The left in Britain today is in an unfortunate position: it has a rather large problem that it has not yet recognised. Unless handled with extreme delicacy, two of the left's key goals are in fundamental conflict with one another. They are: first, to reduce the size of a financial sector that is generating economic instability and perpetuating income inequality, and second, to ensure that living standards for workers rise rather than fall.

The reforms that began in the Margaret Thatcher era had two broad effects on the British economy, both of which were tied up with Thatcher's monetarist-induced interest rate shocks. The first effect was to exacerbate the decline of British manufacturing. According to PricewaterhouseCoopers, British manufacturing accounted for about 35% of the UK's net output in 1970 and less than 20% in 2006. The second effect was the massive growth in the financial sector. According to the Bank for International Settlements, the share of the British financial sector in GDP terms went from about 20% in 1985 to about 32% in 2005.

The decline of manufacturing has stunted export growth, while the rise of finance has strengthened the sterling and allowed for increased imports – imports that are needed because many goods are no longer manufactured in Britain. This has led to large and persistent trade deficits since the mid-1980s. If Britain tried to run these trade deficits without the City of London attracting foreign cash into financial assets, the sterling would likely collapse.

Today, British consumers and producers send sterling abroad to buy imports, and this sterling then comes washing back into Britain in search of investment opportunities in the City. If investors ever found that they had nowhere lucrative to put their sterling, they would likely dump it on the foreign exchange markets. Such massive sales of the currency would drive its value into the ground.

If the left ever moved to reduce the size of the financial sector without some counterbalancing policy that ensured the demand for sterling was maintained, the collapse in the value of the currency would lead to a massive spike in prices for imports. This would manifest as consumer price inflation and would erode the living standards of the average British worker. If workers tried to avoid this erosion of their living standards by bidding up wages, the result could be a sustained and uncontrollable inflation. This is precisely what we have seen, for example, in Argentina in the past few years – we also saw something of a test case in the UK itself when financial activity slowed to a halt in 2007-8 .

Nothing damages the credibility of a left-leaning government quite like a sustained inflation. From Salvador Allende's Chile to Hugo Chavez's Venezuela, general inflations lead to discontent, electoral defeats and even coup d'états. Inflations usher in rightwing backlashes even when they're not tied up with left-leaning politics, as we saw in the late-1970s and early-1980s with the elections of Ronald Reagan and Thatcher. So any progressive government elected in Britain would have to be extremely cautious about how it set about obtaining its economic goals.

The best way to avoid such chaos would be to take a gradualist, investment-led approach. As the economist Mariana Mazzucato has argued, revolutions in innovation, more often than not, arise from state spending. If the British state massively increased R&D spending in well-targeted areas it might be able to start the long, slow process of regaining its export share. The foreign demand for British financial assets might then be replaced with demand for cutting-edge British exports.

In the meantime, the R&D spending, combined with other Keynesian policies such as a Job Guarantee , could ensure that Britain returns to full employment.

Many of the economic problems Britain faces today are due to 30 years of misguided economic policy. If the left really wants to change the game, it needs to get serious about articulating a workable alternative.