Labour's Teutonic ties not as tight as thought

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The development of the Labour Party's economic strategy is a process of real significance. Those who read the entire script of Tony Blair's Mais lecture last week and who were not familiar with the thinking of certain important Labour Party advisers will have been surprised. Something really has changed.

That Labour is a political party dedicated to modern capitalism was not in doubt well before this speech. That Labour, in principle at the very least, was a party committed to the principles of fiscal conservatism and responsible spending was also well rehearsed. But what was less clear was what kind of modern capitalist party it would attempt to be.

A very seductive model for Labour - or any party looking to be distinct but also modern - has been one which could be labelled "stakeholder capitalism". It is the capitalism of Germany. It is based around a set of business institutions less geared towards the interests of shareholders, and more geared towards the interests of other groups.

Shareholders enjoy a somewhat lower profile in Germany than in Anglo- Saxon economies; equity finance is relatively less important and bank finance is relatively more important. Shareholders have fewer rights, employees have more rights. The market mechanisms of corporate discipline such as takeovers are restrained; the administrative mechanisms of corporate discipline such as supervisory boards are encouraged. In general, German companies are more often likely to have one or two big shareholders - be they banks or other companies - taking a more active interest in what is going on than shareholders here, who have typically rather small stakes.

The view that "our car has broken down and we need new parts from Germany" is a natural one for Labour to adopt. The book that makes this case most powerfully is Will Hutton's The State We're In. It is a best seller and popular among Labour supporters because it offers a modern set of prescriptions (completely rejecting the perceived failures of the past) while apparently serving traditional Labour causes. So Germany provides a model that suits the workers rather than the capitalists; it promotes industry rather than services and recognises a bigger role for government and corporatist institutions than do British conservatives. You end up with a fair dose, therefore, of the policies Labour had first thought of, but without many of the drawbacks associated with old Labour.

Stakeholder capitalism looked as though it could unite the party. The left might have been uncomfortable with aspects of the German model - particularly the idea that a powerful group of bankers accountable to nobody would decide on major economic decisions - but close adherence to every piece of the German economic structure was never on the cards. As a general model, Germany was a broadly attractive one.

There was one community never completely at ease with Labour's Teutonic flirtations. That was the City. It never saw itself as the root of all British problems, as anti-industry, as short-term. It didn't want policies it thought Labour might implement - "sand in the works" of the takeover mechanism or restrictions on the level of dividend payouts. It didn't think shareholder value would be created by putting workers on company boards or centralising pay bargaining. However impressive Gordon Brown and Tony Blair, there would be reservations in the City that the Will Hutton manifesto would be the one to take hold in Downing Street.

The significance of Tony Blair's speech was that he appeared to rule out any dramatic shift of the country down the German route. Towards the end of the speech was a section - not much reported - that catalogued several reasons why Britain could not and would not want to emulate German capital markets. The speech said that even Germany itself was moving in our direction, and that the City's lead was a nice little earner for our country. It was an odd section of the speech - Mr Blair did not have to be so specific and definite in his rejection of a direction that maintains strong appeal to many in his party.

His words bore the hallmark of his economic adviser - you might uncharitably say his personal Alan Walters - Derek Scott. An economist at Barclays de Zoet Wedd three days a week and in Tony Blair's office the other two, Mr Scott is a former special adviser to James Callaghan, and a former SDP candidate. He has a strong personal commitment to one thing above all - macro-economic stability. He doesn't reject outright other measures, like some of those supply-side measures Labour has supported - policies for R&D, training, possibly even some small pieces of German-type legislation - but he thinks it is pointless unless macro-economic stability (and in particular low inflation) is achieved first. And he is a little sceptical of the anti-City manifesto.

The striking thing about Tony Blair's speech, then, was that it was an assertion of the dominance of Derek Scott's economic view in the office of the Labour leader.

While that implies at least some shift away from stakeholder capitalism, Scott and other senior Labour thinkers believe they are offering a distinct, modern capitalist programme. They want Labour to be, above all else, the party of investment. All policies - even those that people might think are just pale Tory imitation - are in fact now geared to this objective. So the problem with inflation is that it undermines the incentives to save, and distorts incentives to invest. Conquering inflation is important for this reason, and is thus more important than the Tories realise. Fiscal conservatism is important because big government deficits use up national capital and crowd out industrial investment. Keeping the deficit down is also more important than the Tories have maintained.

That Britain needs more investment is certainly something everyone in the Labour Party can agree on. That Britain can let the City, in more or less its current form, allocate the investment will prove more controversial. It's not clear that even Gordon Brown would have gone as far as Tony Blair in precisely explaining why the City is such an effective British institution.

But assuming that Tony Blair is in complete control, the City should be quietly rejoicing at a subtle shift in policy that leaves Her Majesty's Opposition far less of a threat than it had appeared it might be.