Reforming Global Finance

Inequality and Democratic Capitalism

Was the second half of the 20th century — when capitalism became entwined with democracy, the welfare state and liberalism — just an unusual interlude?

Credit: Vladyslav Starozhylov-Shutterstock.com

Takeaways


  • The middle class in Western democracies has an interest in limiting the power of the rich — so that they would not rule over them.
  • Globalization undercuts the funding sources on which the modern European welfare state was built.
  • The pressures on the welfare state are an attack on the middle class because the middle class is the largest supporter and beneficiary of the welfare state.
  • Since de Tocqueville's times, the middle class was seen as the bulwark against nondemocratic forms of government.
  • The United States has morphed into "the dictatorship of the propertied class" — even if it seems, superficially, to be a democracy.

When the question “Does inequality threaten the sustainability of Western democratic capitalism?” is asked, we need to break the question into three constituent parts in order to come up with a solid answer:

  Does inequality threaten capitalism?

  Is democratic capitalism sustainable?

  Is inequality undermining European democratic capitalism?

Question 1: Does inequality threaten capitalism?

The answer, at least in the medium term, seems to be in the negative. For the first time in human history, a system that can be called capitalist is dominant over the entire globe. Such a system is conventionally defined as consisting of legally free labor, private ownership of capital, decentralized coordination and pursuit of profit.

One does not need to go far back into the past, or to have a great knowledge of history, to realize how unique and novel this is. Centrally planned socialism was only recently eliminated as a competitor. And nowhere in the world do we now find unfree labor playing an important economic role, as it did until some 150 years ago.

Such is the hegemony of capitalism as a worldwide system that even those who are unhappy with it and with rising inequality — whether locally, nationally or globally — have no realistic alternatives to propose.

“De-globalization” and a focus on the “local” is meaningless because it would do away with the division of labor, a key factor of economic growth. Surely, those who argue for “localism” do not wish to propose a major drop in living standards. Forms of state capitalism, as in Russia and China, do exist, but this is capitalism nevertheless: Private profit motive and private companies are dominant.

Increasing inequality of income, however, undercuts some of capitalism’s mainstream ideological dominance by showing its unpleasant sides: the exclusive focus on materialism, a winner-take-all ideology, and disregard of nonpecuniary motives.

But since no ideological alternatives currently exist — and even less, political parties or groups to implement them — the hegemony of capitalism looks pretty unassailable.

Of course, nothing guarantees that it would look like that to our children or grandchildren, for new ideologies can be invented. But this is how it looks to a reasonable observer today.

Question 2: Is democratic capitalism sustainable?

This is already a different question. Note first that these two words — democracy and capitalism — were not often combined in history.

Capitalism in the absence of democracy has been a common feature throughout history. This was the case not only in Spain under Franco, Chile under Pinochet, or the Congo under Mobutu, but also in Germany, France and Japan.

It even occurred in the United States via the exclusion of blacks from the body politic, and in England with its severely limited franchise based on ownership of property at levels sufficient to include only the elite.

Thus, it does not take huge leaps of imagination to see that capitalism and democracy can be decoupled. And inequality can play an important role in that. It already does so by politically empowering the rich to a much greater extent than the middle class and the poor.

The rich dictate the political agenda, finance the candidates who protect their interests, and make sure that the laws that are in their interest are voted in. The American political scientist Larry Bartels finds that U.S. senators are five to six times more likely to listen to the interests of the rich than to the interests of the middle class.

For the poor, “there is no discernible evidence that the views of low-income constituents had any effect on their senators’ voting behavior.” Both democracy and the middle class are being hollowed out. [A PDF of Bartel's study is here. ]

In effect, it is not for nothing that since Aristotle, and more recently since Tocqueville, the middle class was seen as the bulwark against nondemocratic forms of government. It was not by some special moral virtue, embodied among the “middlemen,” that a person who has, for example, ceased to be rich and become middle-class would suddenly prefer democracy.

It is simply that the middle class had an interest in limiting the power of the rich (so that they would not rule over them) and of the poor (so that they would not expropriate them).

Large numbers of a middle class also meant that a lot of people shared similar material positions, developed similar tastes and tended to eschew extremism of both the left and the right. Thus, the middle class provided for both democracy and stability.

All of this is under attack by rising inequality. The middle class in Western democracies is today both less numerous and economically weaker relative to the rich than it was 20 years ago.

In the United States, where the change is most dramatic, the share of the middle class — defined as people with disposable incomes around the median (more exactly, 25% above and below the median) — decreased from one third of the population in 1979 to 27% in 2010. This means that approximately one out of every four persons who were in the middle class is no longer there.

In 1979, the average income of the U.S. middle class was practically equal to the overall mean income. Now it has dropped to only three-quarters of the mean.

The combined result of the decline in relative numbers and relative income is a sharp drop in the economic power of the middle class. In 1979, the U.S. middle class accounted for 32% of total income. Today, it accounts for only 21%. That is a decline of one-third.

The political and economic importance of the middle class has accordingly dwindled. It is not difficult to project into the future the current trends, most vividly seen in the United States.

There, financial support from rich individuals and companies ensures political success. While the U.S. system remains democratic in form because freedom of speech and association is preserved and elections are free, in essence it is becoming a plutocracy.

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In Marxist terms, it is “the dictatorship of the propertied class” — even if it seems, superficially, to be a democracy. The government is nothing else but in Marx’s famous words, “the committee for managing the common affairs of the bourgeoisie.”

And indeed, the gap between the professed ideology and reality will not be anything new to a student of politics and history. Rome seamlessly grew to be an autocratic Empire, while masquerading as a Republic ruled by a Senate.

More recently, a bureaucratic class ruled Eastern Europe, while claiming that both economic and political power was in the hands of the people. Every dictator today argues that he embodies the will of the people — that is, believes himself to be a democrat.

The slide away from democracy can take two forms. One is American and resembles plutocracy. The other may be called Italian. In the latter case, power is extraordinarily transferred to a technocratic government, albeit in an ostensibly legal fashion and within the democratic system.

Technocracy may appear benign, led by people of unimpeachable integrity, but it nevertheless arises as a counterpoint to democracy. It thrives because democracy is shown incapable of solving problems. Technocrats can do it.

Indeed, countries like Singapore are perfect examples of technocratic efficiency. However pleasant it might be to live under such governments, they are nonetheless not democratic. If democracy is a value in itself, they do not provide it.

The current disenchantment with the U.S. Congress, which faces a public approval rating of less than 15% and was recently called by Washington Post columnist Ezra Klein “less popular than Communism,” may be seen as yet another indicator of the drift toward the rule of technocrats desired by some. Yet both the unelected rule by technocrats and the occult rule by the rich are deeply undemocratic.

Question 3: Is inequality undermining European democratic capitalism?

All that was said above about the evolution of democratic capitalism in the United States applies, obviously, to Europe. After all, it is from the Europe of Mario Monti and Lucas Papademos that we drew the examples of the technocratic drift.

But Europe is exposed to additional pressures. The most important is the pressure stemming from globalization, which frequently works both against workers and the middle class and favors the rich.

Western workers and parts of the middle class are exposed to severe competition from workers in emerging economies, by virtue of increased trade, outsourcing or the attractiveness of foreign (as opposed to domestic) investments.

Both the property-rich and the highly skilled gain because their financial and human capital is more mobile and cannot be easily taxed unless one wants them to flee the country. Low taxation in turn increases inequality between the rich and the poor because it undercuts the funding sources on which the modern European welfare state was built.

The story of French actor Gérard Depardieu’s recent search for a more tax-friendly citizenship is a valuable example, not least because few individuals seem to embody “Frenchness” than Depardieu. When national icons run away, what remains for the others who can afford to move than to emulate them?

A second globalization force that Europe is ill equipped to deal with is migration. Migration is no different than other forms of globalization — exports and imports of goods and technology or movement of capital. So it is wrong to discuss it separately, or as somehow independent from the massive income gaps between nations that have been revealed and often exacerbated by globalization.

Not only does Europe lack the experience of dealing with migrants that the United States, Canada or Australia has. But migrants who are often ethnically and religiously different from the native majorities bring different cultural norms that also undercut the welfare state.

The welfare state was built on the assumption of ethnic and cultural homogeneity of the population. Homogeneity not only increases affinity among different segments of the population, it also ensures that more or less all follow similar social norms.

If no one cheats by pretending to be older in order to get a pension, or does not take sick leave when not ill, the welfare state is self-sustaining. But if not everyone observes these norms, it crumbles.

The pressures that have come to bear on the welfare state, both directly from globalization and from migration, are in reality an attack on the middle class. Why? Because the middle class is the largest supporter and beneficiary of the welfare state.

It is true that in most studies we find that the poor gain a lot through unemployment benefits and social assistance. But the middle classes gain even more through free or subsidized health care and education, pensions, and more than anything else, through the certainty of being spared the life of poverty and want.

The welfare state was thus an indispensable element in the strengthening of the European middle class and democratic capitalism. European democracy goes the way of the European welfare state. It came with it — and it may leave with it.

However, one should not be unduly pessimistic. Europe has weathered other, more formidable challenges — even if, it is true, often after paying an enormous human and material price.

It is still among the richest parts of the world and in terms of social rights and social attitudes, probably the most “civilized” part of it. It is, barring a war (which indeed seems unthinkable), likely to remain the most attractive place in the world to live.

But it is doubtful that it will be the most dynamic. And the key features associated with it in the second half of the 20th century, democracy and the welfare state, may be gradually fading.

Was the period between the end of World War II and the end of the Cold War an unusual interlude, in which capitalism became entwined with democracy, the welfare state and liberalism — features that historically it often lacked? There are arguments to see it that way, and to argue that capitalism is now simply reverting to its “natural” features.

What many of us have lived through might just have been capitalism under “exceptional conditions.” It was a capitalism that responded creatively to the Great Depression (by reinventing government), to war (by marshaling resources to win it) and to Communism (by emphasizing social solidarity through the welfare state).

Neither of these threats is present any more. So why would capitalism not go back to what it once was?

An earlier version of this article was published in La Vanguardia Dossier, a Barcelona, Spain-based news magazine.

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About Branko Milanovic

Branko Milanovic is the lead economist in the World Bank's Development Research Group and a visiting professor at the University of Maryland.

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