Martin Wolf: The crisis of democratic capitalism

In his latest book, The Crisis of Democratic Capitalism, Martin Wolf argues that democratic capitalism, although still the most effective and prosperous system, faces critical challenges which threaten its future. The first chapter draws alarming parallels between the present day and the most tragic years of the last century. While the 20th century witnessed World War I and II, the Spanish Flu, and the Great Depression, the 21st century has seen the Great Recession, the COVID-19 pandemic, an authoritarian China, and Putin’s invasion of Ukraine. As a result, Wolf warns, “When we look closely at what is happening in our economies and our policies, we must recognize the need for substantial change if core Western values of freedom, democracy, and the Enlightenment are to survive” (p. xviii). His message is clear—to have prosperous societies, capitalism and democracy must complement each other.

While this would be ideal, the reality is that the relationship between capitalism and democracy is often fraught with tensions and challenges. However, at their core, both systems are built on a fundamental principle—equality of status. As Wolf aptly describes, these systems are “symbiotic twins.“ In a democratic framework, everyone has the right to express their concerns and voice what they want to be changed. Similarly, in a free market, individuals can exchange goods and services as they please. The convergence of capitalism and democracy engenders a complex interplay between economic and political forces. The survival of this marriage relies on the separation between political and economic power, and it is here that Wolf believes things went wrong. The primary source of the malaise of democratic capitalism is crony capitalism.

In one of the most powerful chapters of the book, titled “The Rise of Rentier Capitalism,“ Wolf describes how the once productive and dynamic capitalist system has devolved into crony capitalism. According to Wolf, there are two ways in which the balance between political and economic power can be disrupted—when the state takes control of the economy or when capitalists take control of the state.

To ensure that the marriage between capitalism and democracy is successful, we must find what Acemoglu and Robinson (2019) call the “narrow corridor”. This corridor refers to the delicate balance that allows for both state and societal autonomy. From this perspective, institutions must empower the state with the necessary authority to provide public goods and enforce legal standards, while also limiting excessive power that can result in authoritarianism and impinge upon personal liberties and autonomy. Wolf argues that we are moving away from “the narrow corridor” towards a plutocracy, as the walls separating power and wealth are breaking down, with capitalists taking control of the state. He shows how authors dating back to Ancient Greece have warned about the consequences of a broken democracy. Plato, for example, believed that as the political and economic elites become more intertwined and distant from the average citizen, society would look for a protector against the wealthy. Plato believed that insecurity about the future, fear, and resentment could lead to tyranny. It is remarkable how accurate this description remains today. Populist movements and leaders all over the world have been using this resentment as fuel. They claim to be “against” the corrupt elite and present themselves as protectors of the people. However, as Wolf rightly points out, these leaders are themselves a competing elite, leading to what he calls “pluto-populism”.

Unfortunately, while Wolf correctly identifies crony capitalism and the resulting inequality as the primary cause of dissatisfaction with democratic capitalism and the rise of populist movements, he fails to address the root cause. In fact, his analysis of the problem is limited to state capture by market forces. Rather than framing the problem as otherwise well-intentioned or naive politicians being led astray by “greedy capitalists,” it is vital to recognize the collusion of interests between the two groups, which has allowed them to shape the rules of the game to their own advantage. The correct identification of the problem is important as it might discourage calling for more government intervention as a way of fixing the problem. After all, if both the state and the businessman are to blame for this rigged system, why would anyone believe that more state intervention would be the cure?

Moreover, while Wolf acknowledges the significance of shaping institutions to prevent individuals from harming the system, his emphasis on individual morality may be overstated: “it depends ultimately on truthfulness and trustworthiness in those in positions of responsibility” (p. 377). While it is true that moral and ethical considerations can influence individual behavior, structural issues such as crony capitalism cannot be fully explained by pointing to individual morals. By emphasizing individual traits, he overlooks the need for institutional reform to curtail cronyism. It is worth remembering the advice of David Hume on how to design proper institutions: “Political writers have established it as a maxim, that, in contriving any system of government, and fixing the several checks and controls of the constitution, every man ought to be supposed a knave, and to have no other end, in all his actions, than private interest…” (2013, p.42).

This approach is consistent with Holcombe (2018) who argues that political capitalism is often seen as a separate issue of unethical behavior, rather than an endemic response to structural incentives. As a result of this misdiagnose, the proposed solutions (often a call for more state oversight) fail to recognize the potential link between their proposals and the promotion of the very problem they aim to fix. What is then the root cause of political capitalism?

Holcombe maintains that political capitalism is not a “bug” in capitalism but rather an altogether different economic system. For him, political capitalism is “an economic and political system in which the economic and political elite cooperate for their mutual benefit” (p. 1). Holcombe’s analysis of political capitalism is grounded in established concepts from various fields of study—elite theory, the Coase theorem, rent seeking, and rent extraction.

While political scientists and sociologists have been aware of the distinction between “the elite” and “the masses,” Holcombe shows how the Coase theorem can provide the underlying economic explanation of elite theory. There is a widespread agreement among both scholars (left and right) and the public that the political and economic elite rig the system in their favor by writing rules that benefit themselves. Why, then, do the masses passively accept the rules that the elite impose upon them? Belonging to the low transaction costs group, elites can better coordinate among themselves, while the masses, the high transaction costs group, are incapable of coordinating and achieving their desired outcomes.

Holcombe’s analysis then draws on insights from Gordon Tullock on rent seeking and Fred McChesney on rent extraction to understand the interactions and entanglements between the private and public sector. This provides insight into how the private sector influences the public sector, but also the active role the state plays in creating this rigged system (something that Wolf overlooks) by threatening companies with regulation or removing some protection that firms otherwise would have.

The merit of The Crisis of Democratic Capitalism is that it correctly identifies cronyism as the cause of some of the critical ills of our current system. Given the dismal scenario that Wolf describes throughout the book, it comes as no surprise that he finds himself “doubting whether the U.S. will be a functioning democracy by the end of the decade” (p. 379). Perhaps the tone is too pessimistic, but Wolf is right in his message that our liberal democracies have seen better days. For everyone concerned about the state of market economies and democracies, this is a must-read book. We live in trying times in which both our economies and geopolitical order are unstable. The path forward is not nationalism, tribalism, and protectionism. The wonders we have achieved as a society are the result of flourishing markets and pluralistic democracies that live in a happy and respectful marriage. But we should not take this for granted, as this book articulates. Crony capitalism is indeed a threat to our economic system and the field of public choice has much to contribute to understanding why and what might be done about it.

Despite his pessimism, Wolf´s book is also a message of hope. In the dedication of the book to his grandchildren, Wolf writes, “May their generation do a better job than mine has.“ Their generation is ours. The time is now. May we live up to the challenge.