In the history of the Labour Party, no one is quite as reviled as the ‘turncoat’ PM Ramsay MacDonald. In the face of the Great Depression, rising unemployment, and a growing budget deficit, MacDonald proposed cutting public spending and raising taxes to defend the currency and balance the budget: this saw the collapse of a Labour government (and near destruction of the Parliamentary Labour Party) and in so doing furnished the left with one of it’s most treasured legacies: that it is only through betrayal that socialism has never been realised. Moreover, it explains the psychology of how Labour is responding to the current crisis.

Keynesian economics gained much credence in the wake of what was seen as MacDonald’s austere deflationary programme: thus the idea that ‘something must be done’ in the current crisis is perpetuated. That Keynesian economics (at least as practised) was ultimately proved wrong, that purchasing a little economic stability now stores up huge dislocations later, and that in trying to pump-prime a retail sector bloated will only perpetuate the causes of instability seems beyond the point: the most corrosive element of Keynesian thought to make a comeback is the obsession with the short-term. Rather than focussing on how to keep unemployment low today, the focus should be on what will create the new jobs of tomorrow. UK R&D spending, along with productivity, lags behind other developed countries and it is these that will impede a recovery when it comes.

The most apposite comparison is Germany (which recently dismissed the pre-budget report as irresponsible). In the post-war period Germany focussed on having a stable currency and low inflation. Britain focussed on Keynes instead, and set eye-wateringly low level of unemployment as the primary macroeconomic target. This came at a huge cost in terms of productivity which ultimately led to the collapse of much of UK manufacturing. We are in danger of making the same mistakes now in response to the credit crisis, and though it is painful for a Labour supporter to admit, we may see the destruction of a reputation for economic competence that New Labour worked hard to achieve as a Labour government once again approaches the exit door with high unemployment, a devalued pound, and a budget deficit running out of control.

So, what is to be done? I cannot claim to have any easy answers, but given a historical trade deficit something must be done to return the UK to a position of being a net exporter. We can only finance more debt if there is a prospect that we will, as a nation, have the means to service it. This means supporting innovation, cutting regulation and taxes where necessary, and promoting research and development. It also means updating Britain’s dilapidated transport infrastructure. This however, may all prove to be academic.

The continuing collapse in the value of the pound predates the news that a second bailout may be required for the banking sector. How this bailout is financed is important. It has been calculated that the UK’s external debt is now 400% of GDP so extra borrowing is going to be extremely difficult to finance unless you consider the politically toxic option (for Labour) of going cap-in-hand to the IMF (there is the other option of ‘quantitative easing’: printing new money like wallpaper in laymen’s terms but how this prevents a further slide in the value of the pound is beyond me). So, if the economic situation worsens and more specifically liquidity in the banking system dries up, Labour will be faced with the option of cutting public spending dramatically or bankrupting the country. Faced with that alternative, it might seem that Ramsay MacDonald wasn’t so wrong after all. Would the left admit as much? Of course not. However, it would be a pyrrhic victory for orthodox economics if this came to pass.