The symbiosis of capitalism and democracy

(This review is cross-posted at Goodreads.)

Theorists of the left and the right argue that there are tensions if not contradictions between democracy and capitalism. Left-wing theorists argue that business has undemocratic power, buying influence through political donations and altering policy by threatening to invest elsewhere. Right-wing theorists argue that democratic majorities vote for taxes and regulations that weaken incentives and undermine the efficiency of capitalist enterprises.

Judged by the normative standards of these theorists, these critiques have something to them. But judged by some other standard, such as elected governments maintaining capitalist economic systems with widespread high living standards over long periods of time, the ‘advanced capitalist democracies’ discussed in Democracy and prosperity: reinventing capitalism through a turbulent century, look very successful compared to other political and economic combinations.

democracy and prosperity


One contention of the book’s authors, Torben Iversen and David Soskice, is that a symbiotic relationship between democracy and capitalism contributes to the success of these countries. Although business and rich people may, at least initially, resist the increased taxes that democracies impose for social policy programs, often in the long run these programs contribute to economic success.

For example, education is electorally popular and provides business with the highly-skilled workforces they need. Government unemployment, health, and retirement programs reduce workers’ uncertainty about their future welfare, reducing short-termist behaviour and industrial conflict. Workers are less dependent on their employers.

In turn, key constituencies in advanced capitalist democracies depend on a successful economy for their own jobs and the tax revenues that support social programs. They support political parties that competently deliver economic growth, limiting the political potential of parties that would damage the capitalist economy. The rejection of Jeremy Corbyn’s Labour in Britain is an example.

I would add that both capitalism and democracy have mechanisms to change policies and to peacefully replace failed leaders. So although at times capitalism and democracy under-perform relative to the past and expectations, and that is true in many Western countries today, each has significant powers of self-correction. In most Anglophone countries since the 19th century, and in most Western European countries since the late 1940s, this symbiosis has, despite periodic crises, proved to be remarkably resilient.

The authors are scholars of the varieties of capitalism. They are not saying that there is any one formula for successfully combining capitalism and democracy. Some of the most interesting parts of the book discuss the institutional differences between countries, especially between the Anglophone ‘liberal market economies’ and the ‘coordinated market economies’, including Germany and other continental European variants.

Each system has interlinking and complementary political and economic institutions. For example, countries which make greater use of coordination between unions, businesses and employer associations tend to also use proportional representation voting systems. These allow a wider range of interests and social groups to be directly represented in parliaments than the two-party systems that dominate the liberal market economies.

The book argues that different economic structures affect education systems. In Germany, industry-level wage bargaining reduces competition for labour between firms, and long-term investors reduce the need to maintain the short-term profitability that impresses financial markets. These firms are slow to lay off workers during cyclical business downturns. German firms are willing to invest in training as workers are likely to stay long-term. In turn, greater job security makes workers more willing to invest in firm-specific human capital.

By contrast, the more fluid labour markets of liberal market economies make firms less willing to invest in staff training. That won’t pay off if staff leave; it may benefit their competitors instead. This is one reason why education in Australia and other liberal market economies has much higher rates of private finance than in Europe. Students and workers in liberal market economies, for their part, invest in more general skills that they could use in a variety of jobs with a range of employers.

Although every version of capitalism evolves over time – I’ve read elsewhere that Germany has moved more in the liberal market economy direction this century – Iversen and Soskice dispute the proposition that globalisation necessarily leads to convergence. There is a left-wing fear, and a libertarian hope, that globalisation creates a dynamic of lower taxes and less regulation to attract footloose capital.

While capital flows more quickly and easily across international borders than it once did, the book argues that critical capitalist business activities are deeply embedded in physical places. They need to draw on the complex clusters of skills found in big cities. These in turn rely heavily on personal connections within firms and with local suppliers and customers. It is hard to replicate these in other locations. This is one reason why European countries can preserve their high-tax welfare states in a more globalised world economy.

Unlike many academic works – the authors are at Harvard and the LSE respectively – this book mentions ‘neoliberalism’ only briefly and dismissively. Although political and economic changes often represent ‘ideational’ shifts, this in the authors’ view does not mean that they have primarily ideological origins.

At one level, I think this is right. Despite the famous story of Margaret Thatcher pulling Hayek’s The Constitution of Liberty out of her handbag and declaring ‘this is what we believe’, her government like others in Western democracies was pragmatically looking for solutions to economic and political problems within the constraints of their historical social, political and economic beliefs and arrangements.

The market ideas later described as ‘neoliberalism’ had significant influence from the 1980s to the global financial crisis because they were seen as potential solutions to specific widely-acknowledged problems, not because the political class had converted to classical liberalism or neoclassical economics. Much of the academic critique of ‘neoliberalism’ has an ideas nobody believes causing things that never happened quality to it.

But I would still attribute more agency to ideas than Iverson and Soskice. The plausibility of ideas in people’s minds relates closely to their social, economic and political circumstances, but any one situation almost always has multiple possible interpretations and any problem has more than one potential solution. Ideas and intellectuals can influence which of these interpretations and solutions seem most plausible and attractive, and so change the dynamics of debate and policy.

Socialist ideas are enjoying a revival because pre-existing theories held by a small core of adherents could be quickly mobilised when the time seemed right. Economic problems have undermined the credibility of the previous market era and created a constituency that believes it could benefit from political change. Socialists may not end up in office in any liberal market economy – as of late 2019 a less anti-capitalist populist response looks like the more powerful political reaction to current difficulties – but they have already come closer to power than anyone thought likely 15 years ago, and arguably helped shift policy in the ‘big government’ direction.

Although ideas can be powerful, books like Democracy and Prosperity, with their careful attention to institutions and how they relate to each other, are reminders that the ideas underlying these institutions never perfectly match the models of economics textbooks or the principles of political philosophy. While theorists might think that democracy and capitalism or a welfare state and capitalism don’t go together, in practice these pairs are successful and enduring combinations.

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