Democratic capitalism in peril?

Markets and democracy are not necessarily compatible, and the inherent tensions are becoming more apparent than ever

From his vantage point as the chief economics commentator at the London Financial Times over the past three decades, Martin Wolf has educated and provoked a global audience with his top quality op-eds on economic developments in the world, United States, Europe, Britain and large emerging countries. Arguably, he has been the best English language commentator on such matters. In the last 20 years he has written three substantial books, one on globalisation and two on the North Atlantic financial crisis (NAFC) of 2007-10 and its aftermath. He has now published an absorbing treatise on democracy and capitalism (The Crisis of Democratic Capitalism, Allen Lane, 2023). It reflects extensive research, deep thought and enormous experience. It is also very well written and with passion. Although crafted, explicitly, from the perspective of high-income “Western” democracies, his trenchant warnings and the prescriptions for the diagnosed maladies have mostly universal relevance.

In the brief space available, and at the risk of grave injustice to Wolf’s rich and nuanced analysis, let me try and convey the thrust of his argument in bullet form, sometimes using his words:

• “Liberal democracy” is defined to include (free and fair) universal adult suffrage, representative democracy and equality before the law.
   
• “Market capitalism” means an “economy in which markets, competition, private economic initiative, and private property play central roles” (oddly, the accumulation of capital does not figure).
   
• Liberal democracy and market capitalism share two core elements: The rule of law (effectively implemented) is essential to both, as is the centrality of individual freedom in economic and political life. A nation state has to preserve both and history teaches that this is very difficult: The rule of law is too often subverted and an “illiberal” or “demagogic” state is an ever-present danger.
   
• Market capitalism and liberal democracy have both evolved symbiotically in the West over the past two centuries or so. Together, democratic capitalism has fostered tremendous enterprise, innovation, investment and economic growth over long periods, taking the high-income democracies to where they are today: Even after the spectacular rise of China since 1980, they account for nearly 60 per cent of the world’s output (at market prices), while hosting only 16 per cent of its population. (Wolf pays scant attention to the role of colonialism and empire in powering the West’s rise. Nor does he mention the part played by the genocidal expropriation of large tracts of the Americas by immigrant European populations.) On balance, despite the inevitable ups and downs of history, “the Western system of democratic capitalism does, however, remain the world’s most successful political and economic system, in terms of its proven ability to generate prosperity, freedom and measured happiness”.
   
• But there are inherent tensions in the “marriage of markets to democracy”, since, in a sense, it is a marriage between complementary opposites: “The self-seeking of competitive markets to the collective decision-making of democracy”. The two main ways in which the delicate balance between politics and markets can be destroyed are excessive state control over the economy and capitalist control over the state. One leads to state capitalism and the other to some form of plutocracy or “crony capitalism”.
   
• Democratic capitalism surged after the Second World War, with the number of democracies rising from nine in 1940 to 97 in 2016, with autocratic (war-losing) regimes turning democratic, a spate of “new” nations shrugging off the yoke of empires and choosing (at least initially) democracy, and eastern Europe becoming democratic after the fall of the Soviet empire. The advent of a rules-based liberal international trading order after the war sparked a surge in world trade in both high-income democracies and a large number of developing nations, thus strengthening market capitalism in newly independent countries. Especially from the 1970s onwards, market capitalism went global, ushering in the high tide of globalisation, roughly 1980-2008.
   
• However, from the 1990s, trends were at work in the heartland countries of democratic capitalism, especially the United States, which were weakening the “marriage” between market capitalism and liberal democracy. These trends included: Rising inequality of income and wealth; the “hollowing out” of the middle class; the decline in the share of good industrial jobs; the slowing of productivity growth; macroeconomic instability; excessive “financialisation” of the economy, leading to the NAFC of 2007-10; rising corporate mis-governance; greater role of “winner-take-all” markets in the digital world; the associated increase in rents from agglomeration; reduced competition; rising tax avoidance and evasion; the growing role of race and ethnicity in politics; and the erosion of ethical standards. All this combined to spur a populist backlash against market capitalism (including globalisation), which weakened the foundations of liberal democracy and resulted in the victory of Donald Trump in the 2016 US presidential elections and the Brexit referendum result in Britain. The ensuing “big lie” about the 2020 US presidential election results and the storming of the US Congress in January 2021 underlined the gravity of the threats to democratic capitalism.
   
• Much of the rising strains in democratic capitalism stem from growing weaknesses in the economy and economic institutions, which have undermined broad-based growth and wide sharing of prosperity and facilitated the ratcheting up of “rentier capitalism” and plutocratic tendencies. To contain and reverse these tendencies, wide-ranging reforms in high-income democracies are necessary in many areas, including: “macroeconomic stability, innovation and investment, openness to the world, jobs and quality of jobs, equality of opportunity, improving the welfare state, and, most important, ending the privileges of the wealthy and powerful.” The last needs a stronger corporate governance regime, better competition policies to weaken powerful monopolies, revamped anti-corruption frameworks and far more effective taxation of the wealthy.
   
• Democracies also need to be strengthened “by reinforcing civic patriotism, improving governance, decentralizing government,… diminishing the role of money in politics”, making government more accountable and rethinking the regulatory frameworks for media and advertising to contain the destructive features of new media forms and promote greater respect for truth and accountability.

ILLUSTRATION: Binay Sinha

All this may sound like a very tall order for high-income democracies, let alone for much more numerous and less well-off nations. Wolf recognises this in his final paragraph: “This is a moment of great fear and faint hope. We must recognize the danger and fight now…”.

Democratic capitalism does seem to be seriously challenged.

The writer is honorary professor at ICRIER and former chief economic adviser to the Government of India. Disclosure: he and Wolf were young professionals together in the World Bank in the 1970s and have maintained their 50-year-old long-distance friendship since then