Third Way economics or just Thatcherism?

THE BANALITY of the slogan "The Third Way" masks something more important: the left coming to terms with international liberal capitalism.

Throughout the post-war period, the debate on the British left has been couched in terms of "social democracy versus democratic socialism". Advocates of the former, like Anthony Crosland, wanted to regulate private business rather than nationalise it and preferred a mixed rather than a socialised economy and progressive taxation to union militancy as a vehicle for income distribution.

Now, in a world more highly integrated through trade and capital flows, and after two decades of privatisation and deregulation, the specific issues are different but the underlying problems are the same: how does a government of the left retain market and business confidence? How, within these constraints, does it create space for redistribution and greater public service provision? The Third Way is essentially about reconciling these demands.

Tackling the first problem - confidence - has been taking precedence and priority over the second. Market confidence and financial stability have been pursued through a rules-based approach to macro economic policy: an independent central bank with an inflation target and a framework of medium term fiscal targets.

The value of a rules-based approach - embodied also in the Maastricht criteria for EMU - is shown in the financial stability of the Italian government which now, under an ex-Communist Prime Minister, commands better terms in international capital markets than the UK, or even the US.

If the government sticks to its guns it will benefit (politically as well as economically) in the long term. But there are legitimate doubts about whether it can survive the course. The commitment to Bank of England independence faces growing opposition in the Labour movement with economic slowdown. The decision, for political reasons, not to pursue early entry to EMU has left the exchange rate floating freely: overvalued over the last year and, in the future, vulnerable to further sterling crises.

The unwillingness to use fiscal policy for stabilisation purposes may commend itself to pure monetarists but it has unbalanced the economy and left it with higher interest and exchange rates than financial stability needs.

The Third Way also tries to be business friendly: solicitous of business opinions; committed to low top rate income tax and lower corporation tax.

Previous Labour governments tried to be friendly to business too. Harold Wilson was a fan of entrepreneurs who could be coaxed into Great Britain Ltd. What is new this time is the understanding that business is valuable,that globalisation is a positive force.

One doubt about this government is where business friendliness shades into favouritism. It requires toughness to demand competition in areas colonised by the government's business friends in the telecoms and media industries. It will require even more toughness to refuse requests for bailouts when the impending recession drives major employers to the wall.

If the Third Way concept was only a camouflage for government subordination to market disciplines and business preferences it would merely reinforce the grim determinism of Mrs Thatcher's dictum that "there is no alternative".

The vocal disillusionment of the radical left echoes precisely that assessment. But such a judgement is certainly premature and probably unfair. There are several areas where flesh is beginning to appear on the skeleton of the government's Third Way.

The first is a shift of resources into key public services - health, education and some benefit entitlements - without undermining fiscal discipline. Overall the government's approach to public spending has been austere, with 1.4 per cent annual real growth of current spending planned over the parliament - half the growth rate in the Major parliament - and a declining share of GDP.

The problem which the public spending plans at present is certainly not one of profligacy but that increased public consumption is being funded not from private consumption but from private investment - by raising pounds 20bn in taxes over five years from corporate cash flow and dividends. This is not compatible in the long run with continuing business confidence.

If a genuine Third Way is to emerge, it will start by recognising that there are open, successful, capitalist economies - like the Netherlands or Denmark for example - which provide public goods more generously than the UK (with public expenditure accounting for 47 and 52 per cent of GDP respectively; versus 40 per cent).

But the electorate has to be willing to pay and that political challenge has not been faced, as yet.

Second, a key element in the Third Way has been labour market reform: maintaining the market flexibility inherited from the Thatcher era, while shifting the balance of advantage back towards the employee, through a minimum wage, European social legislation and union recognition.

The net effect of government policy has been modestly to increase the supply of labour through tax and welfare reform - bringing single mothers and unemployed young people into the workforce - while reducing the demand for labour by increasing its cost.

Another ingredient in the government's policy mix is an activist approach to the supply side: incentives for enterprise and innovation; tax changes to promote reinvestment (the budget reform of corporation tax) and long term non-speculative, asset accumulation (the reform of capital gains tax).

Lastly, the Third Way offers an opportunity to think and act imaginatively in relation to the rather sterile ideological dialectic between (good) private enterprise and (bad) nationalisation.

Where the Third Way is underdeveloped is in creating new forms of enterprise which could, for example, enable the residual bits of the public sector like the Post Office and London transport to operate commercially.

And the government appears to have a blind spot about the competitive, non-profit, mutual sector - credit unions, friendly societies, building societies - which is often hamstrung by a combination of restrictive regulation and permissive conversion rules.

The underlying political reality is that all the major developed nations, bar Japan, have governments of what can loosely be called the centre left. None will manage, or seriously try, to reverse the heavy trend towards globalisation. Open markets and competitive capitalism are here to stay. But there is also a need to regulate malfunctioning markets, redistribute income and supply currently depleted public goods. While there are important differences about detail and method, I believe that the striving for a Third Way in Britain is right in its fundamentals.

Vincent Cable, MP, is the Liberal Democrat Finance Spokesman, a member of the Treasury Select Committee and, previously, Chief Economist of Shell