The Crisis of Democratic Capitalism

Chapter One

The Fire This Time

What we may be witnessing is not just the end of the Cold War, or the passing of a particular period of post-war history, but the end of history as such: that is, the end point of mankind's ideological evolution
and the universalization of Western liberal democracy as the final form of human government.

-Francis Fukuyama

When Francis Fukuyama wrote his essay "The End of History?," published as the Cold War ended, in 1989, many agreed with him that the Western synthesis of liberal democracy with the free market had won a decisive victory over its ideological enemies. The end of the last totalitarian ideology seemed to many not just an extraordinary and surprising event, but one that promised a better future for humanity. The era of totalitarian coercion and mass murder was over. Freedom-political and economic-had won.

Neither liberal democracy nor free-market capitalism seems at all triumphant today. This is true not just in developing, emerging, or former communist countries, but even in established Western democracies. Economic failings have shaken faith in global capitalism. Political failings have undermined trust in liberal democracy. The ascent of China, whose ruling communist party has rejected the link between capitalism and democracy, has also shaken the confidence of the West and confidence in the West.

Liberal democracy and free-market capitalism are both now in question. On the nationalist right, Donald Trump in the US, Nigel Farage in the UK, Marine Le Pen in France, Matteo Salvini in Italy, Geert Wilders in the Netherlands, and Heinz-Christian Strache in Austria are shaping-or have shaped-political debate, even when not in power. Self-proclaimed "illiberal democrats"-a euphemism for authoritarians-have come to power in Hungary and Poland, two of the countries that benefited from the fall of the Soviet empire and the opportunity to enter the EU. Following the political example of Vladimir Putin in Russia, Hungary's Viktor Orban and Poland's Jaroslaw Kaczynski set their embattled nations against the world and a purported "will of the people" against individual rights. These various leaders also object to at least one aspect (and frequently more than one) of contemporary global capitalism, be it free trade, free flows of capital, or relatively free movement of people. Inevitably, opposition to those things has also turned into suspicion of the European Union.

Crucially, the US possessed in Donald Trump a president who admired "strong men" and the politics of strong men, hated the free press, was indifferent to the survival of the Western alliance, intensely disliked the EU, was fiercely protectionist, and was happy to intervene arbitrarily in the decisions of individual businesses. He had no ideological attachments to liberal democracy or free-market capitalism. He was populist, instinctively authoritarian, and nationalist. Worst of all, he promulgated the "big lie" that he won the November 2020 presidential election, which he lost by a large margin, thereby undermining the foundations of American democracy. Moreover, the US is not just any country: it is the creator of the post-Second World War liberal world order. Trump lacked the character, intellect, and knowledge needed to be president of a great democratic republic. His rise to power in 2016 and continuing influence over the Republican Party after his defeat in 2020 was (and remains) a worrying failure of the world's most important democracy.

This book will argue that economic disappointment is one of the chief explanations for the rise of left- and right-wing populism in high-income democracies. Many point instead to cultural factors: status anxiety, religious belief, or outright racism. These are indeed important background conditions. But they would not have affected societies so deeply if the economy had performed better. Furthermore, many of these supposedly cultural changes are also related to what has been happening economically: the impact of deindustrialization on the labor force and the pressures of economic migration on established populations are among the important examples. People expect the economy to deliver reasonable levels of prosperity and opportunity to themselves and their children. When it does not, relative to those expectations, they become frustrated and resentful. That is what has happened. Many people in high-income countries condemn the global capitalism of the past three of four decades for these disappointing outcomes. Instead of delivering prosperity and steady progress, it has generated soaring inequality, dead-end jobs, and macroeconomic instability. Predictably, they frequently blame this disappointment on outsiders-minorities at home and foreigners. Thus, one of the points on which populists of both left and right agree is the need to limit international trade. Many also see a need to restrict the movement of capital and workers.

In short, the liberal democracy and global capitalism that were triumphant three decades ago have lost legitimacy. This matters, because these are respectively the political and economic operating systems of today's West. Democracy vests sovereignty in electorates defined by citizenship. Capitalism vests decision-making in owners and managers of private businesses engaged in global competition. The potential for conflict between these political and economic systems is self-evident: democratic politics are national, while market economics are global; and democratic politics are based on the egalitarian idea of one person, one vote, while market economics is founded on the inegalitarian idea that successful competitors reap the rewards.

Today, the synthesis of democracy and capitalism-"democratic capitalism"-is in crisis. The nature of that crisis and what should be done in response to it are the central themes of this book. The discussion focuses on the fate of democratic capitalism in the West, though it is not limited to that, since the future of the West cannot be separated from what is happening in the rest of the world. But the West is the heartland of democratic capitalism. Meanwhile, China, the world's rising superpower, stands for a very different way of managing the links between political power and wealth generation, one we might call "authoritarian capitalism" or "bureaucratic capitalism." Elsewhere, we see the emergence in countries like Brazil, India, Turkey, or even Russia of what might be called "demagogic capitalism" or "demagogic autocratic capitalism." 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. It has also survived great challenges in the past, notably in the 1930s and 1940s, and then again during the Cold War. But it now needs to change again. It must, above all, find a new equilibrium between the market economy and democratic politics. If it does not do so, liberal democracy may collapse.

What do I mean by the terms democracy and capitalism? By democracy, I mean its dominant contemporary form-universal suffrage, representative democracy. Thus, those who want to limit or narrow suffrage are acting antidemocratically.

To be more complete, I mean by democracy what Fukuyama called "liberal democracy." The distinguished political scientist Larry Diamond, of the Hoover Institution, argues that liberal democracy has four individually necessary and collectively sufficient elements: free and fair elections; active participation of people, as citizens, in civic life; protection of the civil and human rights of all citizens equally; and a rule of law that binds all citizens equally. All these elements are necessary and, in combination, sufficient to make a democracy liberal. Note the emphasis above on "citizens." A liberal democracy is exclusive: it includes citizens, but excludes noncitizens. This does not mean noncitizens-foreigners and immigrants-lack all rights; far from it. It means they lack the political rights of citizens.

Crucially, liberal democracy is not just a way of deciding who runs the state, though it is that: the term also defines the sort of state it is. As John Stuart Mill insisted in his Considerations on Representative Government, democracy is, or should be, characterized by "liberty of discussion, whereby not merely a few individuals in succession, but the whole public, are made, to a certain extent, participants in the government, and sharers in the instruction and mental exercise derived from it." For a liberal democracy to work, then, citizens must be entitled to express their opinions, and fellow citizens must be prepared to tolerate opinions they disagree with and the people who hold them. In the terminology of Isaiah Berlin, as citizens, people enjoy negative liberty-the right to make up their own minds, free from coercion-and positive liberty-the right to participate in public life, including by voting. Such a political system is inherently pluralist. It cares about the political rights of minorities because it cares about the political rights of all citizens.

In essence, a liberal democracy is a competition for power between parties that accept the legitimacy of defeat. It is a "civilized civil war." Force is not permitted. But this means that winners do not seek to destroy the losers. A system in which gangsters seek to kill their opponents, trample on the rights of individuals, suppress the free press, and benefit financially from office, yet go through the motions of running rigged elections, is not liberal democracy. Nor is "illiberal democracy" democracy either. Such a system should be called what it is: at best, a dictatorship of the majority, and at worst, "plebiscitary dictatorship." Putin's rule over Russia is a plebiscitary dictatorship, as is Erdogan's over Turkey and Orban's over Hungary. Indeed, increasingly these are just dictatorships, without qualification.

By capitalism, I mean an economy in which markets, competition, private economic initiative, and private property play central roles. This system is "market capitalism." The size, scope, and nature of government, with respect to regulatory intervention, taxation, and spending, vary across capitalist countries. Government intervention has also tended to intensify over time as societies became more democratic. This was inevitable, as the franchise widened to include people without significant assets. But it also reflected the growing complexity of economic life and the pervasiveness of what economists call "market imperfections"-situations in which market incentives may lead to socially or economically damaging results.

Yet, as was the case with "liberal democracy," the state, be it large and relatively intrusive or not, must be law-governed. Without the rule of law, there can be no market capitalism, just larceny. Moreover, capitalist economies, thus defined, are also (and have always been) open to global trade and capital flows, at least to some degree. Capitalism is never entirely national, because the wider world offers a host of opportunities for profitable exchange.

More narrowly, by market capitalism I mean the form of market economy that has emerged over the past seventy years and particularly over the past forty, for which the word globalization provides a shorthand description. In their economic lives, just as in their political ones, people should possess freedom from arbitrary coercion, especially but not exclusively, from the state, and freedom to buy and sell their labor and anything else they may legitimately own. Again, as is also true in political life, such freedoms are not absolute, but must be bounded by regulatory, legislative, and constitutional limits.

The rule of law is an essential shared underpinning of democracy and capitalism because it protects the freedoms essential to both. This means that "all persons and authorities within the state, whether public or private, should be bound by and entitled to the benefit of laws publicly made, taking effect (generally) in the future and publicly administered in the courts." If some individuals or institutions are above the law, nobody without such privileges can be secure in exercising their freedoms. The law must be universally binding and protecting if liberal democracy and market capitalism are to thrive.

Both liberal democracy and market capitalism share a core value: a belief in the value and legitimacy of human agency, in political and economic life. In these respects, both systems rest on "liberal" ideas. But the workability of democratic capitalism also depends on the presence of certain virtues in the population at large and especially in elites. Neither politics nor the economy will function without a substantial degree of honesty, trustworthiness, self-restraint, truthfulness, and loyalty to shared political, legal, and other institutions. In the absence of these virtues, a cycle of mistrust will corrode social, political, and economic relations.

In short, the political and economic systems depend for their success on the prevalence of fundamental norms of behavior or, as they are sometimes called, "social capital." Today, however, liberal democracy and market capitalism are individually sick, and the balance between them has broken. The last chapter of my previous book, The Shifts and the Shocks, on the global financial crisis, bore the title "The Fire Next Time." The penultimate paragraph of that book argued that "the loss of confidence in the competence and probity of elites inevitably reduces trust in democratic legitimacy. People feel even more than before that the country is not being governed for them, but for a narrow segment of well-connected insiders who reap most of the gains and, when things go wrong, are not just shielded from loss but impose massive costs on everybody else. This creates outraged populism, on both the left and the right. Yet willingness to accept shared sacrifice is likely to be still more important in the years ahead than it was before the crisis. The economies of the Western world are poorer than they imagined ten years ago. They must look forward to a long period of retrenchment. Making that both be and appear fair matters."

I was wrong: the fire is not next time; it is now. Moreover, COVID and the impact of Russia's war on Ukraine has made it burn even hotter. The fire is in substantial part the ignition of the slow-burning anger left by the last financial and economic crisis, coming, as that did, after a long period of mediocre performance and wrenching social changes in Western countries. Trump was a product of this process. He promised to drain the swamp, but, inevitably, made it an even worse quagmire. By his actions, his cynicism justified itself. It is conceivable that, as economies recover from the financial crisis and the pandemic, the fire will burn out. But that now seems almost inconceivable. Democratic global capitalism is caught between an unsatisfactory present and an even less satisfactory future of protectionism, populism, and plutocracy, culminating, possibly soon, in autocracy, most significantly in the US.

Restoring health to the Western system is among our biggest challenges. We may not succeed. But nothing good will be achieved if nothing is attempted. The rest of the book elaborates this argument. Part I analyzes the relationship between politics and economics and especially between democracy and capitalism, as I have defined them, in both theory and history. Part II goes on to examine what has gone wrong in the capitalist economy and the democratic polity, as a result of the closely connected rise of predatory capitalism and demagogic politics. Part III analyzes the reforms needed if we are to create a more inclusive and successful economy and healthier democracies. Part IV then looks at how a reinvigorated alliance of democratic capitalist states should engage in the world to defend themselves, promote their core values, and protect global peace, prosperity, and the planet. Finally, the Conclusion returns to the core issue, namely, the responsibility of elites for safeguarding the fragile achievements of democratic capitalism, before they disappear in an incoming tide of plutocratic populism and tyranny.