Democracy and Prosperity

July 17, 2019

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Torben Iversen and David Soskice. Democracy and Prosperity: Reinventing Capitalism through a Turbulent Century. Princeton: Princeton University Press, 2019

The authors are professors of political economy, Torben Iversen at Harvard and David Soskice at the London School of Economics. Their focus is the relationship between capitalism and democratic government in the most advanced capitalist democracies (ACDs).

The authors complain that too much of the recent literature describes that relationship too pessimistically, emphasizing the potential of capitalism to undermine democracy by generating too much inequality. In particular, they summarize Piketty’s Capital in the Twenty-First Century as arguing that “the power of capital to accumulate wealth is governed by fundamental economic laws which democratically elected governments can no longer effectively counter. If they try, capital just moves somewhere else.” This may be a little unfair to Piketty, since he does look to democratic government to curb wealth accumulation: “Although the risk is real, I do not see any genuine alternative: If we are to regain control of capitalism, we must bet everything on democracy–and in Europe, democracy on a European scale.” Nevertheless, Piketty does not seem entirely confident that democracy is up to the task, whereas Iversen and Soskice believe that it is.

A symbiotic relationship

Looking back at the last hundred years, the authors argue that “the advanced capitalist democracies, for all their instability and social problems not least at present, have been remarkably resilient and effective over this whole period.” The key to this resilience is the symbiotic relationship between democracy and capitalism. The democratic nation-state pushes advanced capitalism forward, and advanced capitalism reinforces democracy.

The first reason for this symbiotic relationship is that the state has to be strong enough to perform several crucial roles in the economy, if capitalism is to remain vibrant and innovative. The state must require businesses to engage in fair competition, as opposed to tolerating self-serving monopolies. It must require labor to moderate its demands and cooperate with management initiatives. It must invest in such public goods as education, research and infrastructure. It must negotiate changes in the rules to respond to shocks to the system, such as technological change.

A second reason for a symbiotic relationship is that the democratic electorate expects political leaders to manage advanced capitalism effectively. They have a stake in its success, and they expect results that they can see in their own lives. This is especially true of the citizens that the authors call “decisive voters.” These include the employees of advanced capitalist companies, who are usually well-skilled. In addition, they include many voters with aspirations for themselves or their children for upward mobility.

[T]he aspirational vote has a particular relevance in relation to advanced capitalism. By contrast to status-ordered societies, growth in the demand for skilled and educated labor is core to the idea of advanced capitalism as a result of technological change….Hence, while aspirational individuals, parents, and families have always existed to some extent, it is particularly associated with advanced capitalism.

Rather than simply being divided into the opposing interests of capital and labor, advanced democracies have a large middle class of actual or potential beneficiaries of capitalism. They support the system to the extent that they perceive themselves to be benefiting from it. But their incomes are lower than those of the principal owners and managers, and they depend more on public programs and services like public education and Social Security. “Accounting for more than one third of GDP on average, wide-ranging tax-financed middle-class programs ensure that those with high and rising incomes share some of their wealth with the rest of society.” The large middle class is a moderating influence. It doesn’t want the government to radically redistribute wealth from the rich to the poor, but it doesn’t want it to let the rich hog the wealth either.

A third reason for the symbiotic relationship is that capital remains “geographically embedded” within nation-states. A common initial reaction to global electronic communications was that geography might not matter much anymore. Work could be done anywhere, perhaps far from established urban centers. Instead, “knowledge-based advanced companies, often multinational enterprises (MNEs) or subsidiaries…are increasingly immobile because they are tied to skill clusters in successful cities, with their value-added embedded in largely immobile, highly educated workforces.” Skilled workers have many good reasons to locate close to others with similar or complementary skills, especially when skills are acquired through face-to-face interaction rather than from some manual. And companies that depend on multi-skilled workforces cannot easily move their entire operation elsewhere, although they can more easily outsource particular low-skill tasks. The dependence of capital on geographically embedded skilled labor gives national and even local governments some power to regulate capital, as well as some incentive to invest in human capital development for the good of the nation or other geographic territory.

For these reasons, democratic governments promote advanced capitalism, but also try to manage it in the interests of a large class of voters. Capitalism thrives, but democracy also works to the extent that voters get a good return on their political investments.

Challenges to the symbiotic relationship

The symbiotic relationship is not a static equilibrium. Capitalism is inherently dynamic, and democracy has to be flexible in order to manage it in the public interest.

Technological change is an important driver of economic change, but not in a simple deterministic way. The authors see a new technology as a political opportunity, something that can be managed for the good of the many, although not usually the all. How political responses to the revolution in information and communications technology (ICT) have shaped the knowledge economy is a central concern of the book.

Another challenge for democratic societies is the recent increase in economic inequality and the decline in economic mobility, which is especially pronounced in the United States. “We see the division between the new knowledge economy and…low-productivity labor markets as a new socioeconomic cleavage that has crystallized along educational lines and a deepening segregation between successful cities and left-behind communities in small towns and rural areas.” The rich have been getting richer and the poor have been left behind, but the impact on the middle class is more complicated. A modest reduction in their share of national income has been accompanied by an absolute increase in income, especially in the more educated middle class. The ultimate impact on democracy is yet to be determined.

A third challenge is political populism, an anti-establishment reaction from those who feel threatened by economic and cultural change. Whether it is a powerful enough reaction to do serious damage to either advanced capitalism or democracy is another issue to be considered. The authors doubt that it is.

Maintaining the equilibrium

Iversen and Soskice acknowledge the tension between democracy and capitalism. “One is based on a principle of equality (‘one person, one vote’), while the other is based on a principle of market power (“one dollar, one vote”). In practice, what democratic electorates support is neither an absolute economic equality inimical to capitalism nor a monopoly of market power inimical to democracy.

“Democracy has a built-in mechanism to limit anti-systemic sentiments.” Voters with a stake in capitalism support the freedom of capitalists to invest in profitable enterprises and keep a lot of their profits, but voters also have a stake in the extension of opportunity so they can earn a good share of the economic benefits.

The historical experience has been that joining the ranks of the advanced capitalist democracies is not easy. Many countries have gotten stuck in a system with powerful capitalist enterprises but weak governments, in which politicians are paid off to protect firms against market competition. On the other hand, where advanced capitalist democracy has become established, it has so far proved to be highly resilient. A long-run perspective on ACDs supports an optimistic view, one that is not too dismayed by recent increases in inequality and reactionary populism.

The next post will discuss the emergence of the knowledge economy and the role of government in that transition.

Continued