Ed Miliband must lift the grip trade unions hold on the Labour party and set out a clear strategy on the economy if he is to win the general election, Lord Mandelson has said.
The Labour peer said the 2015 election is "for Labour to lose" but warned it also faces the "very difficult minefield" of the findings of the inquiry into the war in Iraq, which are due to be published next year.
Lord Mandelson also gave a pointed assessment of the performance of Shadow Chancellor Ed Balls, who was lambasted over his response to the autumn statement earlier this month, suggesting he is "better in government than he is in opposition".
Labour's links to the trade unions are a "source of great interest and anxiety" for voters, the former business secretary said. The public "remember" that the leadership was "won by Ed on the basis of the trade union vote" and that power over the contest should be lifted from the unions.
He told BBC 1's Andrew Marr Show: "I think Labour ends the year in a strong position, well ahead on points and given the continuing economic challenges of the country and the problems of incumbency for the Coalition, I think the next election is for Labour to lose.
"I think they are in a good position but to consolidate their lead they have got some things to do in 2014 and I would identify three things.
"First of all, they have got to convert their very effective skilful tactics on cost of living into a strategy which is rooted in policies for economic growth and rising prosperity for the country as a whole.
"So, the economic picture has got to be painted in.
"Secondly, Ed Miliband faces a big test of his leadership in relation to the trade unions. He's effectively got to win the fight that he started quite radically to reform the relationship between the trade unions and Labour.
"Thirdly, I would say too he has to navigate his way through what could be a very difficult minefield and that is the Chilcot inquiry into the Iraq war, which remains a very sensitive issue for many in the Labour party but also many in the public."
Mr Miliband plans to end the automatic affiliation of union members to the party in favour of an ''opt-in'' system but the move has caused tensions with the movement and warnings of a damaging slump in funds.
The proposals were made at the height of a bitter spat with Unite over allegations of ballot-rigging in favour of the union's preferred candidate to fight the Falkirk seat in 2015.
A special conference to approve the measures - being drawn up by former party general secretary Lord Collins - is being held in the spring.
Lord Mandelson dismissed suggestions that the changes should be restricted to new joiners or be put off until well after the 2015 general election, saying the Labour leader does not have an "option".
"What Ed has got to do is follow the logic of his own analysis, his own diagnosis. He said, and I agree with him, that the relationship needs to be between Labour and the individual Labour-supporting members of trade unions rather than with the general secretaries and their block votes.
"What it means is lifting the trade union grip from the party's conference and its policy-making from the membership of the national executive committee of the party and from the trade unions' role in electing the leader of the Labour party."
Asked if Mr Miliband's prospects at the election depended upon trade union reforms, he replied: "I think that what many in the public remember is that the leadership was won by Ed on the basis of the trade unions' vote, notably the support of key trade union general secretaries.
"He's got to sort of distance himself from that and show real change but I think he can do if he turns the relationship into one between the Labour party and individual Labour-supporting members."
Lord Mandelson said the economy was not "quite as gloomy" as Labour sometimes insisted and warned that the party must show it has got the policies to bring about recovery.
He said: "I don't think the state of the economy is as glittering as the Coalition maintain, nor do I think it is quite as gloomy as the Labour party sometimes claims."
He added: "There's a mountain to climb and Labour has got to show it has got the policies, that will, on a sustainable basis achieve those things in years to come."
Asked how he thought Mr Balls was performing, he replied: "I think that Ed Balls has a wealth of knowledge and experience of economics, of international finance of markets.
"I think he has huge expertise which the country will benefit from. I sometimes think though that he is perhaps better in government than he is in opposition but that's not a bad thing. I'd rather have a Chancellor of the Exchequer who is good in government than a shadow chancellor who is simply good at being an opposition spokesman."
Conservative Party Chairman Grant Shapps said: "Ed Miliband only got his job because of trade union bosses, and now he is too weak to stand up to them.
"That means Labour would spend more, borrow more, and hit hard-working people with higher taxes - exactly what got us into a mess in the first place.
"Unless Ed Miliband stands up to his union bosses and changes the rules - so they can no longer pick Labour's leader, candidates and policies - it will be clear he is too weak to stand up for hard-working people."