John Smith has a mountain to climb: Peter Kellner believes Labour can stop sliding down the demographic escalator by embracing the capitalist virtues

THE SINGLE most frightening fact for John Smith to digest as he gathers up the reins of the Labour Party is not that Labour did badly in April's general election, but that it did rather well.

Athletes who lose when they perform below their best know that with more training, better coaching and improved technique they have a chance of winning. The athletes with real problems are the ones who do their best and still lose. In 1992, unlike in 1987 and 1983, there is a powerful case for saying that Labour played its best. Labour lost because the party, as it had evolved, was fundamentally unelectable. And, as time goes by, its problems will grow more acute, not less.

Labour has spent the last three decades struggling to climb a descending escalator. Gradually but relentlessly the Tory-voting classes have expanded, while the Labour-voting classes have contracted. In 1961, 14 per cent of working men and women had managerial or professional jobs. When the 1991 census figures are published they are likely to show that this group has more than doubled, to 30 per cent.

Meanwhile the proportion of workers with manual jobs has declined from 58 to 40 per cent. The chances are that at the next election voters with professional or managerial jobs will outnumber voters with manual jobs, given the higher turn-out of the managerial group.

Contrast that with the four-to- one preponderance of manual workers when Harold Wilson became Labour leader, and you have a measure of the way demography is corroding Labour's traditional electoral base like slow but unstoppable acid.

This would matter less if political loyalties had escaped their class ghettos. Most studies, however, suggest that 'class dealignment' - a vogue concept of the 1970s - has been minimal. Labour has gained some middle- class voters, especially public-sector workers such as teachers; the Tories attracted some skilled manual voters.

But geographically, the country is more polarised than ever: the declining inner cities are more firmly Labour than ever, while the Tories have taken an extended lease on the expanding outer suburbs. Labour has failed to break out from its heartlands. And, with each new set of decisions by the Boundary Commissioners, those heartlands contract by another 10 or a dozen seats.

The task facing John Smith, therefore, is to bend the curve of British political history. How?

Labour would be mad to resurrect the left-wing prospectus that Neil Kinnock buried. Its popularity surged whenever it acted decisively against the left-wing totems - after Mr Kinnock's assault on Militant at the 1985 party conference, for example, or the party's decision finally to abandon unilateralism in May 1989.

The problem is not that Labour has abandoned traditional socialism, but that it has not constructed an effective alternative. The party inhabits an ideological vacuum. It has reconciled itself to market economics, but only grudgingly. It declines to celebrate the virtues of dynamism, freedom and choice that capitalism can deliver.

Labour is too scared of its past to say boldly what is good about modern capitalism - and too scared of its opponents' orthodoxies to say boldly what is bad.

What Mr Smith has to grasp is that without some coherent ideology Labour will keep reacting defensively to events, doomed to proposing only those policies that don't frighten the horses. And the only credible ideology on offer is capitalism. That is the simple, direct truth that almost every leading Labour MP knows, yet none dares voice.

Market forces, competition and private ownership are capable of generating greater prosperity than any other system the world has seen. The collapse of the Soviet empire has destroyed the proposition that the economics of state ownership has anything useful to say about wealth creation.

This is the heart of the matter. Harold Wilson used to say that British socialism owed more to Methodism than Marxism and he boasted that he had never progressed beyond the first chapter of Das Kapital. Yet Marxist thinking blighted socialist thinking in Britain for more than a century.

The notion that 'socialism' and 'capitalism' are rival systems is specifically Marxist. Pre-Marxist socialism, as it was debated in France in the 1820s or operated by Robert Owen at his textile mills in Lanark, had nothing to do with public ownership or state planning.

Its concern was to wrest economic and political power from the landed gentry and spread them to everyone. Liberte, egalite, fraternite inspired radicals long before anyone thought of nationalising the railways.

For Mr Smith now to endorse capitalism wholeheartedly would not be to jettison socialism - only its discredited Marxist version. He would be able to liberate those features of socialism that still have resonance - democracy, justice, compassion, co-operation - from the crushing embrace of state control.

He would have some chance of persuading voters that Labour has a strategy for creating enough wealth to finance its social ambitions.

And, Mr Smith would be able to do something else. Once he acknowledges the virtues of capitalism, he can address its failings. This means, for example, jettisoning Clause Four of the party's constitution - advocating 'common ownership of the means of production, distribution and exchange' - which condemns Labour to relate its politics to an outdated ideology.

The party is like a society of commuters with a constitution advocating stagecoaches; when the car breaks down, they debate the rival merits of the internal combustion engine and the horse. But those who wish to resume their journey must send for a mechanic, not a vet.

Mr Smith must show that he can fix British capitalism. Britain's economy is weaker than its main rivals. Squalor, homelessness and crime are growing. Our schools, health services and railways are underfunded. Our training and investment levels are too low. Like other countries, we have problems in taming capitalism: the system that rewards innovation and enterprise also offers temptations to those who lie, cheat, exploit their workers and seek monopoly power.

A candid repudiation of Labour's ideological baggage would give Labour its first chance for many years to set the agenda. Only by exorcising its historic aim of replacing capitalism can the party think, and sell, serious thoughts about how to bring capitalist prosperity to all.

If there is a single phrase around which Mr Smith should regroup Labour's thinking, it is 'democratic capitalism'. 'Democratic' is an elastic word, often used by rogues to disguise oppression; yet that should not deter those who wish to use it for more noble purposes - the spread of justice and opportunity. The phrase 'democratic capitalism' signals a determination to sustain the best system of wealth-creation and to fight its failings.

Labour must also replace the trade-union block vote.

Although Conservative Party members have no say in the party's choice of leader, chairman or policy, the Tories have never minded being described as undemocratic: they base their appeal on their superior reputation for running the economy and delivering tax cuts. Democracy is, however, central to Labour's purpose. Under Mr Smith, the party will need to show that it can run itself as it would wish to run the country - efficiently and democratically.

The uncertain mood and the scale of Mr Smith's victory give him a freedom that Hugh Gaitskell could only dream of, and Neil Kinnock had to fight tenaciously to attain. If he fluffs his chance, the prospect is not just that he will fail to become the first Labour Prime Minister since 1979, but that the demographic escalator will carry Labour inexorably down towards oblivion.