobs and recovery:

– the Future Jobs Fund

– the September school leavers guarantee

– the youth jobs guarantee

– the Building School for the Future capital programme

And we need urgently to revive the G20 process to support global growth and accelerate progress on international coordination of financial regulation.

THE BIG SOCIETY

But whatever our competing visions for the economy, growth and deficit reduction, there is also a wider and more fundamental issue at stake which could be easily forgotten or postponed as we focus on how best to protect the current status quo in terms of growth, jobs and living standards.

It is the fairness of our society.

How we confront the current financial storm and whether we can reduce the deficit and preserve a universal welfare state and strong public services will, in my view, have a profound impact on how we can tackle the greatest long-term economic challenge we face: the rising inequality in every developed nation in the face of technological change and international competition.

And this is why the debate we must have about when and how to reduce the deficit is not just about economics and jobs but about the future of our country and the competing visions of our political parties.

David Cameron and George Osborne – and Nick Clegg too – are using their crusade to cut the deficit to make a wider ideological argument that the post-war welfare settlement – of universal public services and universal benefits – has somehow failed: a symbol of the over-spending Labour government which must be scaled back, dismantled and replaced with more private provision and co-payments for services.

With Conservative colleagues from the Thatcherite right – and Orange Book liberals too – they have an excuse in the deficit for the programme they have always wanted to pursue for ideological reasons: to shrink the state and leave the vulnerable relying on charity.

So instead of the private and voluntary sectors working alongside an empowering and enabling public sector, the involvement of charities and businesses is being boosted not to enhance public provision but to undermine it. Each new policy, fresh initiative or hasty Bill pushed through Parliament sees the state being withdrawn from support for the economy, the family and public services.

It will not surprise you that I have a very different vision and take a very different view of the importance of sustaining public services and protecting those on lowest incomes as we ensure borrowing comes back down.

David Cameron has a narrow view of the role of the state – that it stifles society and economic progress. I have a wider view of the role of state – a coming together of communities through democracy to support people, to intervene where markets fail, to promote economic prosperity and opportunity.

He has a narrow view of justice – you keep what you own and whatever you earn in a free market free for all. My vision of a just society is a wider view of social justice that goes beyond equal opportunities, makes the positive case for fair chances, recognises that widely unequal societies are unfair and divisive and relies on active government and a modern welfare state to deliver fair chances for all.

Far from thinking that electoral success is based on the shedding or hiding of values, I believe we now need to champion those values and the importance of a fairer Britain – to show we are on peoples’ side after all.

Labour’s next leader needs a much stronger, clearer vision of the fairer Britain we will fight for – very different from the unfairness and unemployment the Coalition’s savage and immediate cuts will cause.

So over the coming months, it is not just an economic argument we need to win: over the pace and scale of deficit reduction; over how to protect jobs and growth in our economy; and over Labour’s responsibility for the situation we find ourselves in.

It is also an argument over fairness and the role of the state to deliver economic strength and social justice in the 21st century.

It is my contention that our opposition and our vision for government must be credible as well as radical and based on our values.

We must make clear that vision of a better Britain is rooted in a robust and credible economic analysis and an alternative economic plan.

We must persuade people in their heads as well as their hearts to come back to Labour again.

And by comparison, we must expose the Coalition’s plans as heartless and wrong-headed.

That is the challenge for Labour’s next leader.

Britain’s austerity is indefensible

Britain’s austerity is indefensible

Martin WolfBy Martin Wolf

Cameron’s arguments against fiscal policy flexibility are wrong
Ingram Pinn illustration©Ingram Pinn

David Cameron’s “there is no alternative” speech last week on the UK economy has aroused much criticism. This is justified. The British prime minister’s arguments for sticking to the government’s programme of fiscal austerity were overwhelmingly wrong-headed.

It is easy to understand why he had to defend the government’s failing flagship policy. The incoming coalition embarked on a programme of austerity with the emergency Budget of June 2010. The economy, then showing signs of recovery, has since stagnated. Even the fiscal outcomes are poor. Indeed, according to the latestGreen Budget, from the authoritative Institute for Fiscal Studies this fiscal year’s borrowing requirement may be bigger than last year’s. Only a productivity collapse saved the day – by keeping unemployment surprisingly low, ameliorating the social impact of the output disaster.

How does one defend this record? Simon Wren-Lewisof the University of Oxford and Jonathan Portes of the National Institute of Economic and Social Research, among others, have demolished the prime minister’s views. Here are the key points.

Mr Cameron argues that those who think the government can borrow more “think there’s some magic money tree. Well, let me tell you a plain truth: there isn’t.” This is quite wrong. First, there is a money tree, called the Bank of England, which has created £375bn to finance its asset purchases. Second, like other solvent institutions, governments can borrow. Third, markets deem the government solvent, since they are willing to lend to it at the lowest rates in UK history. And, finally, markets are doing this because of the structural financial surpluses in the private and foreign sectors.

Again, Mr Cameron notes that “last month’s downgrade was the starkest possible reminder of the debt problem we face”. No, it is not, for three reasons. First, Moody’s stressed that the big problem for the UK was the sluggish economic growth in the medium term, which austerity has made worse. Second, the rating of a sovereign that cannot default on debt in its own currency means little. Third, the reason for believing long-term interest rates will rise is expectations of high inflation and so higher short-term rates. But such a shift is going to follow a recovery, which would make austerity effective and timely.

Mr Cameron also argued: “As the independent Office for Budget Responsibility has made clear … growth has been depressed by the financial crisis … and the problems in the eurozone … and a 60 per cent rise in oil prices between August 2010 and April 2011. They are absolutely clear that the deficit reduction plan is not responsible.” This brought a rejoinder from Robert Chote, OBR director, who noted that: “Every forecast published by the OBR since the June 2010 Budget has incorporated the widely held assumption that tax increases and spending cuts reduce economic growth in the short term.”

Serious researchers, including at international organisations, argue that the multiplier effect of fiscal austerity may be far bigger than the OBR has hitherto assumed, at least in today’s depressed circumstances. Moreover, even if the OBR believes the outcome turned out worse than forecast because of adverse shocks, rather than its underestimation of multipliers, this is an argument for active policy, not against it.

The prime minister also stated: “[Labour] think that by borrowing more they would miraculously end up borrowing less … Yes, it really is as incredible as that.” What truly is incredible is that Mr Cameron cannot understand that, if an entity that spends close to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end up worse than when it started. Bradford DeLong of Berkeley and Larry Summers, the former US Treasury secretary, have shown that, in a depressed economy, what Mr Cameron deems incredible is likely to be true. A recent International Monetary Fundpaper argues that “fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output”. Mr Portes adds that, even if this is not true for the UK on its own, it is likely to be true for Europe since almost everybody is retrenching simultaneously.

Mr Cameron argues that “this deficit didn’t suddenly appear purely as a result of the global financial crisis. It was driven by persistent, reckless and completely unaffordable government spending and borrowing over many years.” In a way, this is the most worrying error – not because the fiscal policy of the Labour party, then in power, was perfect. Far from it. Fiscal policy should have been tighter. But that is not the main reason the UK has a huge structural deficit.

It is the economy, stupid. In 2007, according to the IMF, UK net debt – at 38 per cent of GDP – was the second-lowest in the Group of Seven leading economies. These levels were also exceptionally low by UK historical standards. In the March 2008 Budget, the Treasury estimated the structural cyclically adjusted deficit on the current budget at minus 0.7 per cent in 2007-08 and minus 0.5 per cent in 2008-09. The collapse in output has caused the explosion in deficits and debt. Almost everybody underestimated the vulnerability, the Conservative leadership among them: pre-crisis, it committed itself to continuing the plans that Mr Cameron now calls “reckless and unaffordable”.

Some think reckless spending explains the jump in government spending from 40.7 per cent of GDP in 2007-08 to 47.4 per cent two years later. Yet, between 1996-97 (the year before Labour came into office) and 2007-08 (the year before the crisis), the share of spending in GDP rose by only 1.2 per cent. No: the collapse in GDP, relative to expectations, caused the jump in spending and decline in receipts, relative to GDP. The Green Budget compares the forecasts for 2012-13 made in the 2008 Budget and the 2012 Autumn Statement: nominal GDP is down 13.6 per cent, receipts are down 17.6 per cent, spending is down 5.6 per cent and borrowing is up 372 per cent. It is because the OBR (and others) believe most of this lost GDP is permanent that the position seems so grim. (See charts.)

Mr Cameron’s argument against fiscal policy flexibility is wrong. But, beyond this, we have to consider why the economy has proved so fragile and rebalancing so difficult. That is for next week.

martin.wolf@ft.com

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York strives to pay living wage as cuts bite and poverty spreads

The city has a tradition of philanthropy dating back to the Rowntrees – and the council is determined that its workers will not bear the brunt of austerity

At the turn of the 20th century, the chocolatier and philanthropist Joseph Rowntree bought 150 acres of land north of York and created New Earswick, a low-rent garden village for his employees and others decanted from the rank slums of the city. A Quaker, he believed in investing in the wellbeing of his workers.

Today, New Earswick remains lavishly green and pleasant and is also home to a network of retirement bungalows and a care home in which Dawn Watson, 51, has worked as a general care assistant for 14 years. In January, her wage packet saw a dramatic and permanent increase of £200 a month, earned for the same job, and the same hours. The reason is that her employer, the Joseph Rowntree Foundation (JRF), now pays its staff the voluntary living wage of £7.45 an hour (£8.55 in London). “It helps with the cost of everyday life,” Watson says. “But it also makes me feel valued, better in myself – if better is the right word.”

This Tuesday marks the city of York’s 100th day as Britain’s first living wage city. The challenges it faces are immense. “Who is against a decent wage?” says Ian Gillies, leader of the Tory group on the Labour-held city council. “But it’s an issue of affordability. If we have to borrow to pay it, it becomes a political whim with dubious consequences.”

York, with a population 205,000, has significant areas of deprivation among large islands of affluence and a real housing crisis, with supply meeting only 8% of need. More than 250 jobs from a council staff of 7,500 will go over the next two years. By the end of 2015, the city will have cut 25% of its total budget – a sum amounting to millions. At the same time, £338,000 has been set aside to ensure that from April, 573 council employees will have salaries increased to the living wage. How can that make sense? Or is the living wage a compass by which progressive local authorities might steer a fairer way through austerity?

In 2011, the independent York Fairness Commission, sponsored by John Sentamu, the archbishop of York, was established. Commissioners came from JRF and Aviva, an important local employer, and included Kate Pickett and Richard Wilkinson of York University, who co-wrote a book called The Spirit Level. Its thesis is that a range of social ills, including illiteracy, violence, mental and physical illness, unemployment and low civic engagement – all costly to the public purse – are affected not by how wealthy society, is but by how unequal it is. Big gaps between rich and poor are bad for everyone, even the well-off. “Inequality is so much more widespread than many people realise,” Pickett says. “Once they do know, the first instinct is to say: ‘That’s not right’.”

According to the charity One Society, the pay gap between top and bottom earners is, on average, 15 to one in local authorities and a huge 262 to 1 in FTSE 100 companies. So far, one in eight local authorities have reduced the pay of chief executives and one in five are committed to paying employees the living wage.

In addition to the living wage, the Fairness Commission also recommended an investment in preventive action against inequality and a living wage clause in council contracts and procurements. All were adopted by the council. “Social justice is in the city’s DNA,” says Kersten England, the chief executive of the council. “We want to put money into the pockets of the poorest earned from a fair day’s pay. Money means status and has a psychological impact. York is a growth city but we want to take everyone on the journey, not just the privileged.”

“The living wage is necessary but not sufficient in itself,” Julia Unwin, JRF’s chief executive, points out. “It has to be part of a much bigger picture.” The Citizens Advice bureau in Blossom Street, York, deals with more than 60 increasingly desperate inquiries a day. Here, Unwin’s point is made manifest. “Two years ago, we always had a solution. It might not have been brilliant, but we had one,” says Clare Guinan of the CAB. “Now, we don’t.” For the working poor, income no longer matches expenditure while job insecurity is rampant. “You are no longer employed or unemployed for a period,” Guinan says. “It depends on the day.”

George Vickers, a manager at the bureau, says York has seen a 45% increase in involuntary part-time work in the past year. It is not uncommon for a person to work full time but be given a 20-hour-a-week contract. The reduction or withdrawal of benefits by Jobcentre Plus is widespread: in one case a man was given a job, beginning a fortnight later, and was sanctioned for not seeking work in the intervening 14 days. “That’s demeaning. The squeeze is on at such a fundamental level,” says Guinan.

The squeeze is also spreading. Julia Histon is the chief executive of York Housing Association, which pays the living wage and rents to those on the lowest incomes. She says: “People massively underclaim on benefits. We help them with budget planning and ways to avoid homelessness. But what’s now happening is that young professionals are also being squeezed out of the private rental market and they aren’t eligible for the housing we offer.”

Statistics reveal the scale of the crisis. The average income in the city is £20,420; the average house price £201,000. Nearly half of households have an income of less than £24,000 year but an annual income of £42,000 is required to rent a three-bedroom home. The waiting list to rent social housing is 2,690 names long and growing. “We are building 40 units a year but if you think of the scale of the problem, that’s tiny,” Histon says.

The council plans 5,000 affordable houses in four years. “Otherwise, the kids of our families can’t afford to live in their own city,” England says. “That’s also the challenge of income inequality.”

Martyn Weller is co-owner of a York business that organises adventure activities such as kayaking and caving. York has 800 small businesses employing, on average, a staff of seven. Weller’s has a turnover of £175,000 a year. Nationally, two-thirds of small businesses pay the living wage but it isn’t feasible for all. Weller pays his staff £6.50 an hour and himself £675 a month. The Ministry of Defence last year contracted his company at £255 a session, four sessions a week. Now, it’s two sessions, at £135 each. “That’s happening everywhere.”

According to KPMG, one in five of the national workforce are paid less than the living wage. In York, 103 of JRF staff have received a 20% pay increase while those at the top end have had no increase. JRF has commissioned a number of studies to assess the impact, but one bonus is already apparent. Previously, there was a 20-30% turnover of care staff, and it costs £600 to recruit and train each individual. “Turnover is much lower,” JRF’s Shaun Rafferty says. “The living wage can be a good deal for employers too.”

Six mornings a week, at Carecent, behind the giant Central Methodist church in York, volunteers provide free breakfasts, food, help and clothes to a large band of the homeless, many suffering mental ill health, all showing the wounds of permanent exile from society. Up to 60 come each morning. Donations from the public are plentiful. “York is that kind of place,” says Nicky Gladstone, project manager. Here, cuts and the living wage have little relevance. If you take nothing from nothing, you have nothing.”

“York looks pretty but it is very typical of a lot of England,” Unwin says. “Low income, low pay. What we have is strong leadership and a shared vision of what a sense of fairness might achieve. If it can be done here, it can be done anywhere.”

 The Observer, Sunday 10 February 2013