The two child benefit cap affects an estimated 1.5 million children across the country. Recent research suggests that as many as one in four children in some of England and Wales’s poorest constituencies are in families left at least £3,000 poorer by the policy. This article discusses the role of the financial markets in shaping policy aimed at addressing the current cost of living crisis and outlines that way that governments and potential governments are disciplined into adhering to the economic status quo.
Since almost 200,000 families living in Labour-run councils are affected by the two-child benefit cap, with the party holding power in seven of the 10 local authorities worst hit by the policy, the question for many interested in using progressive policy to address entrenched poverty, is whether an incoming Labour government would be committed to repealing this policy. After all, removing the cap may be the most cost-effective way of reducing the number of children living in poverty. Abolishing the cap would cost £1.3bn a year but would lift 250,000 children out of poverty, and a further 850,000 would be in less deep poverty.
The recent policy announcement that, should they win power, Labour will not commit to scrapping the two child benefit cap policy has therefore proved controversial. Indeed, this policy has led to attacks from anti-poverty campaigners and disquiet from senior figures in the party. So why has this announcement come to pass?
While there has been speculation on an ideological disinclination toward progressive policy on the part of the current Labour Party and on the influence of the right wing press, research suggests that a focus on financial markets may be a worthwhile lens through which to understand anti-poverty policy in the run up to the next general election.
The relationship between politics and financial markets is central for many, if not most, political economy arguments. Politicians worry about financial markets because asset prices have major implications for voters and key societal groups, and hence influence popular evaluations of policymaker performance. Financial investors worry about politics because political choices decisively influence financial returns and volatility. Political developments often constitute a major risk or opportunity for investors.
Indeed, the literature on politics and financial markets typically considers not only whether a given political phenomenon drives asset prices up or down on average, but also whether it contributes to heightening or lowering the amount of uncertainty surrounding the realization of the expected returns.
Stability and predictability appear to be key. If an event is easily foreseeable, the market response when the event occurs is small because the information is already reflected in the price of a given asset. Indeed stock market volatilityincreased significantly after the transition from Imperial Germany, an authoritarian regime, to the Weimar Republic, an (unstable) democratic regime. This was attributed this effect to the increased political uncertainty under the new political regime
In an analysis of four major foreign-exchange markets (UK-Ireland, U.S.-Canada, Germany-Sweden, Australia- New Zealand), it was shown that consensual forms of democracy characterized by proportional representation tend to buffer currency markets from the effects of political uncertainty. In majoritarian electoral systems, elections are more likely to produce significant changes in economic policy, which makes the effect of political uncertainty on their currency markets more pronounced.
Liz Truss and Kwasi Kwarteng found this out the hard way when they announced a radical new economic agenda of tax cuts and spending worth tens of billions of pounds, funded by borrowing – the true total of which was unknown. Truss’s drive for growth proved too radical for traders. The pound was sent spiralling to reach its lowest value against the US dollar, and an intervention from the Bank of England was made to avoid a raid on pension funds, and rebukes from foreign observers, including the International Monetary Fund (IMF), were swift. Government bonds, known as gilts, had also seen a sell-off. And markets were predicting a sharp increase in interest rates, as the Bank of England stepped in to offset the inflationary impact of the plans.
The argument being made here is not that a potential Labour Government will alone be prone to market pressure; the Truss Government’s tax cuts would have heralded in the most right wing political economy in decades. Rather that the key is stability, predictability and certainty. To this end there was a tiny element of truth in the Truss assertion that they got the messaging wrong. That the policy was morally bankrupt was an aside to capital markets whose market openness allows participants in financial markets to react dramatically to changes in government policy outcomes, indeed with a speed and dexterity that political institutions can’t come close to.
It is for this reason that Corbyn and McDonnell were planning for a possible run on the pound if Labour went into government in 2017. John McDonnell said Labour was doing “war-game-type scenario-planning” for events such as “a run on the pound” as Labour governments during the 1960s and 1970s came under financial pressure in the markets, leading them to devalue the pound, by lowering the exchange rate, on more than one occasion. Labour’s 2017 election manifesto contained pledges to bring rail and water companies and Royal Mail back into public ownership as well as a number of other large spending commitments – to be funded by borrowing and higher taxes on business and the better-off. Exactly the kind of radical change that would have triggered the radical disciplining of policy via capital markets.
Indeed it was the ability of the markets to move capital with speed that likely forced John McDonnell into reassuring the markets in January 2019 that capital controls would not happen under a Labour government. However the reality is that excluding capital controls from economic policy is to essentially exclude any policies which disturb high finance.
That investors can respond swiftly and severely to actual or expected policy outcomes means incoming governments are forced to consider financial market participants’ preferences when creating and discussing policy. As long as the markets can crash an economy in a weekend then a primary political conversation will be with the capital markets.
There are profound problems with the way that the policy process is communicated in popular political discourse and misconceptions of the policy process fail to adequately reflect the real-world complexity of the processes and practices of policy-making and implementation. The desire for policy interventions to address the rampant wealth inequalities that crush the lives of an increasing number of UK residents have to be understood in this context.
If progressive policy to rebalance the economy in favour of the millions who have been sacrificed at the alter of austerity and prolonged neoliberalism is to be achieved, then the focus of political activity and activism needs to be pointed toward international cooperation toward regulated financial markets. Until then we will continue to founder in a simulacrum of democracy where discourse on economic fairness hides the domination of high finance to discipline governments of all political persuasion to adhere to the economic status quo.