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Introducing Kuznets Waves: How Income Inequality Waxes and Wanes over the Very Long Run
The Kuznets curve was widely used to describe the relationship between growth and inequality over the second half of the 20th century, but it has fallen out of favour in recent decades. This column suggests that the current upswing in inequality can be viewed as a second Kuznets curve. It is driven, like the first, by technological progress, inter-sectoral reallocation of labour, globalization, and policy. The author argues that the US has still not reached the peak of inequality in this second Kuznets wave of the modern era.
In 1955 when Simon Kuznets wrote about the movement of inequality in rich countries (and a couple of poor ones), the US and the UK were in the midst of the most significant decrease of income inequality ever registered in history, coupled with fast growth. It thus seemed eminently reasonable to look at the factors behind the decrease of inequality, and Kuznets famously found them in expanded education, lower inter-sectoral productivity differences (thus the rent component of wages would be equalized), lower return to capital, and political pressure for greater social transfers. He then looked at (or rather imagined) the evolution of inequality during the previous century and thought that, driven by the transfer of labour from agriculture to manufacturing, inequality rose and reached its peak in the rich world sometime around the turn of the 20th century. Thus, he created the famous Kuznets curve.
The Kuznets curve was the main tool used by inequality economists when thinking about the relationship between development or growth and inequality over the past half century. But the Kuznets curve gradually fell out of favor because its prediction of low inequality in very rich societies could not be squared with the sustained increase in income inequality that started in the late 1970s in practically all developed nations (see the long-run graphs for the US and the UK). Many people thus rejected it.
The Upswing in Current Inequality as a Second Kuznets Curve
In a new book (Milanovic 2016), I argue however that we should see the current upswing in inequality as the second Kuznets curve in the modern times, being driven, like the first, mostly by a technological revolution and the transfer of labour from more homogenous manufacturing into skill-heterogeneous services (and thus producing a decline in the ability of workers to organize), but also (again like the first) by globalization, which has both led to the famous hollowing out of the middle classes in the west and to a pressure to reduce high tax rates on mobile capital and high-skilled labour. The elements listed here are not new. But putting them together (especially viewing technological progress and globalization as practically indissoluble, even if conceptually different) and viewing this as part of regular Kuznets waves is new. It has obvious implications for the future, not the least that this bout of inequality growth will peak like the previous one and eventually go down.
But before I address that part, let us consider recent important work done by economic historians such as van Zayden (1995); Nogal and Prados (2013); Alfani (2014) and Ryckbosch (2014), who have documented periods of waxing and waning inequality in pre-modern Europe. The interesting part is that Kuznets cycles in pre-modern societies basically replicate the Malthusian cycles because they take place in conditions of quasi-stationary mean income. The pre-modern Kuznets cycles are not driven by economic factors but by epidemics and wars. Both lead to a decrease in population, an increase in mean income, higher wages (because of labour scarcity) and thus lower inequality, that is, until population growth in a Malthusian fashion reverses all these gains.
Thus, we can observe Kuznets waves over some six or seven centuries of European history. In pre-modern times, they are observable against time because mean income is more or less constant (it is just one point on the x-axis). After the Industrial Revolution, however, we see the waves responding to economic factors (e.g. technological change, transfer of labour), and can plot them as Kuznets thought against mean income. This is shown here in the graphs for the US and the UK (Figure 1 and 2). In addition, I show in my book long-term inequality cycles for Spain, Italy, the Netherlands, Germany, Japan, Brazil, Chile, and over a shorter period for China.
While Kuznets’ explanation was focused almost entirely on economic and thus ‘benign’ forces, he was wrong to overlook the impact of ‘malign’ forces (especially wars) that are powerful engines of income equalisation. I find this somewhat puzzling because Kuznets himself, having worked during World War II in the US Bureau of Planning and Statistics, must have noticed how the war led to the compression of income through higher taxation, financial repression, rationing, price controls, and even sheer destruction of physical assets (as in Europe and Japan).
Inequality May Not Be Overturned Soon
Which leads us to the present. How long will the current upswing of the Kuznets wave continue in the rich world, and when and how will it stop? I am skeptical that it will be overturned soon, at least not in the US where I see four powerful forces that keep on pushing inequality up. I will just list them here (they are, of course, discussed in the book):
- Rising share of capital income which is in all rich countries extremely concentrated among the rich (with a Gini in excess of 90);
- Growing association of high incomes from both capital and labour in the hands of the same people (Atkinson and Lakner 2014);
- Homogamy (the educated and the rich marrying each other); and
- Growing importance of money in politics which allows the rich to write rules favourable to them and thus to maintain the inequality momentum (Gilens 2012).
The peak of inequality in the second Kuznets wave should be lower than in the first (when in the UK, it was equal to the inequality level of today’s South Africa) because the rich societies have in the meantime acquired a number of ‘inequality stabilizers’, from unemployment benefits to state pensions.
The pro-inequality trends will be very hard to overturn during the next generation, but eventually they may be – through a combination of political change, pro-unskilled labour technological innovations (which will become more profitable as skilled labor’s price increases), dissipation of rents acquired during the current bout of technological efflorescence, and possibly greater attempts to equalize ownership of assets (through forms of ‘people’s capitalism’ and workers’ shareholding).
Now, these are of course the benign factors that, I think, will ultimately set inequality in rich countries on its downward path. But history teaches us too that there are malign factors, notably wars, in turn caused by domestic maldistribution of income and power of the elites (as was the case in the World War I), that can also do the job of income levelling. But they do it at the cost of millions of human lives. One can hope that we have learned something from history and would avoid this destructive path to equality in poverty and death.
References
Alfani, G (2014), “Economic inequality in the northwestern Italy: a long-term view (fourteenth to eighteenth century)”, Dondena Working Paper No. 61, Bocconi University, Milano.
Alvarez-Nogal, C and L Prados de la Escosura (2013), “The rise and fall of Spain (1270–1850),” Economic History Review, vol. 66(1), pages 1-37.
Atkinson, A and C Lakner (2014), “Wages, capital and top incomes: The factor income composition of top incomes in the USA, 1960-2005”, November version.
Gilens, M(2012), Affluence and Influence, Princeton University Press.
Kuznets, S (1955), “Economic growth and income inequality”, American Economic Review, March, pp. 1-28.
Milanovic, B (2016), Global inequality: A new approach for the age of globalization, Harvard University Press.
Ryckbosch, W (2014), “Economic inequality and growth before the Industrial Revolution: A case study of Low countries (14th-16th century), Dondena Working Paper No. 67, Bocconi University, Milano.
van Zanden, J L (1995), “Tracing the beginning of the Kuznets curve: western Europe during the early modern period”, The Economic History Review, vol. 48, issue 4, pp. 1-23. November.
Can Democracy Help with Inequality?
Inequality is currently a prominent topic of debate in Western democracies. In democratic countries, we might expect rising inequality to be partially offset by an increase in political support for redistribution. This column argues that the relationship between democracy, redistribution, and inequality is more complicated than that. Elites in newly democratized countries may hold on to power in other ways, the liberalization of occupational choice may increase inequality among previously excluded groups, and the middle classes may redistribute income away from the poor as well as the rich.
There is a great deal of concern at the moment about the consequences of rising levels of inequality in North America and Western Europe. Will this lead to an oligarchisation of the political system, and imperil political and social stability? Many find such dynamics puzzling given that it is happening in democratic countries. In democratic societies, there ought to be political mechanisms that can inhibit or reverse large rises in inequality, most likely through the fiscal system. Indeed, one of the most central models in political economy, due originally to Meltzer and Richard (1981), suggests that high inequality in a democracy should lead the politically powerful (in their model the voter at the median of the income distribution) to vote for higher levels of taxes and redistribution, which would partially offset rising inequality.
But before asking about what happens in a democracy, we could start with some even more fundamental questions. Is it correct factually that democracies redistribute more income than dictatorships? When a country becomes democratic, does this tend to increase redistribution and reduce inequality? The existing scholarship on these questions, though vast, is quite contradictory. Historical studies, such as Acemoglu and Robinson (2000) and Lindert (2004), tend to suggest that democratization increases redistribution and reduces inequality. Using cross-national data, Gil et al. (2004) find no correlation between democracy as measured by the Polity score and any government spending or policy outcome. The evidence on the impact of democracy on inequality is similarly puzzling. An early survey by Sirowy and Inkeles (1990) concludes, “the existing evidence suggests that the level of political democracy as measured at one point in time tends not to be widely associated with lower levels of income inequality” (p. 151), though Rodrik (1999) finds that both the Freedom House and Polity III measures of democracy were positively correlated with average real wages in manufacturing and the share of wages in national income (in specifications that also control for productivity, GDP per capita, and a price index).
In a recent working paper (Acemoglu et al. 2013), we revisit these questions both theoretically and empirically.
Theoretical Nuances
Theoretically, we point out why the relationship between democracy, redistribution, and inequality may be more complex than the discussion above might suggest. First, democracy may be ‘captured’ or ‘constrained’. In particular, even though democracy clearly changes the distribution of de jure power in society, policy outcomes and inequality depend not just on the de jure but also the de facto distribution of power. Acemoglu and Robinson (2008) argue that, under certain circumstances, elites who see their de jure power eroded by democratization may sufficiently increase their investments in de facto power (e.g. via control of local law enforcement, mobilization of non-state armed actors, lobbying, and other means of capturing the party system) in order to continue to control the political process. If so, we would not see much impact of democratization on redistribution and inequality. Similarly, democracy may be constrained by other de jure institutions such as constitutions, conservative political parties, and judiciaries, or by de facto threats of coups, capital flight, or widespread tax evasion by the elite.
Democratization can also result in ‘inequality-increasing market opportunities’. Non-democracy may exclude a large fraction of the population from productive occupations (e.g. skilled occupations) and entrepreneurship (including lucrative contracts), as in Apartheid South Africa or the former Soviet Union. To the extent that there is significant heterogeneity within this population, the freedom to take part in economic activities on a more level playing field with the previous elite may actually increase inequality within the excluded or repressed group, and consequently the entire society.
Finally, consistent with Stigler’s ‘Director’s Law’ (1970), democracy may transfer political power to the middle class, rather than the poor. If so, redistribution may increase and inequality may be curtailed only if the middle class is in favour of such redistribution.
But what are the basic robust facts, and do they support any of these mechanisms?
Empirical Evidence
Cross-sectional (cross-national) regressions, or regressions that do not control for country fixed effects, will be heavily confounded with other factors likely to be simultaneously correlated with democracy and inequality. In our work we therefore focus on a consistent panel of countries, and investigate whether countries that become democratic redistribute more and reduce inequality relative to others. We also focus on a consistent definition of democratization based on Freedom House and Polity indices, building on the work by Papaioannou and Siourounis (2008).
One of the problems of these indices is the significant measurement error, which creates spurious movements in democracy. To minimize the influence of such measurement error, we create a dichotomous measure of democracy using information from both the Freedom House and Polity data sets, as well as other codings of democracies, to resolve ambiguous cases. This leads to a binary measure of democracy for 184 countries annually from 1960 (or post-1960 year of independence) to 2010. We also pay special attention to modeling the dynamics of our outcomes of interest – taxes as a percentage of GDP, and various measures of structural change and inequality.
Our empirical investigation uncovers a number of interesting patterns. First, we find a robust and quantitatively large effect of democracy on tax revenues as a percentage of GDP (and also on total government revenues as a percentage of GDP). The long-run effect of democracy in our preferred specification is about a 16% increase in tax revenues as a fraction of GDP. This pattern is robust to various different econometric techniques and to the inclusion of other potential determinants of taxes, such as unrest, war, and education.
Second, we find an effect of democracy on secondary school enrolment and the extent of structural transformation (e.g. an impact on the nonagricultural shares of employment and output).
Third, however, we find a much more limited effect of democracy on inequality. Even though some measures and some specifications indicate that inequality declines after democratization, there is no robust pattern in the data (certainly nothing comparable to the results on taxes and government revenue). This may reflect the poorer quality of inequality data. But we also suspect it may be related to the more complex, nuanced theoretical relationships between democracy and inequality pointed out above.
Fourth, we investigate whether there are heterogeneous effects of democracy on taxes and inequality consistent with these more nuanced theoretical relationships. The evidence here points to an inequality-increasing impact of democracy in societies with a high degree of land inequality, which we interpret as evidence of (partial) capture of democratic decision-making by landed elites. We also find that inequality increases following a democratisation in relatively nonagricultural societies, and also when the extent of disequalising economic activities is greater in the global economy as measured by US top income shares (though this effect is less robust). These correlations are consistent with the inequality-inducing effects of access to market opportunities created by democracy. We also find that democracy tends to increase inequality and taxation when the middle class are relatively richer compared to the rich and poor. These correlations are consistent with Director’s Law, which suggests that democracy allows the middle class to redistribute from both the rich and the poor to itself.
Conclusions
These results do suggest that some of our basic intuitions about democracy are right – democracy does represent a real shift in political power away from elites that has first-order consequences for redistribution and government policy. But the impact of democracy on inequality may be more limited than one might have expected.
This might be because recent increases in inequality are ‘market-induced’ in the sense of being caused by technological change. But at the same time, our work also suggests reasons why democracy may not counteract inequality. Most importantly, this may be because, as in the Director’s Law, the middle classes use democracy to redistribute to themselves. Nevertheless, since the increase in inequality in the US has been associated with a significant surge in the share of income accruing to the very rich, compared to both the middle class and the poor, Director’s Law-type mechanisms seem unlikely to be able to explain why policy has not changed to counteract this. Clearly other political mechanisms must be at work, the nature of which requires a great deal of research.
References
Acemoglu, Daron and James A Robinson (2000), “Why Did the West Extend the Franchise?”, Quarterly Journal of Economics, 115: 1167–1199.
Acemoglu, Daron and James A Robinson (2008), “Persistence of Power, Elites and Institutions”, The American Economic Review, 98: 267–291.
Daron Acemoglu, Suresh Naidu, Pascual Restrepo, and James A Robinson (2013), “Democracy, Redistribution and Inequality”, NBER Working Paper 19746.
Gil, Ricard, Casey B Mulligan, and Xavier Sala-i-Martin (2004), “Do Democracies have different Public Policies than Nondemocracies?”, Journal of Economic Perspectives, 18: 51–74.
Lindert, Peter H (2004), Growing Public: Social Spending and Economic Growth since the Eighteenth Century, New York: Cambridge University Press.
Meltzer, Allan M and Scott F Richard (1981), “A Rational Theory of the Size of Government”, Journal of Political Economy, 89: 914–927.
Papaioannou, Elias and Gregorios Siourounis (2008), “Democratisation and Growth”, Economic Journal, 118(532): 1520–1551.
Rodrik, Dani (1999), “Democracies Pay Higher Wages”, Quarterly Journal of Economics, 114: 707–738.
Sirowy, Larry and Alex Inkeles (1990), “The Effects of Democracy on Economic Growth and Inequality: A Review”, Studies in Comparative International Development, 25: 126–157.
Stigler, George J (1970), “Director’s Law of public income redistribution”, Journal of Law and Economics, 13: 1–10.
New Developmentalism: Macroeconomics for Developing Countries
After developing remarkably over the course of the 20th Century, the Brazilian economy stagnated in the 1980s, as a consequence of high inflation and a substantial foreign debt crisis.
Since 1994, despite these two obstacles having been overcome, the country’s growth per capita has been limited to 1% per year, down from an average of 4.5% between 1950 and 1980.
In 2007, I wrote Macroeconomics of Stagnation in order to develop a new theory to understand and explain the Brazilian economy’s poor performance. This article is about the application of that theory to Brazil. The 2007 essay garnered little attention when it was published because a commodities boom caused the Brazilian economy to skyrocket, but the following years confirmed my diagnosis. Globalization and Competition (2010) and Developmental Macroeconomics (2016, co-authored with Nelson Marconi and José Luiz Oreiro), represent a more extensive articulation of the theory.
The theory gradually took shape and received a name: new developmentalism. Inclusive of development macroeconomics and a political economy of developmental capitalism, the theory contrasts with two extremes: liberal capitalism and statism.
New developmentalism’s macroeconomics is innovative in how it addresses the exchange rate and the current account balance and by virtue of its focus on the five macroeconomic prices: the interest rate; the exchange rate; the wage rate; the rate of profit; and the rate of inflation.
Education, institutions, investment in infrastructure, a financial system able to facilitate investment, and sustained demand are all essential to the economic development process. I argue that the exchange rate and the current account balance are just as essential, and, together with sustained demand, their outcomes are short-term.
Of all the macroeconomic prices, the exchange rate has received least interest from economics. In The General Theory of Employment (1936), John Maynard Keynes created a ‘closed’ economy model involving no foreign trade and posited a fixed exchange rate, thereby excluding exchange rate policy from his book.
Liberal or neo-classical economists believe the exchange rate is satisfactorily determined by the market and their only proposal in this regard is free currency exchange.
Classical development economists like Arthur Lewis, Albert Hirschman, Raúl Prebisch, and Celso Furtado understood the importance of the exchange rate, but instead of arguing for a competitive rate, they proposed a problematic substitute to foster industrialisation: high tariffs on imports of manufactured goods.
Many still believe the exchange rate is only important in its effect on imports and exports but it is crucial for inflation as well. According to new developmentalism, the exchange rate is a significant determinant of investment and savings, and therefore of economic development.
An exchange rate that is overvalued in the long run makes a country’s manufacturing firms uncompetitive, discourages investment, and thereby becomes an obstacle to growth. In addition, the corresponding current account deficit leads the country into a balance-of-payments crisis. Nevertheless, the overwhelming majority of economists fails to recognize the importance of current account deficits. They are rightly concerned with the fiscal indiscipline expressed by severely high public deficits but are deeply mistaken to not argue for exchange rate discipline as well, in order to guard against severe current account deficits.
1. Against Current Account Deficits
A theory possesses value if in addition to being true to fact it is also counter-intuitive. The simple replication of common wisdom is not good science.
New developmentalism’s macroeconomics begins with a counter-intuitive principle: middle-income countries like Brazil do not need foreign capital. Current account deficits, which are necessarily financed by foreign funds, hamper economic development rather than fostering it. The notion that capital-poor countries must attract capital from rich ones seems true, but is misguided.
The argument for taking on foreign debt is that a current account deficit equates to ‘foreign savings’ and that foreign savings and domestic savings together make up total savings, which always spells investment. This, however, is an accountant’s reasoning, not an economist’s. An economist thinks in terms of cause and effect, not in terms of identities.
When a country has a current account deficit, its exchange rate rises in parallel; secondly, the revenues of labourers (wages) and rentiers (interest, rent, and dividends) increase in real terms; thirdly, profits fall, discouraging firms from investing, while workers and rentiers are encouraged to consume. The influx of foreign funds, therefore, leads to a high level of substitution of domestic savings for foreign savings.
The only situation in which the substitution of domestic for foreign savings will not be as significant is when a country is already experiencing very marked growth when investment opportunities are multiplying, and the propensity to invest is increasing. The last time this occurred in Brazil was during the 1968-1973 economic ‘miracle’.
As figure 1 shows, there is a direct link between the current account balance (horizontal axis) and the exchange rate (vertical axis). A current account deficit corresponds to a higher exchange rate than that required for a balanced current account.
This can be illustrated by a country like Brazil, which has already industrialised but exhibits a very slow growth rate, low investment and savings rates, and high public and current account deficits.
In a country like this, an exchange rate that would keep the current account at zero is R$3.30 to the US dollar, whereas an exchange rate that would enable manufacturing companies to be competitive is R$4.00 to the US dollar, corresponding to a current account surplus of 1% of GDP. In the same country, a current account deficit of 3% of GDP would correspond to a higher exchange rate of R$2.80 to the US dollar. Figure 1 displays this correlation.
When a government decides to pursue growth through foreign savings, it, therefore, decides to incur a current account deficit. The decision is self-defeating because the growing current account deficit denotes an exchange rate that in the long run, is so high as to make technologically competitive companies (i.e., those using the best technology available) uncompetitive in monetary terms.
By accommodating a current account deficit, the government engages in exchange rate populism: the country incurs a current account deficit that causes wages interests, real estate rents, and dividends to be artificially high, rather than encouraging investment and growth.
In order for Brazilian firms (be they local or multinational) to remain internationally competitive, the government must ensure an exchange rate of around R$4.00 to the US dollar, corresponding to a current account surplus of just over 1% of GDP.
This idea is counter-intuitive because it means the country does not need foreign funds. In fact, by incurring a current account surplus the country will grow while reducing its foreign debt, increasing its international reserves, and/or financing local companies investing abroad.
2. Dutch Disease
In the example above, the exchange rate that balances the current account, or holds it at zero (R$3.30 to the US dollar) is the ‘current equilibrium’ exchange rate. The competitive or ‘industrial equilibrium’ exchange rate is different – at around R$4.00 to the US dollar – because the country suffers from the Dutch disease. In this example, the Dutch disease represents the R$0.70-to-the-US-dollar difference between the industrial and current equilibriums.
The Dutch disease is a long-term over appreciation of a country’s currency caused by commodities exports which – whether due to a momentary boom in prices or differential or Ricardian rents – can be profitably exported at an exchange rate significantly higher than that enabling state-of-the-art manufacturing firms to remain internationally competitive.
Although the Dutch disease represents a R$0.70-to-the-US-dollar differential in this example, it may be far greater in other cases, especially in oil-exporting countries where the cost of extraction is very low. The severity of this competitive disadvantage will vary in accordance with international commodities prices.
A country affected by the Dutch disease will experience a current account surplus. In figure 2, with the exchange rate on the vertical axis and time on the horizontal axis, the two equilibriums are shown by the near-parallel red and blue lines: the current equilibrium is the lower red line, and industrial equilibrium is the blue line above. In a commodities-exporting country, commodities will determine the current equilibrium because this equilibrium corresponds to a satisfactory rate of profit for local producers.
Neutralising the Dutch disease means raising the current equilibrium to the level of the industrial equilibrium. Because the latter is higher than the former, this means that neutralising the Dutch disease and thereby ensuring a competitive playing field for firms operating abroad necessarily involves a current account surplus.
The two equilibriums vary over time. For the purposes of this article, it suffices to say that the industrial equilibrium varies mainly with increased productivity and rising manufacturing wages, whereas the current equilibrium varies mainly with changes in commodity prices.
How can the Dutch disease be neutralised? Before it was properly acknowledged, the Dutch disease was neutralised intuitively through high customs tariffs. Governments justified this using the infant industry argument, while critics accused governments of protectionism. However, in many cases, high customs tariffs aimed to neutralise the Dutch disease for the sake of the foreign market.
The United States, for example, endured the Dutch disease due to oil exports, so maintained high tariffs until 1939. To speak of an infant industry at that point would have been absurd, and nor does it make sense to think in terms of protectionism. In fact, high tariffs were a necessary condition for US industrialisation. The US stopped neutralising the Dutch disease in 1939 because it was already very rich and – because of the war – it lacked competitors.
Ordinarily, countries neutralize the Dutch disease from a certain stage of development onwards, following an import substitution model of industrialization. To this end, they subsidize exports of manufactured products in addition to implementing high import tariffs on foreign goods. Brazil did this successfully between 1967 and 1990. In 1965, manufactured goods exports represented just 6% of total exports; this had risen to 62% by 1990!
The WTO now forbids subsidies. The alternative is to tax commodities exports at variable rates based on commodity prices, whereby, in the Brazilian case, the exporter of a certain commodity would pay 0.70 per US dollar of exports earned. As a consequence of the reduced supply caused by the tax, the exchange rate would depreciate, thereby re-establishing supply, with the manufacturing industry becoming internationally competitive. The tax on commodities exports would lead the market to automatically equalize the current and industrial equilibriums.
This is a very interesting way to neutralise the Dutch disease because ultimately it doesn’t cost exporters anything. What they pay, they receive back in full by way of currency depreciation.
3. Exchange Rate Overvaluation
Figure 2 also shows a third curve, with cyclical behaviour expressed by two peaks; this is the real exchange rate curve. If the market operated as liberal economists assume, the curve would float around the current equilibrium. We know, however, that this is not the case.
According to new developmental macroeconomics, in developing countries afflicted by the Dutch disease, severe long-term exchange rate overvaluation is typical, leading the economy from one financial crisis to another. The peaks correspond to financial crises, after which the exchange rate falls sharply.
In Brazil’s case, this occurred in 2002 and 2014, when the exchange rate briefly rose above the industrial equilibrium. The exchange rate then crossed beneath the industrial equilibrium, then the level of the current equilibrium, to enter the area representing a current account deficit (between the real exchange rate and the current equilibrium), finally stabilizing for a few years at a ‘bottom level’ that was not good for commodities, but enough to keep producers exporting.
Two things cause the exchange rate to rise after a crisis: the Dutch disease and very high interest rates. The Dutch disease ‘pulls’ the exchange rate only as far as the current equilibrium because, for a commodities exporting country, it is commodities that determine the current equilibrium. But the exchange rate continues to drop below the current equilibrium. This is because a commodities exporting country implements substantially higher interest rates than rich countries. Finally, the exchange rate reaches a bottom level, which, in the Brazilian case, was around R$2.80 to the US dollar (at today’s prices) from 2007 to 2017, accompanied by drastic deindustrialisation and quasi-stagnation.
While the exchange rate fluctuates around this bottom level, the current account deficits incurred year after year gradually increase firms’ foreign currency-denominated debt and therefore the debt of the country.
Because the exchange rate regime is free-floating, the deficits should cause the country’s currency to depreciate, but this is prevented by the forming of a credit bubble. Foreign creditors are happy to benefit from high interest rates, economists explain the deficits as ‘foreign savings’, beneficial for the country, and creditors continue to gladly extend credit. In consequence, local manufacturers become internationally uncompetitive and accumulate debt.
Usually, more than half of the foreign debt is financed through foreign investment, which only extends the period of overvaluation. But creditors eventually realize the risk of sovereign default and suspend refinancing of the foreign debt. Alternatively, multinational companies, fearful of being unable to repatriate profits, stop investing. Local firms (manufacturers especially) which have been forced to take on debt, having ceased to be competitive, may also conclude they have to stop accumulating debt. In any case, firms stop investing and a financial crisis is triggered, while the exchange rate rises sharply once again.
Interest rates in developing countries are usually justified by two ‘needs’: that of attracting foreign capital, and that of using the exchange rate as an anchor against inflation.
It should be clear that a policy designed to attract foreign capital is self-defeating.
Central banks have to use interest rates to fight inflation. The level of the real interest rate around which the central bank conducts policy is particularly important. It is fine for this level to be a little lower than that of rich countries, but nothing justifies a much higher level. A third cause for high interest rates can be their benefit to rentiers and financiers, which is perverse when one realises that healthy economies in democratic countries are characterised by low interest rates. Justifying high rates through foreign savings is a mistake: the resulting exchange rate rise leads to higher levels of consumption rather than higher levels of investment.
The use of the exchange rate as an anchor against inflation is absurd. Economists are outraged when governments hold back the prices of state-owned companies (like Petrobras, for example) to keep inflation under control; they should be similarly outraged when central banks hold back the ‘price of the country’: the exchange rate.
4. Financial Crises
Every country is subject to financial crises, which mainly consist of banking crises in rich countries and balance-of-payment or foreign exchange crises in developing countries.
Conventional economics explains crises away in terms of fiscal irresponsibility. Indeed, financial crises may stem from this: excessive government spending can cause increases in demand, imports, and ultimately, fiscal and current account deficits. When these occur together, they are referred to as the ‘twin deficits’.
Still, crises may emerge in the absence of fiscal indiscipline, simply as a consequence of policies of growth through foreign savings.
These days, government fiscal accounts are increasingly scrutinised by rating agencies, financial economists, and the press, so that imbalances like those of the Rousseff Administration are more of an exception than a rule amongst middle-income countries.
On the other hand, current account deficits and the indebtedness of firms do not receive the same level of attention from conventional economists, be they liberal or developmental, because they mistakenly assume the market will provide appropriate controls. It is therefore understandable that these deficits are the main causes of developing countries’ financial crises.
5. The Exchange Rate and Development
Investment is the key variable in the development process. The state’s economic role in contemporary societies is to provide equitable income distribution and ensure conditions for capital accumulation. In this latter role, firstly, it has to provide education; secondly, institutions that ensure market efficiency; thirdly, infrastructure investment; fourthly, long-term finance, and fifthly, a stable national currency.
Keynes diagnosed capitalism’s tendency for insufficient demand and added a sixth condition: demand for investment. New developmentalism adds a seventh general condition: an exchange rate capable of ensuring firms’ access to demand. The exchange rate is like a switch that will turn access to foreign and domestic markets on or off.
Economic development textbooks do not discuss exchange rates because they are seen to represent short-term problems and economic development is chiefly interested in long-run trends. Exchange rates are acknowledged to be volatile, but this volatility does not occur around the current equilibrium. If that were the case, its negative effect on investments would be relatively small because businessmen would not take a higher interest rate for reference when making their investment calculations.
New developmentalism views the problem differently because it is the only theory accounting for the fact developing countries have a tendency for cyclical and long-run exchange rate overvaluation in-between financial crises.
In Brazil, for example, the exchange rate remained overvalued for seven years from 2007 to 2014, during which it hovered around R$2.80 to the US dollar. Under these conditions, businesses find investment does not help them remain competitive, even if using state-of-the-art technology, and choose not to invest.
6. Economic Policy
To ensure increases in savings and investment, macroeconomic policy must not only guarantee fiscal responsibility but exchange rate responsibility as well, with an even greater focus on the latter because current account deficits are less justifiable than public deficits.
Of paramount importance is that five key prices are effectively controlled: low interest rates; competitive exchange rate; wage rates compatible with rates of profit sufficient to provoke investment; and a low rate of inflation.
The exchange rate is the most important of these five prices. Exchange rates should be maintained close to the industrial, or competitive, equilibrium. In other words, cyclical exchange rate overvaluation must be neutralised to ensure firms can access both foreign and domestic demand. Industrial policy is also necessary, but as a supplement, never a substitute, for macroeconomic policy.
In order to maintain a competitive exchange rate, the Dutch disease should be neutralised through a variable tax on commodities exports, and should also reject the three policies habitually embraced by developing countries which cause additional currency appreciation: the policy of growth through foreign debt; the use of the exchange rate as an anchor against inflation; and – the policy used to enable the former two – high interest rates.
Central banks should certainly use interest rates to combat inflation, but it should be kept low – slightly above rich country rates. Because central banks are responsible for keeping inflation in check, they are constantly tempted to keep interest rates high and the exchange rate overvalued. That is why central banks should be responsible for growth in addition to inflation. As is already the case in certain countries, exchange rate policy committees should operate similarly to existing monetary policy committees. Naturally, the government should also be able to control capital flows.
7. Where the Difficulty Lies
The theory is simple and so is the exchange rate policy that derives from it. New developmentalism explains why so many developing countries face the competitive disadvantage of long-term exchange rate overvaluation and are therefore unable to industrialize, and why middle-income industrialised countries which dismantle their mechanisms for neutralising the Dutch disease then deindustrialise, as has been the case in Brazil.
The reason countries like Brazil have followed the course they have is the pressure received from the rich world since the 1980s, when developing countries surrendered to economic liberalism and opened up their economies, thereby dismantling mechanisms which had previously prevented exchange rate overvaluation: import tariffs and subsidies for the production of manufactured goods.
New developmentalism explains the fortunes of deindustrialising middle-income countries and offers policy responses. But now that the theory is available, why don’t developing countries, Brazil included, embrace the necessary policies?
Firstly, in spite of interest from younger scholars, trained economists have enormous trouble learning and internalising new things.
Secondly, there is a short-run cost involved in shifting from a current account deficit to a surplus. The necessary one-time devaluation reduces the income of both workers and rentier capitalists.
The fact neither workers nor rentiers like devaluation is why development economists who defend the short-term interests of wage-earners, and liberal economists who basically represent the interests of rentiers and financiers, are both opposed to devaluation.
Rentiers oppose devaluation with a better reason than workers. For the latter, a depreciation will cause wages to lose purchasing power in the short run, but they will soon be rewarded with additional jobs, and later, with increased productivity and higher wages. For rentiers, the picture is different. A devaluation will similarly reduce the purchasing power of their revenues (interests, dividends, and real estate rents), but also the worth of their wealth. Devaluation will also occur only via an interest rate cut, which definitely runs counter to rentier interests. That is why – besides the neo-liberal education they receive in American and British universities – liberal economists refuse to countenance a competitive exchange rate and inevitably ‘forget’ exchange rates when discussing developing countries’ economic problems.
Faced with the macroeconomic issues caused by large current account deficits and public deficits, liberal economists merely propose fiscal adjustment. By causing recessions and unemployment, sole reliance on fiscal measures reduces interest rates and makes the national currency more competitive without devaluing it. In this way, only waged and salaried workers pay for the adjustment by way of a drop in wages.
New developmentalism’s proposals include fiscal adjustment too but alongside a simultaneous cut in interest rates and a currency devaluation. This leads to a more complete adjustment of the country’s accounts and a more equitable distribution of the cost of the adjustment.
Under conditions of ‘liberal’ adjustment, costs are entirely borne by workers, who lose their jobs and see their wages and salaries reduced. In contrast, the bill for new developmentalism-style adjustment is distributed between wage earners and rentiers.
The Surplus Approach to Rent
Theories of rent are wide-ranging. However, whether neoclassical, Marxist, or Proudhonist, they tend to neglect evolutionary institutionalist theorising. Increasingly dominated by the income approach, rent theories need to be expanded, partly to correct existing work, partly to break persistent intellectual monopoly and oligopoly, and particularly to develop institutional theories of rent. In this paper, I attempt to do so by presenting and evaluating the surplus approach to rent, particularly R.T. Ely’s, highlighting its power and potential and stressing its critiques and contradictions. Drawing, among others, on the original writings of Ely, it is argued that, while the emphasis on property rights, land as a ‘bundle of sticks’, and rent as surplus rather than income help to advance heterodox approaches to rent, the surplus approach is severely limited in its analysis of inequalities and how they can be addressed, especially in extractivist and rentier societies. To unravel long-term inequalities that characterize rent and rentier economies, it is crucial for surplus theorists to engage stratification economics which, in turn, can drive the surplus approach to rent.
1. Rent: Beyond Income
Neoclassical economists define rent as the price paid for the use of land obtained in a competitive market (see, for example, O’Sullivan, 2012, p. 157-161). Therefore, rent is an open-market price paid for the use of land – much like interest is income for the use of capital. In this income approach, rent functions as a driver of growth. Also, rent – like price, more generally – becomes a mechanism for allocating land as a scarce resource.
The surplus approach to rent is rather different. Advanced by a wide range of classical and other economists, including the physiocrats, Smithians, Ricardians, Georgists, institutionalists, Marxists and the French Régulationists, rent is not simply the return price for the use of land; it is also surplus (Ely, 1922, 1927; Haila, 1990, 2016; Fine, 2019; Faudot, 2019). Every surplus approach offers a critique of approaches in neoclassical economics and their related policy prescriptions, but the surplus approach also provides a comprehensive and coherent alternative framework to analyse extractivism and other socio-ecological problems (Butler, 2002). In practice, the surplus approach also offers a springboard for developing practical transformative steps and policies to change the world.
Beyond these generalities, the surplus approach has many nuances. Various theorists have debated what land rent is, and what it is not. Many analysts focus on regimes of growth, particularly the French régulationnistes (See, for example, Faudot, 2019, the work of Robert Boyer, and its extensive discussion, including Vercueil, 2016; Harada & Uemura, 2019). When determining how to address inequality, they deal with the question of rent as a surplus, but how to deal with that surplus and whether to emphasise growth or inequalities, land or capital varies widely. Generally, in the surplus approach, a critical question is whether to re-invest the surplus “to expand and transform the existing economic system”, whether the surplus should be ‘wasted in luxury consumption, leading to economic decline’ (Martins, 2018, p. 41), or whether to redistribute the surplus for inclusive economic development. What proportion of land rent should be returned to the landowner? Should a landowner whose labouring activities help to improve land rent be compensated or should all land rent be given back to society?
Richard T. Ely, a pioneering institutional economist, sought to provide new answers to these questions. He did so by emphasising land, especially redefining land, reintegrating economics and law through land, and bringing in the courts as arbiter to the land rent question. Accordingly, Ely’s focus was not so much on growth, but rather on how land rent is an instrument for creating and maintaining systemic inequality and in what ways inclusive prosperity or wellbeing might be nurtured in an ecologically sound society.
These contributions are of continuing importance. Three reasons help to make the point. The first is that the Revue de la régulation1 is seeking to bring back the rent approach to the political economy of the régulation school at a time when the study of extractivism is at the crossroads on whether to give any place to ‘earlier’ rentier state analysis pioneered by Hossein Mahdavy (see, for example, Mahdavy, 1970).
The second is that the rent approach to the study of inequality has been marginalised in political economy, which is increasingly centred on labour and capital, and their growth (Obeng-Odoom, 2020a; 2021), rather than on land and its place in redistribution (Sheil, 2015; Asongu, 2016). In the USA, Piketty (2014) shows that inequality levels have reached 1910/1920 levels of between 45-50 percent wealth concentration in the hands of the top 10 percent of the population in that country (also, updates in Piketty, 2020). OXFAM (2014) reports that 85 people now have the same wealth as half of the world (3.5bn people). The attempts to explain this inequality has typically focussed on capital and labour. For example, Piketty’s contributions have largely focused on the capital-income ratio (see, for example, Piketty, 2014, p. 8, p. 18, p. 40, p. 42). In general, a careful analysis of land and property rights has largely been ignored, as Robert Rowthorn (2014) pointed out in his review of Piketty’s work for the Cambridge Journal of Economics. Much like Piketty’s work, the OXFAM report focuses on total wealth and the proportion going to the class of capitalists, while others demand attention to labour, but only make superficial or rhetorical comments about land-based inequality.
A third and final reason for the continuing importance of Ely’s contribution is that he has been overlooked as an institutionalist.
Ely gradually disappeared from American social sciences after the early twentieth century […] neoclassical thought […] made every effort to limit his place in the history of thought, granting him only a few mundane lines in the New Palgrave. (Rocca, 2020, p. 11)
Institutionalism is well developed in modern political economics, but its relationship to land and property rights especially as echoed in the work of Richard Theodore Ely, is poorly understood. The entries on ‘institutionalism’ in the Encyclopedia of Political Economy make no reference to Ely (see Waller, 2001, p. 523-528; O’Hara & Waller, 2001, p. 528-532; Hutton, 2001, p. 532-535; Hodgson, 2001, p. 535-538), although he is the “progenitor” of institutional political economy (Vaughn, 1994, p. 28), “founder of land economics” (Weimer, 1984; Malpezzi, 2009), “dean of American economists” (Vaughn, 2000, p. 239) and the founding editor of the field’s pre-eminent journal, Land Economics, initially called the Journal of Land and Public Utility Economics (Salter, 1942).
The existing work on Ely is so little that it can easily be summarised. One type is biographical, looking at the life and contribution of Ely (see, for example, Rocca, 2020). Another is laudatory of his proposals, while the third is entirely dismissive of the political proposals of Ely about war, and unions, for example (see a review in Bradizza, 2013, p. 13-16). Bradizza’s (2013) book and Rocca’s (2020) book chapter are some of the rare recent contributions on Ely seminal interventions on property rights, but these studies do not address Ely’s surplus approach to rent. It seems Ely’s work on rent has largely been forgotten.
Demonstrating the continuing importance of Ely, I draw on his original books and papers, along with existing wider analyses of his work, including reviews of his books published around the time his books were first released. In doing so, in this paper I seek to explain and evaluate Ely’s distinctive approach to rent and to reflect on its significance in modern institutional economics and political economy more widely at the time of a resurgence in extractivism and rentierism.
Like other surplus theorists, Ely rejected the income approach to rent common in neoclassical economics. However, unlike other surplus theorists, Ely recognised that landowners bear substantial costs, so not all the rents going to them should be socialised. He contended that the rent going to landlords was justified so long as they put their private property to social uses. If they failed to do so and, hence, inequality continued to increase or remained entrenched, again Ely broke ranks with other surplus theorists by refraining from the use of revolutionary political processes. Instead, he preferred evolutionary transformation in the form of changes in laws and, notably, appeal to the courts to intervene in addressing growing inequalities. This emphasis on law and rules also distinguishes Ely’s approach to land, which other surplus theorists considered as a unity. For Ely, land was not only a ‘bundle of sticks’ with diverse interests and tenures; land rent also differs based on use, type of land, and change of use and land type, along with all the typical surplus approach emphasis on, say, location and fertility (see, for example, Ely, 1940, p. 76, p. 80-81). In this sense, like Marx’s theories of rent (Munro, 2022), Ely’s surplus approach is historically specific, against absolutism, and crude determinism (Rocca, 2020, p. 4). However, unlike Marx’s theorising, Ely’s approach was evolutionary, rather than revolutionary, and his ‘bundle of sticks’ approach, far more granular. In general, Ely’s specific surplus approach created a “Golden mean”, with three defining features (Rocca, 2020, p. 3), namely: offering a critique of the status quo, providing the principles undergirding evolutionary alternatives, and providing concrete practical steps or policies for creating an inclusive society.
Ely contemplated the limits of his surplus approach. For instance, he suggested that if the courts failed, new judges could be appointed. Concurrently, commissions of enquiry could be established and used to pursue reform (Rocca, 2020, p. 9). However, he was less successful in foreseeing the tendency for property rights to entrench inequality and how that inequality itself gives power over the courts. Also, he overlooked the various ways in which the courts are stratified and racialized. The difficulties of simply appointing new judges in such a racialised environment was not carefully analyzed either. More fundamentally, Ely paradoxically endorsed the global intersections of national inequalities, and entrenched stratification.
To flesh out these arguments, the rest of the paper is divided into three sections. Rent and surplus explains Ely’s conceptualization of rent, stressing how it differs from other theorizations of rent. Rent and distribution discusses how Ely’s surplus approach to rent is applied in the analysis of property and maldistribution. Critiques and contradictions shows the limitations of Ely’s approach.
2. Rent and Surplus
Rent features prominently in Ely’s political economy. While many political economists equate rent and surplus, Ely considered some, but not all, rent to be surplus. In his article, “land income” (Ely, 1928), he clarified how his three-part contribution relates to neoclassical economics, classical economics, and institutional economics. For both neoclassical and classical economics, he offered critiques, paving the way for his attempt to make a positive contribution to institutional economics.
Neoclassical economics regards rent as a payment for the use of land, itself a gift of nature whose value is determined through the interaction of supply and demand. According to Ely, none of these is accurate (Ely, 1928, p. 409). Ely (1917, p. 20, p. 28; 1928) considered rent to be payment for more than land use. Rent reflects privilege for the use of a multiplicity of property rights in land, which is itself made up of several rights together, not a unity. Ely was one of the early exponents of the notion that property is a ‘bundle of rights’ (see, for example, Ely, 1940, p. 76, p. 80-81), not the singular view of property so commonly held in neoclassical economics. This emphasis on rights and economics also made Ely a pioneer of the economics approach to law or the law approach to economics, the combination of which is much bigger than the total of the various parts. For instance, the ‘bundle of rights’ metaphor for Ely also signified an evolutionary approach to social inclusion, not simply a meme of laws and rights (Rocca, 2020, p. 7). In Ely’s political economy of rent, therefore, the courts are clearly central in settling questions of rent and social injustice. In neoclassical economics, too, property rights need to be guaranteed by the courts of law, but in the case of Ely, “they are not absolute rights of an abstract or isolated individual but social arrangements to be justified because they serve definite social-economic ends” (Cohen, 1917, p. 388). The courts in Ely’s surplus approach do not simply favour the landlord, but they consider the social good of private property.
Ely’s approach differs from other surplus approaches, at least in three respects. Firstly, land is not a free resource of nature. Secondly, not all rent is surplus. Thirdly, although contingent rather than categorical, Ely’s proposed solution to the surplus problem is to be found in the courts. Explaining these three differences is crucial for appreciating the essence of Ely’s surplus approach. Starting with whether land is free for Ely is fundamental. Unlike in the classical economics tradition of surplus value which considers that land is a gift, neither land nor land-use is free in Ely’s surplus approach to rent. There are waiting and ripening costs to be borne by the user of land. For these reasons, land income, Ely’s preferred expression for land rent, is not simply the product of supply and demand. He recognises location advantages, the role of public investments, luck, and uncertainty in determining rent, but how they influence rent is shaped by both land-use type, land-use form, and the change between land uses, ranging from mineral land, agricultural land, urban land, and forest land, to many other types of land (Ely, 1922, p. 39-42; 1928).
The second difference between Ely’s approach and other surplus approaches relates to whether all rent is ‘surplus’ (Ely, 1914, p. 400-411). In many of the surplus approaches, rent is an extra payment received over and above what non-privileged people receive; or rent is the extra payment received over subsistence levels. Alternatively, rent could be seen as anything that is owed to labour after it has been paid an exploitation wage. There is also rent as “economic surplus”, which Ely considers the most similar to his approach. According to him, this rent or economic surplus is the “excess over and above what is required to secure the application of the requisites of production” (Ely, 1914, p. 401). What sets Ely apart is that his reading of ‘surplus’ was unlike most classicals who contended that any payment that exceeds what is socially necessary for the factor of production to be used is to be considered as rent or surplus. Karl Marx used ‘surplus value’ to denote anything in excess of what is paid to labour. Henry George, on the other hand, generally considered all land income to be unearned increment and, hence, postulated that the annualised rental value of land should be taxed away, while removing taxes on labour and capital.
Ely’s proposed solution to rent-based problems also set his approach apart from other surplus frameworks. Ely recognised that privilege and interests, even insider group-trading and information can pave the way for extraordinary advantages to accrue to individual landlords. That is, that society creates the conditions for rent. He called this influence of group characteristics a “‘group relationship’ theory of land income” (Ely, 1928, p. 421, italics added). However, he maintained that the broad-based surplus approach is problematic. It is not the privileges per se that generate the increases in value, but the public facilities. However, even these so-called ‘unearned’ incomes are earned because individual landlords incur costs. Ely points to waiting costs and ripening costs as examples (Ely, 1928, p. 409-414). Accordingly, he contended that landlords must be compensated for the cost of waiting and of deferring the use of land to a future date.
To the charge that speculative investments should be discouraged, Ely argued that such speculation is justified because often land investors need to acquire adjoining parcels of land, if they consider that other uses to which such lots could be used would hamper the realisation of the full potential of the land. So, speculation is socially necessary (Ely, 1928, p. 414-416). Ely also argued that land can suffer decrements. If rents can increase, they can also fall. In Ely’s expression, there are both “unearned increments and likewise unearned decrements” (Ely, 1928, p. 426). For all these risks, landlords should not be assumed to always benefit from “unearned income”. “It is suggestive of serious mistakes”, wrote Ely, “that the consideration of land rent and land income has not been closely connected with the consideration of costs. […] The classical view of the rent of land is that it is income without cost” (Ely, 1922, p. 33).
Still, Ely’s approach to rent is based on the surplus approach in a narrower sense. In Outlines of Land Economics, under “Definition of surplus used in this work”, Ely wrote, “The economic surplus is that which is paid over and above such a return to those who are engaged in production as will induce them to do their part fully and efficiently in the work of production” (Ely, 1922, p. 23). Of the five forms of surplus, Ely names “rent of land” as the first, the rest being interest, personal surplus, monopoly gains, and gains of conjecture (Ely, 1922, p. 26). Contrary to the classicals, Ely makes a distinction between surplus and socially useful surplus. The latter is surplus which, when taken back from rent via tax (for example), the land investors will be so demoralised that they give less than optimal contribution to land investment (Ely, 1922, p. 26-27).
Finally, Ely’s preference is to use the courts to address problems of surplus and rent. However, unlike others who were more categorical about such claims, Ely insisted that his position of rent was not cast in stone. Rent was one of the fields of research he set out in his course about, and vision of, land economics (Ely, 1917, p. 28-29). There were three aspects in these endeavours: Description, Definition, and Determination of the claims about rent. In terms of description, he argued that the field of land economics should focus on evolutionary changes in the use of the terms, to analyse the significance in the use of the term and to evaluate how rent is used both in science and in the market. In terms of Definition, he insisted on rent as power or privileged position. Both of these percolate his third charge: to offer empirical assessments of rental theories continuously (including the effects of custom and competition on rent). Reflecting the influence of the German Historical School on Ely (Rocca, 2020, p. 2), his surplus approach is historically specific, against determinism, and absolutism. These features also Ely’s approach to extractivism and distribution.
3. Rent, Extractivism, and Distribution
To examine how Ely’s surplus approach is applied to the analysis of extractivism, structural or long-term inequality, examining his book, Property and Contract in Their Relations to the Distribution of Wealth (hereafter Property and Contract, Ely, 1914) is critical because of its use of “wealth” as “weal” or “that which produced well-being” (Ely, 1914, p. 19) – a central issue in the analysis of global social problems about extractivism. Wealth, as a concept has many intertwined aspects, namely: economic wealth and social wealth. Private wealth, Ely explains, “means economic goods which yield utilities to the individual, and it may even mean something which detracts from social wealth”. Even though private wealth includes “legitimate and proper claims on others”, private wealth “is a concept which belongs primarily to a discussion of individual distribution, while social wealth is a concept which receives special emphasis in production” (Ely, 1914, p. 23). Public and social wealth may be similar (e.g., a post office), but not all public (state) wealth is social wealth.
It is from this formulation that Ely develops his approach to distribution. In Property and Contract (Ely, 1914), he sets out to build on this formulation. In doing so, he argues that distribution is more about ownership than location. While Ely’s questions such as “in whose hand do they rest as property?”, that is “who has the right to consume them, to sell them, to give them away?” (Ely, 1914, p. 1) have a Marxian ring, his question: what are the “underlying economic institutions upon which the economic structure rests” (Ely, 1914, p. 5), takes the analysis one step beyond the Marxist ‘structuralist’ perspective.
Ely’s approach to the study of inequality is based on three questions. First, what is the distribution of income and wealth among ‘the various units of the social organism?’ (Ely, 1914, p. 2). Next, what portion of this wealth produced is derived from or given back to land, labour, capital, or entrepreneurship? Then, what institutions support the present economic structure? Marxists typically leave their analysis at the second level in the enquiry, while for Ely, the third aspect constitutes the ‘fundamental’ issue: “The third line of enquiry […] is concerned with the underlying economic institutions upon which our whole economic structure rests. The fundamentals have been much neglected […]” (Ely, 1914, p. 5). On page 6, Ely also equates institutions with “foundation”. Figure 1 is a schematic presentation of Ely’s approach.
Figure 1. Ely’s approach to analysing the distribution of wealth
Figure 1 is an annotated diagram of Ely’s analysis of distribution. The institutions in the figure are the fundamentals of the system. They come in the form of collective social forces that consciously or unconsciously shape inequality. Unconscious social forces are those that are not directed at distribution per se (e.g., some laws) but end up having an impact on the question of distribution (e.g., through the unequal application of these laws). The self-conscious forces, called “social self-consciousness”, are rather different. They are aimed at affecting the question of distribution. They may come in the form of legislation, action (judicial, police, executive/government), and public opinion (through praise, criticism, punishment, and reward). Social self-consciousness can also come in the form of social and interest group activity that lobby to change the distribution of incomes and wealth. Such lobby groups can be associations, labour organisations, consumer leagues, and religious groups. There is a relationship between the social self-conscious and the unconscious social forces in the sense that the unconscious may become affected by the conscious with the effluxion of time just as the conscious may evolve into unconscious forces with time.
Individuals are not regarded as institutions in Ely’s approach, but their actions interact with institutions. Individual actions can be conscious, or individuals can unconsciously shape their proportion of wealth. Conscious actions such as planning and training may improve the individual’s proportion of income and wealth. Unconscious actions such as being disciplined, staying out of trouble, and study that is not aimed at improving the individual proportion of incomes and wealth may all contribute to a bigger stake in incomes. However, whether conscious or unconscious, such individual actions interact with institutions such as the media (Ely, 1914). Overall, it is the interaction of all these factors that shapes the distribution of income and wealth. As Ely notes:
We have the incomes which come to us partly because we work for them, in part also we have them because society has decided that we should have them, and not infrequently we have them because certain social forces, operating more or less unconsciously, have cooperated with our own efforts to secure them, or have even procured them for us without any efforts on our part. (Ely, 1914, p. 14)
Institutions, then, are the key forces for Ely. The institution of inheritance and the movement of property values are given by Ely as classic examples of what society does for us in terms of getting a proportion of the incomes and wealth. These considerations lead to the question of how institutions are formed. For Ely, they are collectively created, not individually devised. In his own words: “Passing over to an examination of the fundamentals in the existing socio-economic order, the first truth to note is that they are established not by individuals, nor by nature, but by human society” (Ely, 1914, p. 16).
While institutions are crucial in this approach, it does not mean that institutions themselves are built by individual action. Institutional analysis consciously veers away from beginning with individual characteristics, not only because it is institutions that matter but also because individual actions have been constrained/enabled/influenced by institutions over time and they are still being moulded by institutions. Of all the institutions of analysis, however, Ely centres his case on property, especially private property. In his own words: “The first fundamental institution in the distribution of wealth is the sphere of private property” (Ely, 1914, p. 58, capitalization in original quotation removed).
To illustrate this point, consider oil extractivism, rentierism, or (re)primarisation. A range of scholars and activists and scholar-activists reduce the process to mere extraction of oil in which case every extraction of oil is extractivism and hence, the demand to leave oil in the ground (Obeng-Odoom, 2014, p. 33-36). Others, notably Marxist scholars, consider extractivism as linked to the system of transnational extraction of oil (Nwoke, 1984a, 1984b; Cooney, 2016; Barkin, 2017; Cooney & Freslon, 2019). Thus, the ownership structure along with the international division of labour in which the Global South is consigned the role of raw oil production and the Global North supplies the tools needed to do the extraction and processing are all extractivist, meaning they come with little or no structural transformation in the economy, for example, through local-centred industrialisation. In this sense, colonialism was an extractivist regime because it transferred oil rents from the Global South to the Global North by disinvesting in oil and other infrastructure to ensure socio-economic transformation of oil economies. With the growing power of transnational corporations, Marxists argued that it would be impossible to bargain with them (see Nwoke, 1984b). In this respect, since it is difficult to bargain with transnational-colonial-imperial state complex for rent, Marxists advocated the nationalisation of oil resources. This highly influential position inspired many postcolonial oil economies to create national oil companies to socialise the rents from oil. Examples of such national oil companies are Iraq, Iran, Saudi Arabia and, until recently, Mexico (Sarbu, 2014, p. xii, p. 35). Yet, as is now well known, even when oil wells have been nationalised, oil institutions have still transferred resources into the hands of private entities.
Perhaps, the issue is not so much capital, or not solely capital, industrialisation, and state based-growth, it is also land, wider socio-ecological transformation, and inclusive change (Ely et al., 1917, p. 3-18). “Conservation policies are then land policies” (Ely et al., 1917, p. 54). “Conservation means three things: viz (1) Maintenance as far as possible; (2) Improvement where possible; (3) Justice in distribution” (Ely et al., 1917, p. 3). Ely points to a tendency for concentration through private property rights (Ely et al., 1917, p. 60-69). “Conservation is considered […] to show that it is first of all a problem of property relation” (Ely et al., 1917, p. 3). Yet, ‘property’ is a poorly understood concept. Even in property economics – supposedly the centre for the study of the economics of property – ‘property’ is confusingly regarded as a ‘thing’, often real estate and ‘possession’ of property confused with the ‘ownership’ of property (cf. Steiger, 2006; Griethuysen van, 2012). Property rights analysts add a layer of ‘rights’ to explain ‘property’ by demanding that property be regarded as a ‘bundle of rights’ exercised over a thing, often real estate and land.
Ely also uses the ‘bundle of rights’ metaphor (see, for example, Ely, 1940, p. 76, p. 80-81), but he shifts the emphasis from property relations to social relations. According to him: “the essence of property is in the relations among men arising out of their relations to things” (Ely, 1914, p. 96). For the purpose of rent theories, Ely’s focus suggests a double shift, first from individuals to property and, second, from property to society. Therefore, property, connotes class, status, and position. Property is not merely individuals having a bundle of rights, individuals exercising certain rights over things, or “the category of legal doctrines concerned with allocating rights to material resources”, as legal and new institutional economics perspectives hold (Alexander & Peñalver, 2012, p. 6). If property implies class, subclasses and inter-group differences, then so does rent: its payments could vary according to group position and its very existence is a spark for and maintains inequality and social stratification in an environment in which different groups pay different types of rent. In this sense, Ely delves into the workings of property, notably its (a) characteristics (b) mode of transfer, and (c) how it is established among various groups.
Ely refers to the ‘sphere’ of private property. This notion connotes two main features of property: its extensivity and intensivity. The extensivity of private property refers to how widespread is property which is individually owned. Intensivity refers to how many sticks are in the ‘bundle of rights’ (see, for example, Ely, 1940, p. 76, p. 80-81). Therefore, to consider property, the analyst must dig into both the breadth (extensivity) and depth (intensivity) of private property. Ely also recognises other types of tenure, namely public property (exercised by a political unit such as a city or a nation-state) and common property (exercised by a social grouping such as a community). While Ely’s attention is centred on private property, to investigate property as a driver of inequality, all types must be analysed. In doing so, the conditions under which property is held, the laws about the transfer of property (e.g., taxation or no taxation; extensive or limited transfer taxes), and the evolution of property in both its intensivity and extensivity must be studied. Property itself may be classified as ‘subjects’ (classification according to actors) and ‘objects’ (classification according to objects over which rights are exercised). Property subjects may be classified into common, private, and public property, while property objects may be human beings, land, and capital (Ely, 1914, chap. 10, book 2). It is also possible to classify property according to duration (e.g., freehold). That being said, Ely points to the crucial test of being in the propertied class: ownership as distinct from possession. Mere possession of property does not confer ‘property’ class status. According to Ely, this is why anarchists have strongly advocated that tenants in possession would rather have their possession commuted to ownership (Ely, 1914, chap. 4, book 2). Ownership confers the right of exclusivity, alienation, and appropriation (Ely, 1914, chap. 5, book 2), while possession does not necessarily confer these property rights. Applying his approach to the distribution of wealth as it relates to property and property rights in the twenty-first century illustrates the point further.
Figure 2. Key argument about the tendency under the social theory of property
The process of growing rent itself is disempowering for the poor because they are forced to move away from central areas to the margins. For some landlords, the process of concentrating property rights works through the advance of risky loans. In this process, there is much dispossession aided by both state and market rules interacting with customs and mores. Two examples of how this works are the non-application of land taxation and the removal of all taxes that constitute a brake on the private acquisition of land.
This argument and the approach on which it is based is substantially different from neoclassical or new institutional economics (mainstream economics in this paper) typically based on general equilibrium analysis and Kuznets’ ideas of inequality (see an extensive review by Asongu, 2016). For mainstream economists, inequality is not necessarily considered to be bad because it can be an incentive to hard work. Second, inequality is the result of individual effort or sloth such that the difference between the incomes and wealth can be attributed to hard work or laziness. Otherwise, in general, inequality tends towards disappearance in the form of a spatial equilibrium. The neoclassical approach to the study of wealth and income concentrates largely on the economic aspects of wealth, not its social aspects.
When land is studied, the primary assumptions are that private property motivate its owners to work hard, invest, and trade in land which in turn, will improve the social conditions of landowners and support national economic growth. However, this approach suffers conceptual bias because for most land in the Global South (e.g., Africa and the Pacific), neither of these assumptions is valid. Instead, land and property are communally held, managed, and used such that even when individual kith and kin pursue personal aspirations with ‘their land’, the use must be governed by and in pursuit of the collective good broadly defined (Anderson, 2011; Elahi & Stilwell, 2013). So, there is no congruence between neoclassical assumptions and the real land economy of customary landowners. New institutional economics (NIE), on the other hand, accepts that neoclassical economics is in error in making methodological individualist assumptions about customary land tenure, however, NIE assumes that such customary systems will ipso facto evolve to Western land tenure systems (see, for example, Yoo & Harris, 2016; The Economist, 2019) – without acknowledging counter ‘hegemonic’ forces that resist such evolution and the autonomous development of customary land tenure (Moyo & Yeros, 2005). The argument in this paper, drawing on Ely’s approach, runs against both neoclassical and new institutional economics for these reasons.
The argument in this paper is also quite distinct from Marxian analysis and claims. For Marxists, inequality is reprehensible, and under the capitalist mode of production, is persistent, and expansionary. The source of inequality, for Marxists, is the capitalistic exploitation of labour. A rich body of Marx’s work on land has recently been analysed (Munro, 2022), but in general Marxist political economy, land is of secondary importance. So, Marxists tend to seek changes in the distribution of surplus-value and the economic structure. Ely’s approach is much wider. Focused on institutions that support the economic structure, land is of particular interest. In this sense, Ely’s pursuit of just distribution is akin to that of Henry George, but his approach differs from that of George in many respects (for a review of the work of Henry George, see Gaffney, 2009; 2015). For instance, in terms of the weight Ely gives to other institutions and their relationship with property rights, in terms of how inequalities need to be addressed, and in terms of whether all rent is to be regarded as surplus. Nevertheless, Ely’s institutionalism complements other heterodox approaches rather than demolishing them. Therefore, Ely’s surplus approach to rent is one more scaffold not only to build a heterodox alternative but also to more deeply mark the terrain and intellectual apparatus of original institutional economics and political economy in general.
Critiques and Contradictions
Ely has been widely criticised. Concerns have ranged from his apparent support of propertied interests to his non-commitment to the founding ideals of the United States. Some have pointed to “his handling of legal material” as being of “a slip-shod character” (Cohen, 1917, p. 399). Others point to his overly optimistic view about the neutrality of judges (e.g., Hand, 1915). Ely himself suggested many ways to overcome such challenges, either by using existing legislation or creating new legislation. As noted by Swayze (1915, p. 825): “the right of taxation, the right of eminent domain, the right to exercise the police power, the right to control transfers, especially by way of inheritance, the right to exempt certain property from education and distress in order that a man [sic] may not be deprived of the means of doing his part in the world by working at his trade or calling”. Ely also suggested a flexible system in which new judges are appointed to overturn archaic judicial philosophies and practices (Swayze, 1915, p. 828), but these positions have been criticised. For example, “It is far better to wait until public opinion is finally settled on a disputed question, and time makes it possible to determine whether proposed changes are real reforms or not” (Swayze, 1915, p. 828). With respect to his surplus approach to rent, these criticisms need to be extended in at least two respects centred mainly on questioning his theorising of inequalities and his trust in “police power”. The surplus approach to rent locates inequalities primarily at the national level where race, gender, class, nor other identities are considered seriously. Yet, as a large body of research has shown, the rise in inequalities is not only at the national level, but can also be seen at the subnational, regional, and global levels (e.g., Bush & Szeftel, 2000; Cahill & Stilwell, 2008; Gaffney, 2009, 2015; Plack, 2009; Obeng-Odoom, 2021). Whatever the scale, inequalities have taken particular identity lines, ranging from caste, colour and class, to gender, disability, and sexuality, among others.
These inequalities and social stratification arise from different underlying institutions and historical periods, and they have entirely different geographical forms. However, they have all tended to lead to similar outcomes: Dispossession, Discrimination, and Concentration. In the United States, this privatization of land has had a distinctive racial orientation. As we see in N.D.B Connolly’s (2014) book: A World More Concrete: Real estate and the remaking of Jim Crow, the process of instituting private property was also the process of establishing white supremacy. Not only have Zoning laws, the use of state power of eminent domain, and so-called campaigns to improve housing for African-Americans in ghettoes ended up dispossessing and displacing African Americans of their land but also these forces of stratification have locked them into the rental market as renters or subprime mortgagors and associated them with undesirable features (e.g., crime, grime, drugs, and dereliction) that drive down property values, while white Americans have made millions off them in rent and mortgage payments.
While there have been black property owners, and these have collaborated with white property owners, for example, by lending each other money to pursue propertied empires, the institutions in that country have made it increasingly difficult for them to expand their property holdings for example by making it much more difficult to obtain the types of loan that white property owners can access to surge ahead (Connolly, 2014, p. 1-16). Such Jim Crow barriers matter, but as Darity and Mullen (2020) have shown recently, these processes of racialised wealth inequalities extended from the era of slavery through Jim Crow to modern multiples of discrimination and privilege. In Africa, the number of sticks in the bundle of private property rights has significantly increased. Common water is now being fenced off and being parcelled out as part of the sphere of private property, as we see in the recent book by John Anthony Allan and his colleagues: Handbook of Land and Water Grabs in Africa (2013). In Ely’s terminology, then, both the extensivity and intensivity of private property have been substantially widened, but they have concentrated wealth in private and racially privileged hands.
None of these engaged Ely’s attention in his time. It is not that Ely was unaware of persistent stratification. He was, but he thought it was deserved, often canvasing a particular type of eugenics in which so-called inferior races would be oppressed to such a level that they would be exterminated: “we have got far enough to recognize that there are certain human beings who are absolutely unfit and should be prevented from a continuation of their kind” (Ely cited Leonard, 2016, p. 74). “Negroes”, Ely noted, “are for the most part grownup children, and should be treated as such” (cited in Leonard, 2016, p. 121). Ely campaigned to exclude immigrants from opportunities because he considered them to be racially inferior (Leonard, 2016, p. 8). He campaigned against giving work to the disabled, to pave way for the worthy poor (Leonard, 2016, p. 131-132), while he deemed white people to be of the “superior classes” (cited in Leonard, 2016, p. 52).
Ely, in short, echoed the dark illiberal side of progressive institutional economists who also sought protection for women, but not equality with them (Leonard, 2016, p. 182-185). Ely, for example, deemed women to be biologically weaker and hence in need of protection (Leonard, 2016, p. 170 & 174). Accordingly, Ely’s surplus approach overlooks, even reinforces, the colour of rent, and the multiple identities of those marginalised by the extraction of rent across the uneven landscape of global political economy both in terms of analysis and proposed ways of addressing the problem.
Yet, in these processes, it is the majority poor peasants, migrants, politically marginalised, blacks, women, nomads and others of minority identities who give up or are made to give up their land and from whom community water is taken. Research published in Feminist Economics establishes that women’s land is often the first and easiest targets. Established plantations disrupt long-standing gendered roles that guarantee certain jobs for women by employing men, often from different communities, to take up women’s jobs (e.g., Daley and Pallas 2014; Poro and Neto, 2014). Mining and drilling activities surged at the height of land grabs Cooney, 2016; Barkin, 2017; Cooney & Freslon, 2019).
41Often the ‘winners’ do not control land forever, but the process can range from 50 to 99 years. People are hardly consulted, as powerful groups take unilateral decisions or government officials even in clear contravention of the law are over-excited about the social benefits the project will bring and, hence, the social theory of this private property movement is that enclosures are good for society. Jobs, technology, knowledge transfer, foreign exchange, and modernisation, development and positive social change have all been promised as a justification for these enclosures – albeit they have remained just that: promises (Obeng-Odoom, 2013a; Elhadary & Obeng-Odoom, 2012; Obeng-Odoom, 2020a). In effect, these multiple transformations have transferred rent from the Global South to the Global North, from blacks to whites, from men to women, from weaker classes, castes, and colours to more powerful groups.
The outcomes have been changing property relations in favour of the rich, wealthy, and mighty. That is, Polanyi’s (1945) “great transformation” has generated stratified hierarchical property relations characterised nearly always with the weaker groups taking the lower and more precarious position in the property ladder. In the case of real estate, indebted mortgage recipients live with the myth that they are property owners when in fact, they only possess property and hold conditional rights that can easily be terminated by the real property owners: banks, doubling as speculators, and landlords who double as bankers, supported by a wide range of professional valuers and real estate organisations (Obeng-Odoom, 2020b). In the case of agrarian relations, proletariats become converted into wage labour sometimes for 50 years, others for much longer. So, while the land will ultimately return to the land-owning communities, community members will have long passed on – especially in countries where the life expectancy is less than 70 or they become much more wretched than they were prior to the process.
By country, the top 10 appropriators as of 2012 were the USA, Malaysia, the UK, China, the United Arab Emirates, South Korea, India, Australia, and South Africa (Land Portal, 2012), while countries in Sub-Saharan Africa provide 70 percent of all land captured (World Bank, 2010). Leon’s (2015) more recent work suggests that these figures are accurate: most of the land purchased has been located in Africa and most of the centres from which the purchases have been financed are the world’s super-rich or rich cities, most notably New York, London, Singapore, Seoul, and Kuala Lumpur (Leon, 2015). Seventy-five percent of the time, the land acquired in such processes is put to the cultivation of biofuel plants, being a change of their previous use (food/non-food uses).
The rest is put to food cultivation, but mainly for export purposes (Borras & Franco, 2012; International Land Coalition, 2012). In turn, access to local food consumption has become insecure or expensive for those in weaker property relations. So, the increase in global food security is mainly for the so-called ‘developed regions’ for which both the number and percentage of people who are undernourished are on the decline. As shown in Table 1, such regions have consistently recorded a decline in undernourishment problems – “A state, lasting for at least one year, of inability to acquire enough food, defined as a level of food intake insufficient to meet dietary energy requirements” (FAO, IFAD & WFP, 2014, p. 50)
Africa (Sub-Sahara and North Africa), where most parcels of land have been taken up in the ongoing global process of private enclosure, is the region with the worst trends in feeding its people. While the causes of undernourishment are many and certainly not simply restricted to the loss of land, the trend in Africa is not a mere question of ‘correlation’. Rather, the reduction of land available for food production is a major contributor to the maldistribution of the burden of food insecurity which in turn, feeds into the problem of undernourishment. As noted in the Africa Agriculture Status Report, “large acquisitions by nationals and foreigners in other countries have greatly increased inequality. From the seller’s point of view, there is concern about distress sales where poor households have no alternative for meeting emergencies than to sell their land at very low prices” (AGRA, 2013, p. 36). Land taken is typically used for agribusiness. As Timothy Wise has shown in his latest book, Eating Tomorrow (Wise, 2019), such a regime of agriculture undermines ecologically sustainable agriculture with its emphasis on genetically modified seeds, excessive emphasis on the use of agro-based fertilizer and other chemicals, and the insistence on viewing agriculture as a for-profit business.
Wise’s work is revealing. Most farmers he has interviewed in Africa are opposed to agribusiness. He refers to his interviews with female farmers in Mozambique who reject agribusiness because, for the farmers, such food system only serves the interest of the West and the local landlord class (Wise, 2019, chap. 1). “Seeds of opposition”, to quote The Economist (2019, p. 32-33), were sown in Mozambique eventually. Prosavana, a corporate initiative, aimed at turning 107,000 square kilometres (a large tract of land analogous to the size of Bulgaria) into a food basket, was launched in 2009. By 2019, not much progress had been made. Rather, plans had been afoot to raise $2bn private equity funds for another agri-business in 2013. By 2019, such was the opposition that The Economist (2019, p. 32-33) described the situation as “stony ground”. Stefan Ouma (2020) has offered a more systematic, more up-to-date account. The financialisation of land and resulting dispossession and deprivation have become even more serious today. The question, then, is no longer whether such inequalities exist but what institutional forces or in the terminology of régulationists, “institutional forms” (Vercueil, 2016), drive, sustain, and mould the trends in the distribution of wealth in relation to property.
Whether the ‘police power’ intended to ensure that such privatisation and private capture of value is an effective check requires careful analysis. In his tome, Legal Foundations of Capitalism, J.-R. Commons, Ely’s student, carefully documents the changing meanings of ‘police power’ in the American and the English courts (Commons, 1924). The courts will often take a larger view of ‘value’ and the ‘economy’ than neoclassical economists would because the courts consider the economy as constituted by the interaction or transaction between two people (plaintiff and defendant), constituting electrons in motion (see Commons, 1924, p. 7-8): not individuals, atomistic individuals, whose actions are static as in neoclassical economics.
Yet, even the courts cannot ipso facto confirm what is ‘reasonable value’ and how the police power might be used, as the use depends on the particular location, time, and constitutional provisions (Commons, 1924). Nowhere is this contingent interpretation better demonstrated than in India where judicial decisions on the question of public and private space have been shifting dramatically from pro-marginalised groups interests to business interests. The state and its agencies even in the days of pro-hawker judicial decisions had always found ways around court decisions to pursue their own interest (Schindler, 2014). Elsewhere, in many cases, courts have used the police power to favour the rich. In one case, this police power was exercised in favour of investors who had been misled into investing in a private land venture in Togo, West Africa (Obeng-Odoom, 2016). Lyn Ossome has conducted a detailed analysis of police power, which seeks to answer the question: “Can the Law Secure Women’s Rights to Land in Africa?”
After considering the evidence, she notes:
There is still no conclusive evidence of the viability of customary law’s efficacy in securing women’s rights to land. Rather, contemporary land deals take place in the context of a legal, political, and economic terrain that requires constant negotiation and reinterpretation in line with the lived realities of communities and women within them. This study demonstrates that customary law is not yet exhausted as an avenue for redress. It exposes the colonial fallacies upon which the customary was based, the attempts to put it aside, and the assumptions that underlay these attempts. It also examines the problematic nature of formalisation in the contexts of land acquisitions, which in essence pits the state against itself. (Ossome, 2014, p. 172)
While this evidence relates to customary law, the research findings about constitutional law and courts follow similar patterns. John Mbaku’s (2018) research on constitutional protection of minority rights in Africa makes the point. According to him, constitutional structure and constitutional making are contingent on socio-historical context. Forcibly united under colonialism, countries such as Cameroon have tried to build constitutions, but such documents are exclusive not only in their rules, but also in their application and enforcement. The Supreme Court of Ghana might be much more inclusive both in how the Ghanaian constitution was drafted and is interpreted (Date-Bah, 2015). But both the US Supreme Court and the South African Supreme Court have been exclusive and ideologically biased against minorities. Typically, the rules of court, constitutional provisions, the complicity of judges and lawyers, and the wider political economies of the two countries combine to concentrate land in the hands of white, wealthy and powerful landlord classes (Bonica & Sen, 2020; Ngcukaitobi, 2021).
Fundamentally, whether inclusive or exclusive, long-term inequalities, social stratification, and property concentration have increased in Africa (Obeng-Odoom, 2021) and elsewhere in the world (Stilwell, 2019; Piketty, 2014, 2020; Darity & Mullen, 2020). Indeed, in the US, research (Maclean, 2017) shows that James Buchanan, the leading theorist behind the public choice school of economics, conceived of the Supreme Court as an institution to support white propertied interests, rather than as an instrument of harmonious arbitration between the landlords and ordinary members of the American society. Not only are black judges in the minority, research shows that their decisions are more likely to be overturned on appeal (e.g., Sen, 2015).
That said, this contingency does not amount to a concerted attempt by lawyers and judges to create what Marxists perceive to be a deliberate institutional framework to encourage extractivism for foreign interests (see, for example, Freslon & Cooney, 2019, p. 26-27). Nigerian courts, for instance, have tried to constrain extractivisms of various kinds when seeking to bring transnational oil companies under their jurisdiction (Obeng-Odoom, 2020a, p. 195-196).
International law itself has been complicit in creating concepts such as terra nullius which have been used to justify extractivisms and many imperial courts like those in Britain still make decisions on many occasions to favour the transnational corporations from the imperium. (For a discussion of concepts and international law, see Amin, 2020). While the Prosecutor at the International Criminal Court (ICC) has promised to prosecute land grabbers at the ICC, no such action has taken place (Surma, 2021). If it does, there is no guarantee of success. It follows that the police power is no guarantee, as suggested by Ely’s surplus approach to rent.
Conclusion: Rent and Reconstruction
Rent is central to political-economic discussion of long-term inequality and social stratification. However, rent is largely neglected in neoclassical-economic analysis of inequality. The surplus approach to rent tries to rectify this problem. The social theory of property, advanced by Ely, offers a distinctive contribution to the surplus approach to rent. Not only does it differ from other surplus approaches in terms of its analysis of how rents arise, Ely’s surplus approach is also distinctive in emphasising land as a ‘bundle of rights’ and reform, not via the socialisation of rent for wider social policy or for workers’ liberation, but through revisiting and revamping the courts (see, for example, Ely, 1940, p. 76, 80-81).
Yet, as the evidence in this paper has shown, the social trust bestowed on private property owners has long been broken and the police power offered as a check on the excesses of private property ownership is way too limited to serve as an effective constraint on the propertied class. The concentration of land-wealth has dramatically normalised, and pre-transformation property relations have been moulded in diverse, different and differentiated ways across scales and over time, particularly in the extractivist forms of accumulation.
Not all these are surprising. Ely’s surplus approach is more strongly focused on national, not multi-scalar global inequalities and global social stratification. Inherent in the social theory of property rights is structural bias against racial and other minorities. As discussed in this paper, the surplus approach also places too much categorical weight on the police power which, in practice, is clearly contingent. Marxian revolutionary alternatives are similarly uncertain. Other evolutionary surplus approach alternatives – including Georgist political economy – are a bit more certain. Drawing on multi-level state power, community, and global institutions, a Georgist alternative can more reliably socialise rent as surplus.
The trouble with all the surplus approaches is that they are either race blind or racist. At the same time, it could be analytically useful to bring Ely ‘back in’ to the debate about the social theory of property and distribution of wealth in extractivist and rentier societies, and link inequalities to institutions, notably the courts. In this way, Ely is one antidote to Buchanan in the sense that he sees institutions as one set of ways to transform society in an evolutionary inclusive way. But, like Buchanan, Ely’s theorizing also explicitly sought to subjugate minorities, especially black people.
If Ely’s theorizing can succeed in this role, therefore, then his theory has to be emptied of its problematic underpinnings which can helpfully be replaced by stratification economics, pioneered by black political economists to become the most advanced school of institutional and evolutionary political economy on inter-group inequalities, analysis of which is a story for another time (for further reading, see Darity, 2009; Darity et al., 2015; Darity, 2021). What can be stressed even now, is that the surplus approach to rent can benefit from the broad approach offered by the régulation school. This group of thought seeks an historical approach that links previous socio-economic and ecological processes to present ones (e.g., rentier processes to new extractivist processes). This school of thought also provides the canvass for an open-ended approach to uniting or amalgamating diverse forms of institutional and evolutionary alternatives. The aim is usually to question orthodoxy, more deeply understand, and more comprehensively change uneven and unequal global political economy. Clearly, one way for stratification to advance is for it to take the driving seat in the surplus approach to rent.
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How Financial Inclusion is Driving Fairer Growth in Emerging Markets?
Rising global inequality is one of the biggest social and economic challenges of the 21st Century—a problem further exacerbated by the COVID-19 pandemic. While inequality is a global issue, it is often more pointedly felt in emerging countries, as they tend to have a large informal sector, greater regional divides, wider gaps in access to education, and more significant barriers to employment for women. Financial inclusion is often seen as an important factor in bridging these divides, while also supporting better economic and social outcomes.
This article discusses how financial inclusion supports fairer development in emerging countries, highlights some leading examples, and outlines how the investment landscape may evolve over time. Financial inclusion is becoming a key priority for governments, and will therefore likely increasingly matter to businesses and investors. The integration of finance with technology is helping accelerate financial inclusion, creating compelling investment opportunities within fast-growing economies.
Financial Inclusion at a Glance
Financial inclusion is the process of providing suitable financial services to the “unbanked” (individuals or businesses) in an affordable, sustainable, and ethical way. This can involve access to traditional credit through banking and insurance products, but also saving mechanisms for healthcare or education and even investment products, allowing citizens to benefit further from the rapid growth of their economies.
It has been shown that increasing financial inclusion can drive economic development, possibly increase GDP by up to 14% in EM and a staggering 30%1 in frontier economies. According to World Bank studies, globally around 1.7 billion people, or 31% of the adult population, lack access to financial services.2 Half of this unbanked population live in Asia, 25% in Africa, and 10% in Latin America. A significant portion of these unbanked groups are women. Therefore, improved financial inclusion can also lead to greater gender equality.
Financial inclusion is a key enabler of the UN Sustainable Development Goals (SDGs), which will be a key driver of reducing poverty and enhancing shared global economic prosperity. This is important to investors as economic growth is a fundamental long-term driver of corporate revenues and earnings, which supports asset prices. Financial inclusion’s importance is illustrated by being a target in no less than seven of the 17 goals (Exhibit 1).
For example, through better access to financial services such as bank accounts and insurance products, citizens in emerging countries can come out of poverty (enabling SDG 1). Access to funds and insurance also helps people working agriculture to better manage their finances, achieve higher yields, and thereby increase food security (SDG 2 and SDG 3). Financial inclusion means people can invest in their children’s education (SDG 4) and improved female empowerment can address gender equality (SDG 5). These five SDGs feed into the wider socio-economic goals such as shared economic growth (SDG 8) and innovation and sustainable industrialisation (SDG 9).
Regulators are also prioritizing financial inclusion, given the link to economic growth. Over 60 countries have made commitments to financial inclusion, and more than 50 have launched or developed a national financial inclusion strategy. digitization and electronic transactions have helped fuel an increase in financial inclusion rates. Some of the leading examples of rapid financial inclusion have been within India and Kenya, where access to accounts has grown rapidly in last decade (Exhibit 2). However, there still remains a wide disparity between countries (Exhibit 3).
How Tech and Digitization Is Driving Financial Inclusion
The growing importance of financial inclusion provides a structural opportunity for financial institutions and businesses, with some already capitalising on this shift. Small and mid-sized enterprises (SMEs) play a central role in financial inclusion as they represent about 90% of business and more than 50% of employment worldwide.3 Formal SMEs, which tend to be more structured businesses with contracted employees, salaries and other employment benefits, contribute up to 40% of GDP in EM, and this figure is even larger when more informal businesses are included. However, nearly half of the SMEs in developing countries face challenges in obtaining finance, representing a $5.2 trillion unmet annual financing need.4 This compares to a favourable 15% of SMEs in high-income countries. The low EM penetration rate highlights how providing financial services to segments that lack financing can be a huge structural growth opportunity for businesses.
Traditional banking rarely allows money to reach lower market segments (such as micro credit and SME) for cost and/or efficiency reasons, necessitating the need for new business models. The rapid evolution of fintech, digital, and mobile banking is accelerating the rate of financial inclusion by raising efficiency, lowering transaction costs, and expanding outreach to new clients and markets. This digital evolution, which has sharply increased during the pandemic, is disrupting high cost of customer acquisition/interactions, credit assessment, and credit underwriting. It is also enhancing cross selling of products and accelerating growth.
Leading Country Case Studies
India – Powerful Public and Private Partnerships
One of the fastest-growing markets for financial inclusion is India, driven by government initiatives as well as public-private partnerships. Examples include the PM Jan Dhan Yojana scheme (PMJDY), priority sector lending directives to all financial institutions, as well as the government’s Unified Payments Interface (UPI) platform.
Under the JD scheme, Indians were given the facility to open a Jan Dhan bank account using the Adhar biometric ID system. This, together with a fast-growing mobile usage, has accelerated digital adoption. As a result, 424 million Indian citizens have been served by PMJDY as of May 2021, including 234 million female customers. The scheme has also increased the number of banking outlets in rural Indian villages from 67,694 in March 2010 to nearly 13 million by the end of 2020.5 The establishment of the UPI, an instant real-time payment system, has also increased usage of cashless payments, with major telecom players helping drive adoption.
Kenya – Pioneering Mobile Banking Success
Kenya stands out as a success story for financial inclusion due to its early adoption of mobile banking and the fintech revolution. This has led to a very high percentage of the population having access to a bank account relative to peer countries. Much of this achievement is due to the mobile banking M-Pesa system, started by Safaricom and Vodafone. Leveraging the network of telecom subscribers, it allows mobile payments, and provides banking access to the rural population where bank branches would be too expensive to operate.
Mobile money transactions are now well established in Kenya, accounting for a staggering 44% of GDP in 2019.6 Financial institutions such as Equity Bank have successfully used the mobile and agency banking model to expand access to banking services much more quickly and efficiently than through traditional banks. The socioeconomic impact of mobile banking has been significant in Kenya. It is estimated that M-Pesa alone has lifted 2% of the Kenyan household out of poverty.7
China – Accelerating Digital Payments and E-commerce
The SARS epidemic in 2003 changed consumer behaviour towards e-commerce and accelerated the launch of e-commerce and digital payments in China. Alibaba launched Taobao that year, its first e-commerce website, and soon after created Alipay to help online payments acceleration. JD.com also started selling products online in 2003.8 This shift, supported by a robust identification system and internet infrastructure, has resulted in lasting online payments adoption, with China now the leader in digital wallets and digital payments. The COVID-19 pandemic has further accelerated the rise in digital payments transactions in China and globally. This trend will likely be supported further by the adoption of digital currencies.
Brazil – Frontline in Fintech Innovation
Brazil is becoming a hub for fintech and digital innovation which should accelerate financial inclusion, especially as the fintech disrupters are focusing on mass market and SME lending targeting the approximately 55 million of Brazil’s 213 million population which remains unbanked. Although Brazil has one of the highest numbers of fintech start-ups, the companies with payment offerings as well as credit track record tools are fast becoming the more successful financial inclusion businesses. Some traditional banking groups are also embracing digitisation, helping to drive further financial inclusion. Liberal banking regulations and the launch of PIX, an instant payment platform offered by the Central Bank of Brazil, have also increased digital adoption. This should make the market more competitive and services more affordable for customers.
Mexico – Bridging the Gender Finance Gap
Mexico has some of the lowest financial penetration rates in GDP per capita and HDI (Human Development Index) terms, especially with respect to women. At its level of development, financial inclusion for women should be much higher than the current 33% level.9
One company really driving financial inclusion in Mexico is Gentera, which is the country’s largest microfinance institution (MFI), serving clients at the bottom of the socioeconomic pyramid. Focusing on group lending for women through its Crédito Mujer service, the company has built a client base which is 89% female and accounts for 16% of all female borrowing in Mexico. A key driver of its success has been the group-lending model and ability to maintain low default rates, despite income variability and the lack of credit history, using group/community guarantees. Gentera also contributed to social impact during the challenges created by COVID-19 by providing services to clients while simultaneously suspending interest payments.
How We See the Investment Landscape Evolving
Financial inclusion is not just a sustainability trend, it is also structural growth opportunity for businesses and investors. Traditional financial inclusion models have largely focused on micro-lending of cash loans to either support working capital needs or bridge consumption needs. However, limited micro credit models are increasingly being challenged.
A significant amount of evidence suggests that low income households need access to much wider range of financial services to generate income, build assets, smooth consumption, and manage risks. These include products such as savings, insurance and healthcare, transfer payments, and pension etc, not just access to credit. The businesses carving out large market presences in these areas, while adopting digitisation, are likely to enjoy higher growth, and for longer, as developing economies benefit from global technological advances.
We believe fintech has begun to take over where traditional banks have not managed to service significant segments of the population or SMEs, and this is where we are seeing exciting opportunities. Financial inclusion opportunities are greatest in markets that embrace and support technological innovations and effectively regulate the segment, as illustrated in in Kenya, Brazil, and India.
Overall, we see financial inclusion being a key priority for the UN SDGs and governments, which in turn should drive business agenda and investor interest. With COVID-19 exposing and worsening social inequalities between nations and within societies, the importance of supporting financial inclusion has never been more of a priority for building a stronger and more inclusive global economy.
Notes
1 Source: EY (2018). Retrieved from https://www.ey.com/en_cz/news/2018/01/improved-financial-inclusion-could-boost-global-bank-revenues-by-us-200b
2 Source: World Bank (2017). Retrieved from https://globalfindex.worldbank.org/sites/globalfindex/files/chapters/2017%20Findex%20full%20report_chapter2.pdf
3 Source: UN (2020). Retrieved from https://www.un.org/en/observances/micro-small-medium-businesses-day
4 Source: World Bank. Retrieved from https://www.worldbank.org/en/topic/smefinance
5 Source: Reserve Bank of India (2020)
6 Source: Central Bank of Kenya (2019)
7 Source: MIT News (2016). Retrieved from https://news.mit.edu/2016/mobile-money-kenyans-out-poverty-1208
8 Source: World Economic Forum (2020). Retrieved from https://www.weforum.org/agenda/2020/05/digital-payments-cash-and-covid-19-pandemics
9 Source: GIWPS (2019). Retrieved from https://giwps.georgetown.edu/index-story/mexico/
Entrepreneurship in the Context of Western vs. East Asian Economic Models
Recent developments in the global economy, notably the accelerating trade war between the US and China and the impact of the Covid-19 pandemic, have fuelled the debate as to which model of economic development, Western or East Asian, is more competitive in a long-term perspective.
The intention of this paper is a brief investigation, based on historical and empirical research, into the role of entrepreneurship as a major factor of competitiveness and a key driver of economic development in both models.
The Western liberal narrative envisages a determined course of history in which economic progress will inevitably drag East Asia on a trajectory towards the Western model. There is sound evidence that this will not happen.
The Nexus of Entrepreneurship and Economic Development
The word ‘entrepreneur’ emerged quite late in the history of economic literature; it was introduced by the Irish-French economist Richard Cantillon in his Essay sur la Nature du Commerce en Géneral, published posthumously in 1755. Cantillon’s concept of the entrepreneur tells of a risk-bearer and discoverer of market opportunities. Its focus on risk-taking and alertness sets it apart from the idea of the entrepreneur as the organiser of factors of production, which dominated the classical economic thinking of Adam Smith, Jean-Baptiste Say, Karl Marx, and later the neoclassical school of Walras et al. until the end of the 19th century. The classical entrepreneur is not a capitalist, not a landlord, not an employer or manager, although these distinct roles of agency in a market economy often merge in one person.
He “must be a decision-maker… It is his function and this function alone that deserves the title of ‘entrepreneurship’” (Blaug, 2000, p. 76). The almost automatic process of investment and production at the core of classical and neoclassical economic models blended well into the general equilibrium theory of Walras, which has no need of a theory of entrepreneurship. Its static equilibrium, conceived in resonance to Newtonian mechanics, does not leave any room for dynamic change in economic development. The world of discoverers, explorers, overseas trade, and other risky ventures driven by entrepreneurs avant la lettre did not play a systemic role in classical economics; the entrepreneur remained “a shadowy entity without clearly defined form and function” (Baumol, 1968, p. 64).
However, the significant advancements of the second industrial revolution in the early 20th century provided new evidence that economic development was powerfully driven by other forces than the conventional allocation and coordination of production factors in a static framework.
Josef Schumpeter conceived an entirely different perspective on economic development. He perceived economic growth, progress, and development as the result of entrepreneurial innovation, which does exactly what neoclassical economists abhor: the creative destruction of static economic equilibria by introducing new combinations of production factors, including technical innovations, thus shaping economic development in a state of permanent disequilibrium:
“This concept covers the following five cases: (1) The introduction of a new good … (2) The introduction of a new method of production … which need by no means be founded upon a discovery scientifically new … (3) The opening of a new market … (4) The conquest of a new source of supply of raw materials … (5) The carrying out of the new organisation of any industry, like the creation of a monopoly position … or the breaking up of a monopoly position” (Schumpeter 1934, p. 66).
Triggered by innovation and entrepreneurial leadership, creative destruction does not happen exclusively in market economies. Schumpeter ascertained that it has its place under vastly different historic conditions and diverse social and political contexts, and can, as an almost omnipresent phenomenon, thrive as well in a socialist economy, or a primitive horde (Schumpeter, 1926, p. 111).
The idea of a continuous structural change caused by entrepreneurship, which drives economic development, had a tremendous impact on economic thinking, ranging from growth theory (Abramowitz, Solow) to enquiries into the dynamics of innovative firms (Porter), to economic history examining the relationship between institutional change and economic and technological progress (North).
The third industrial revolution, spreading internet-based commerce and communication globally, raised a new awareness about the importance of science-driven entrepreneurship, as technology-driven companies such as Apple, Alphabet, and Microsoft have become global market leaders, and about the need to create an enabling ecosystem conducive to commercial success on a previously unprecedented scale.
Douglass North, a co-founder of the New Institutional Economics school in the US, illuminated the fundamental importance of institutions for economic development. Although his enquiries into economic history are firmly rooted in the neoclassical tradition of methodological individualism and a firm belief in the superiority of Western liberal market economies (North and Thomas, 1973), he acknowledged that the neoclassic credo “just get the prices right” had failed to capture the dynamics of economic development. He discovered the crucial importance of the institutional framework of an economy in shaping and protecting property rights – through the credible commitments of governments – to provide entrepreneurs with incentives to set up new business activities. North‘s analysis gave Schumpeter’s entrepreneur-centred theory of economic development a firm grounding in economic history, readily adopted by the World Bank which, after 1980, started to globally convey the message: institutions matter.
Global Empirical Research on Entrepreneurship and Competitiveness
Empirical research on the impact of entrepreneurship on economic development is based on the work of Schumpeter and his followers as its primary theoretical source. Over the last 20 years, the Global Entrepreneurship Monitor (GEM) initiative has compiled the most comprehensive international database on entrepreneurship[1]. More than 150,000 adults from 50 economies participated in interviews for its 2019-2020 report. Even broader in scope (141 economies examined) and focusing on economic development from a wider perspective is the World Economic Forum’s Global Competitiveness Index 4.0 (GCI). In its 2019 report, the authors use the metaphor of creative destruction to describe the challenge of mitigating the adverse social effects of fast technological advancements: “In the Schumpeterian process of ‘creative destruction’, creativity must be encouraged, and the destruction must be managed” (GCI, 2019, p. 7).
The Global Entrepreneurship Index (GEI), a research programme based on data from GEM and GCI, introduces the concept of the entrepreneurial ecosystem with a reference to the same tradition: “Ever since the time of Schumpeter the concepts of entrepreneurship and innovation have been intertwined with economic development” (GEI, 2019, p. 2).
What does the quantitative research of GEM and GEI tell us about the entrepreneurial element in the competitiveness of the Western versus the East Asian economic model?[2] It comes as no surprise that the Western economies rank at the top of the list:
Figure 1: In my country, it is easy to start a business (% adults)
Adults who aspire to start a business see the entrepreneurial ecosystem in countries like the UK, US, Poland, Sweden, or Canada as significantly more supportive than in any country in the MENA region or Latin America. In Asia, only India finds a place in the top ranks, in sharp contrast with China, Taiwan, and especially Japan at the low end of the spectrum. The individual perceptions of opportunities in national business start-up culture differ widely from country to country; in Europe, Western countries score higher than Eastern countries – with the exceptions of Poland and Slovenia. In Asia, the Indian subcontinent scores higher than East Asian countries.
The correlation of the social and cultural incentives for starting a business with income per capita is apparently weak: low-income India scores higher than high-income Sweden; low-income Puerto Rico and high-income Japan are at the bottom of the ranking list.
“It may be that some high-income economies have policies and conditions that foster entrepreneurship, while others do not, even if the general business environment is highly advanced. On the other hand, in some low-income economies, there may be few constraints on business activity, while other economies have uncertain operating environments” (GEM, 2020, p. 30).
In the application of North’s theory, the presence or absence of a credible commitment by governments to protect property rights and sanction breaches of contractual obligations is an essential element of the dynamics of a national business culture and thus the potential for economic progress.
Do people see themselves as potential entrepreneurs, do they think they have the necessary skills, knowledge, and experience at their disposal to successfully start an enterprise? The GEM survey gives evidence of a vast difference between perceptions of the external ecosystem (Fig. 1) and self-perceptions (Fig. 2).
Figure 2: You have the knowledge, skills, and experience to start a new business (% adults)
Contrary to participant views of the entrepreneurial ecosystem, China is classified – in terms of self-perception – higher than the US; in Europe and North America, Norway drops from second place down to the bottom. Participants in other countries perform more consistently on both questions, e.g., the Russian Federation and Japan keep their place at the lower end.
The GCI 2019 report from the World Economic Forum draws a different picture. It applies a wider set of indicators to its ranking process for competitiveness, in which entrepreneurship is only a part, a subset of the analysis. The computation of the GCI Index is based on successive aggregations of scores, from the disaggregated level of the 103 single indicators to the overall GCI score as the highest level. The indicators are aggregated in twelve pillars and the pillars are organised in four overarching components: enabling environment; human capital; markets; and the innovation ecosystem. The GCI methodology blends objective indicators based on macroeconomic data with subjective indicators derived from the annual WEF Executive Opinion Survey, The Voice of the Business Community (GCI, 2019, p. 633).
Environmental sustainability, social cohesion, and inequality issues are examined with regard to their impact on national competitiveness, aspects which play a marginal role in the GEM and GEI surveys. The importance of an intact social fabric, including the health sector and care economy, is more broadly reflected in the ranking system. The GCI report puts the East Asian economies at the top of its ranking list: “Led by Singapore, the East Asia and Pacific region is the most competitive in the world, followed by Europe and North America… Among the BRICS, China is by far the best performer, ahead of the Russian Federation” (GCI, 2019, p. IX).
The WEF’s more comprehensive approach to competitiveness evokes the narrative of a close race between the Western and the East Asian economic models. Inflexible institutions, deficits in infrastructure, and weaker skills and entrepreneurial ecosystems in the East are compensated for by its superior product and labour market capacities and financial support systems which provide competitive advantages in international markets.
The GEM, GEI, and GCI reports assess and rate national economies with a heavy Western bias. The GEM/GEI approach examines the entrepreneurial ecosystem exclusively from the perspective of methodological individualism: “The GEM approach looks … at individuals, assessing attitudes and perceptions towards entrepreneurship … This allows for a unique profile of entrepreneurship in society” (GEM, 2020, p. 23). However, in East Asia, that approach does not capture the cultural, social, or economic role of collective forms of entrepreneurship in an adequate way. A prominent example is the town-and-village enterprises (TVE) in China, which emerged after 1978 in the wake of Deng Xiaoping’s economic reforms. His Four Modernisations programme was extended to households to provide rural areas with urgently needed goods and services. Although subordinated to the town and village governments and owned and operated by a collective of peasants, in practice those TVEs act in the market as private companies: “TVEs can be regarded as the beginning of contemporary Chinese entrepreneurship” (Li, 2013, p. 20). We shall return later to the evolution of the entrepreneurial culture in East Asia, which followed quite a different trajectory to its counterpart in the West, particularly in countries where a socialist revolution had taken place.
The GCI 2019 report, firmly anchored in the Western liberal tradition, celebrates high-powered competitiveness as the only solution to reconcile fast economic development, environmental degradation, and rising inequality: “The perceived trade-offs between economic, social and environmental factors may emerge from a short-term and narrow view of growth but can be mitigated by adopting a holistic and longer-term approach to growth”. (GCI, 2019, p. 6).
But the acceleration of climate change and global loss of biodiversity do not provide any evidence that higher competitiveness provides a convincing recipe to solve the dilemma of divergent policy imperatives (Ibid, pp. 25-28). On a parallel track, differences in competitiveness have had no coherent impact on the gap between rich and poor, which has grown dramatically since 2000 in the majority of OECD countries (Ibid, pp. 31-32). The GCI report 2019 tries to save its line of argument by constantly flipping from its empirical assessments, based on its comprehensive database, to normative prescriptions for what national economies ought to do in search of holistic solutions, always under the following pretence: “The GCI shows that the combination of growth, equality and sustainability is indeed achievable – and must be the urgent work of policy-makers around the world over the next decade” (Ibid, p. 8).
The magic wand which dissolves all contradictions and oxymora in this complex game is total factor productivity (TFP), “… the ‘unexplained’ part of GDP growth, which encompasses all non-physical inputs, such as technological progress, human capital, and institutional and cultural factors” (Ibid, p. 26). TFP is at the core of the GCI ranking system, and the entrepreneurial ecosystem is a key element of TFP. Despite the significant differences in methodology, the GEM, GEI, and GCI reports converge in giving entrepreneurship and competition a major role in the economic development of nations and regions. They mirror the firm belief in Western liberal economics, prominently elaborated by North, that the rule of law and the security of property rights, guaranteed by the credible commitment of governments, are unrivalled in reducing uncertainty for entrepreneurs and risk for private investors.
Do they adequately capture the rise of the successful economies in East Asia? That remains questionable indeed, as in that region other cultural, social, and economic forces seem to be at work that do not easily fit into the Western freedom and democracy paradigm.
Scepticism about the systemic superiority of the Western economic model has been voiced – after Marx and Engels – by economists from the German Historical School, whose writings influenced Schumpeter, the very economist whose theory has been widely embraced by liberal economists and policymakers since the 1980s. Gustav Schmoller, one of the most influential scholars of the Historical School, illuminated the ambiguity of entrepreneurship as “both a productive and destructive force of economic development” (Ebner, 2005, p. 262). Higher productivity and fast product creation stand against growing inequality, exploitation of workers, and a general social disintegration, manifest in business elites’ lack of responsibility for the common good (Schmoller, 1875, pp. 131-132).
In his major early work, the Theory of Economic Development, Schumpeter himself argues that entrepreneurial creative destruction is not exclusively linked to liberal market economies. He is deeply sceptical about the future of capitalist economies, for which he predicted a gradual transition from a dynamic and innovative entrepreneurial state to a rentier state, mired in trustification and stagnation and also that organisational change brings forth the formation of larger corporations and powerful bureaucratic routines and pushes individual entrepreneurial leadership to the side-lines of advanced market economies.
Schumpeter assumes that socialist countries find their own opportunities to reinvent themselves as entrepreneurial states that put the entrepreneurial function, the discovery of new combinations, in the hands of government agencies (Ebner, 2009, pp. 371-373). In his later work, Schumpeter confirms and extends the essential role of the entrepreneurial state for economic development, in particular its options for a creative adaptation of private-sector innovations in technology, business administration, and finance. He suggests that non-Western economic models, based on histories of socialist revolutions, are not at a systemic disadvantage in being able to generate rapid economic growth: “Every social environment has its own ways of filling the entrepreneurial function” (Schumpeter 1949, p. 255).
Mariana Mazzucato provides ample evidence that technological breakthroughs are due to public and state-funded investments in innovation and technology and that the private sector only finds the courage to invest after an entrepreneurial state has made the high-risk investments (Mazzucato, 2013). Joseph Stiglitz confirms that argument: “For many of the billions in the developing world and emerging markets, China, using its distinctive ‘socialist market economy with Chinese characteristics’, has provided a dynamic alternative vision to that of America” (Stiglitz, 2019, p. 28).
Entrepreneurship in East Asia
Town-and-village enterprises (TVE) in China have already been briefly introduced as the forerunners of modern Chinese entrepreneurship. In light of North’s theory, the specific institutional settings of TVEs differ significantly from those in Western economies, where private property rights are firmly guarded by law: “Under the TVE system, formal ownership is vested in local towns and villages, but the enterprise is run as if privately owned …, [a regulation which is] not easy to reconcile with North’s narrow concept of property” (Faundez, 2016, p. 383).
According to Huang, in 1985, “… of the 12 million businesses classified as TVEs, 10 million were completely and manifestly private” (Huang, 2008, p. XIV). Yet the TVE sector was severely hit by the economic reforms in the mid-1990s; the official hostility towards private entrepreneurship forced them to restructure substantially and many went out of business. With increased market integration and competition and the government’s preference for foreign-owned enterprises, TVEs lost their competitive position.
Another dynamic East Asian economy, Vietnam, developed a similar transitional structure of business ownership before its private sector covered the majority of its national economy. However, both countries chose different paths to transform their economies: “While Chinese reforms are normally treated as a classical example of gradualism, Vietnamese reformers introduced Polish style shock therapy treatment (instant deregulation of most prices and introduction of convertibility of the dong) … and still managed to avoid a reduction of output” (Popov, 2014, pp. 96-97).
The socialist revolutions in China and Vietnam wiped out feudal rule and foreign domination and pushed both countries on to the development path of export-oriented market economies in the late 1970s. Even in Singapore and Malaysia, where no socialist revolutions occurred, a political infrastructure emerged with a closer resemblance to China and Vietnam than to the American and European economic model.
Milanovic calls the East Asian economic model political capitalism,[3] as opposed to the liberal meritocratic capitalism in the West. It bears three distinct characteristics: (i) an efficient bureaucracy; (ii) the de facto absence of the rule of law; and (iii) the autonomy of the state:
“… bureaucracy has as its main duty to realize high economic growth and implement policies that allow this goal to be achieved. Growth is needed for the legitimization of its rule. The bureaucracy needs to be technocratic and the selection of its members merit-based if it is to be successful, especially since the rule of law is absent” (Milanovic, 2019, p. 91).
Deng Xiaoping, the eminent architect of the model of political capitalism, rigorously pursued an approach in which “capitalists’ interests were never allowed to reign supreme, and the state retains significant autonomy to follow national-interest policies and, if needed, to rein in the private sector” (Ibid, pp. 92-93).
When Deng Xiaoping started his economic reform programme, ‘The Four Modernizations’, in 1978, the percentage of urban workers employed by state-owned enterprises (SOE) was around 80% of the total workforce and the industrial output produced by SOEs close to 100%. Until 2016 the SOEs share of the total workforce had fallen to less than 20%.
Milanovic argues that the three characteristics of political capitalism inevitably lead it into two contradictions: “… [First,] a technocratic elite is educated to follow the rules and to operate within the confines of a rational system. But arbitrariness in the application of the rules directly undermines these principles. The second contradiction is that between (i) inequality-increasing corruption, which is endemic in such systems because the discretionary power granted to bureaucracy is also used by its various members to obtain financial gain, the higher their position, the greater its use; and (ii) the need, for reasons of legitimacy, to keep inequality in check” (Milanovic, 2019, pp. 93-94).
Thus political capitalism is constantly moving along an unstable equilibrium, confronted with different but equally powerful challenges to those of its liberal Western counterpart.
How does Schumpeterian entrepreneurship, i.e., creative destruction, thrive in an economic model with substantial institutional ambiguities like insecure property rights, endemic corruption, or an unconditional precedence of national political interests over economic development?
After the launch of Deng’s Four Modernizations programme and China’s entry into the WTO in 2001, “a kind of fuzzy property rights arrangement” (Li, 2013, p. 26) persisted, most entrepreneurial ventures still emerged under the umbrella of TVEs – the so-called red hat strategy – which made it easier to conceal private ownership and provided basic legitimacy for commercial business development. In the new millennium, political capitalism in China and Vietnam – after both countries had observed the earlier economic rise of the East Asian ‘Tiger’ states – gradually upgraded its support policies for technological innovation and its market implementation by private enterprises. In 2015, China’s State Council launched a comprehensive entrepreneurship and innovation strategy (Opinions on Several Policy Measures to Promote Mass Entrepreneurship); in 2019, the government issued guidelines for better protection of intellectual property rights. Parallel to those policies to secure a safer institutional space for property rights, a business angel market emerged in China, which for the first time enabled start-up entrepreneurs to get access to early-stage venture capital. “[T]he Chinese market of business angel investments today plays an increasingly noticeable role.” (Reshetnikova 2018: 513)
Easy access to venture capital and private equity is widely considered a crucial prerequisite for a dynamic entrepreneurial ecosystem. Step by step, the East Asian economies have implemented efficient support mechanisms in the development of their domestic financial markets, particularly their private equity and venture capital segments. Today, the gap between Western and East Asian entrepreneurs’ access to capital is but a gradual one.
The impact of corruption on the entrepreneurial ecosystem and economic competitiveness has been controversially disputed since the 1960s. Leff, Huntington, and Leys claim that corruption can foster the realization of major infrastructure projects and drive an ambitious economic growth policy, as it greases the wheels in the complex public-private economic engine (Tomaszewski, 2018, p. 252). The speed of the engine depends both on the innovative capacities of the entrepreneurial ecosystem and the responsiveness of government institutions whose collaboration in the planning and execution of the projects is indispensable.
In contrast, North and Baumol, in their historical research on the allocation of entrepreneurship (Baumol, 1990), highlight the detrimental effect of corruption on economic growth – sand in the wheels – caused by the distorted policies of bribed government institutions, which lead to higher transaction costs and uncertainty for enterprises and to lower investment in the private sector (Tomaszewski, 2018, p. 253).
In the case of China, competing local governments have developed a complex system of special deals to build and promote local enterprises as champions for rapid economic growth in their region (Bai, Hsieh, and Song, 2019, pp. 2-6). Those special deals are an essential part of inter-local and inter-regional competition; first and foremost, they drive innovation and creative destruction. Milanovic argues that a certain level of corruption is an inevitable side effect of globalization and inextricably linked to the free movement of capital and labour, and therefore a ‘normal’ element of both economic models:
“Corruption … is spurred by the ideology of money-making, which is the ideology that underlies capitalist globalization, and it is made possible thanks to the mobility of capital. But in addition, both political capitalism and the trend toward plutocratic rule in liberal capitalism‚ normalize it” (Milanovic, 2019, p. 131).
Indeed, the abundant legal lobbying activities of corporations in Western countries have similar systemic potential to distort public economic policy and generate even higher levels of inequality than illegal corruption does in political capitalism.
After 2010, China’s leadership acknowledged the risks of rampant domestic corruption spinning out of control. In 2012, the National Congress of the Communist Party launched a sweeping nationwide campaign to reign in bribery and the abuse of political power. More than 100,000 citizens were indicted between 2012 and 2015; the relentless anti-corruption policy of the Chinese government became a hallmark of Xi Jinping’s presidency (Economist, 2015). Economists are still debating whether that campaign and subsequent anti-corruption initiatives have had a tangible impact on the slowdown of China’s economic growth since 2012.
As previously outlined, the World Economic Forum’s 2019 GCI report appreciates these efforts over recent years and celebrates China as the competitiveness champion among the BRIC economies. There is strong evidence that up to now, China’s version of political capitalism has managed to keep its systemic contradictions at bay and to generate impressive economic growth in comparison with other transitional economies, prudently replicated by Vietnam in its wake: “…for the first time in history successful economic development on a major scale is based on an indigenous, not Western-type economic model” (Popov, 2020, p. 28; original author’s emphasis). Milanovic concludes that we are presently witnessing an open contest of competitiveness between liberal and political capitalism: “which one does it better is an empirical question” (Milanovic, 2019, p. 119).
But is it an empirical question? I doubt it. More research based on statistical data can probably provide further insights into the difference between the two models but it will fail to illuminate the otherness of the East Asian economic model with regard to the Western model. That otherness in its history, traditions, values, and its social and economic interactions, lies beyond the reach of economic science.
The Entrepreneurial Self, Tianxia, and the Welfare State
Western liberal capitalism has embraced the concept of entrepreneurship as a key factor of competitiveness and driver of economic growth. It partly reinvented itself by focusing on start-up business cultures working on creative destruction as an escape route from trustification and stagnation. Its growing popularity has pervaded all subsystems of the economy: young enterprises compete for a champion or even unicorn market position (a valuation of over $1 bn.); venture capital and private equity companies compete to discover the next big thing to make their investors rich; and employees transform themselves into intrapreneurs competing with their teammates in delivering the best performance to increase the company’s share value and stakeholder value.
That pervasiveness of competitive thinking and behaviour manifests itself in the massive media appeals for empowerment, total quality management, and disruptive innovation, the growing pressure of self-optimisation that locks citizens firmly in a Hobbesian world dominated by friend-foe relations, and creates an inherently violent society constantly at war with itself and others, homo homini lupus. That mindset, the entrepreneurial self (Bröckling, 2016), has taken hold wherever the debordering of markets in the process of globalisation linked more countries and communities to the Western model and subordinated them under Western hegemony. In Schumpeter’s words, the entrepreneurial self has “the dream and the will to found a private kingdom, … the will to conquer: the impulse to fight, to prove oneself superior to others” (Schumpeter, 1934, p. 93).
The philosopher Zhao Tingyang perceives other forces at work in China, past and present. He has developed an authentic, indigenous Chinese theory of (political and economic) world order based on the concept of tianxia, ‘all-under-heaven’, which was conceived about 3,000 years ago in the Zhou dynasty (Zhao, 2020, pp. 50-59). Tianxia has three meanings: (i) the earth or all lands under the sky; (ii) a common choice made by all peoples in the world, or a universal agreement in the ‘hearts’ of all people; and (iii) a political system for the world with a global institution to ensure universal order.
With the concept of tianxia, therefore, the world is understood as consisting of the physical world (land), the psychological world (the general sentiment of peoples), and the institutional world (a global institution) (Zhang 2010). Tianxia regards the world as the highest political unit, while the Western liberal model puts the nation-state at the centre of its political and economic analysis, even in its global perspectives on international trade or the clash of civilizations.
An essential element of tianxia is its principle of non-exclusion, which leaves no space for anything or anyone being shut out or ostracised. It “defines the concept of ‘the political’ as the art of co-existing through transforming hostility into hospitality” (Zhao, 2018). That relational ethical approach, traced back by Zhao to Confucius, gives the Chinese model of economic development a fundamentally different grounding compared with the Western model (Ahlstrom and Wang, 2010, pp. 406-412). It provides a social guarantee for the poor to participate in economic development and keeps inequality at acceptable levels. Zhao emphasises the inclusive character of such economic development, which he calls a Confucian optimum, in marked contrast to Pareto-optimal resource allocations in liberal economic theory (Zhao, 2018).
In an economy ruled by tianxia principles, the entrepreneurial self, its radical methodological individualism and its restless propensity to self-optimisation, competition, and exclusion would not dominate society. The common good has a superior position in national policy where it holds sway over individual interests. The Western liberal narrative envisages a determined course of history in which economic development will inevitably drag any national economy on to the path to liberal capitalism. But China’s economic development and vision for a future world order seems to deviate entirely from that assumed determined outcome, as it is based on non-Western values: “China is, in many ways, the ‘absolute other’ to our understanding of international order” (Godehardt, 2016, p. 11).
The Western liberal approach to inclusive capitalism is the theory of the welfare state, which has been developed by mainstream economics in the tradition of Hobbes, Locke, Smith, and Mill. John Rawls built upon the work of these predecessors and conceived an internationally acclaimed theory of the national welfare state but he categorically excluded the application of his principles of distributive justice, which set limits to inequality, to the international order. There is no conceptual barrier for inequalities between rich and poor national economies in Rawls’ theory, and any resistance of the Global South against the unjustified gap between poor countries and the affluence of Western countries could be a subject of interventions. Zhao recognises the legitimation of a modern North-South imperialism as the necessary consequence of that ideology (Zhao, 2020, pp. 193-194).
However, there is another European tradition of the welfare state besides that of Western liberalism, which may find a more appropriate way to connect to the Chinese economic model based on tianxia. Leibniz, Rousseau, and Kant have conceived elements of an inclusive and hospitable political and economic world order which comes, at least partly, close to tianxia. Zhao explicitly refers to Leibniz’s divine principle of a possibility of coexistence for all living beings, and to Kant’s reflections on the conditions of the possibility of eternal peace (Zhao, 2020, pp. 21, 189-192). Cornerstones of inclusive capitalism were introduced in most EU member states by social democratic parties when they came to power: advanced civil and social security mechanisms – notably healthcare – and more equitable tax and transfer regimes. In these national economies, the public sector generally holds a share of GDP over 40%. Contrary to Rawls’ theory, there are no conceptual barriers to a global application of the continental European model of welfare.
Conclusion
In conclusion, it would be worthwhile to juxtapose tianxia and the continental European model to explore their similarities and differences as a subject of future research. The West versus East Asia debate could gain new valuable insights if it abandons the idea of a monolithic West.
Peter W. Heller
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[1] Permission to use figures from the GEM 2019/2020 Global Report, which appear here, has been granted by the copyright holders. The GEM is an international consortium and this report was produced from data collected in, and received from, 54 economies in 2019. My thanks go to the authors, national teams, researchers, funding bodies and other contributors who have made this possible.
[2] An introduction into the methodology of GEM, GEI, and GCI would be beyond the scope of this paper. Data on the entrepreneurial ecosystems are sorted into groups (pillars) of indicators; in the case of the GEI, these are (entrepreneurial) attitudes, abilities, and aspirations.
[3] He borrows the term ‘political capitalism’ from Max Weber, who defines it as the use of opportunities for predatory profit from political organisations or persons connected to politics (Weber, 1978, pp. 164-165).
Postmaterial Experience Economics, Population, and Environmental Sustainability
Postmaterial values with their reduced emphasis on accumulating material possessions lead to greater political support for limits on environmental pollution and to a less entropic way of life that increases environmental sustainability. Similarly, reducing human fertility to replacement levels can stabilize population and increase environmental sustainability in the future by reducing the pressure of population growth on environmental resources. In recent history, increases in per capita economic well being has been a primary driver of expansion in postmaterialism and reduce human fertility worldwide. The irony of this phenomena is that economic development potentially destructive to the environment leads to more postmaterialism and reduced fertility, both of which benefit environmental sustainability.
The driving motivation in the modern life of the global economy most observers would agree is to accumulate material possessions. From possessions come life’s essential accomplishments and enjoyments. Many profess a belief in God as the final source of meaning, but what we do in practice to give our life significance is go to the cathedral of the mall or amazon.com. An emerging alternative view, one that can be called ‘postmaterialist’, claims instead that many human satisfactions come from the experiences of creative expression and interactions with human others in the enjoyment of life’s cultural and natural wonders independent of private possession. Economic theorizing focuses heavily on the notion that accumulating material possessions is a necessary and sufficient path to a positive life experience. While material possessions may be necessary for the good life, they need not be sufficient nor even necessary beyond a threshold amount, opening up the possibility for human engagement in activities where material possession is secondary and not especially important.
Postmaterial values, and their reduced emphasis on accumulating material possessions, lead to greater political support for limits on environmental pollution and to a less entropic way of life that increases environmental sustainability. Similarly, reducing human fertility to replacement levels can stabilized population and increase environmental sustainability in the future by reducing the pressure of population growth on environmental resources. In recent history, an increase in per capita economic well-being has fostered an expansion in postmaterialism on one hand, and reduce human fertility worldwide on the other. The irony of this phenomena is that economic development potentially destructive to the environment leads to more postmaterialism and reduced fertility, both of which benefit environmental sustainability. In the pages to follow, the underpinnings of these conclusions will be set out as well as possible ways around the dilemma they bring.
Inglehart’s Theory of Postmaterial Values
The theory of postmaterial experience economics presented here is inspired by the work of Ronald Inglehart, a University of Michigan political science professor, who formulated the original conception of postmaterialism in terms of attitudes towards collective social goals with an eye to its use in empirical research (Abramson & Inglehart, 1995; Inglehart & Abramson, 1994, 1999; Welzel & Inglehart, 2008). If you attach high priorities to such purposes as (1) protecting freedom of speech, (2) giving people more say in important government decisions, (3) seeing that people have more say about how things are done at their jobs and in their communities, (4) trying to make our cities and countryside more beautiful, (5) progress toward a less impersonal and more humane society, and (6) progress toward a society in which ideas count more than money, then you are a postmaterialist. If instead you attach high priorities to such goals as (7) maintaining order in the nation, (8) fighting rising prices, (9) a high level of economic growth, (10) a commitment to strong defense forces, (11) a stable economy, and (12) the fight against crime. In this case you are a materialist. If your highest priorities are all materialist, that’s what you are; if your highest priorities all go the other direction you are a postmaterialist; if you have a mix of highest priorities you fall on a spectrum between materialism and postmaterialism (Abramson & Inglehart, 1995; Inglehart, 2008).
Survey research on postmaterialism finds that if you are currently a young adult, you probably grew up in a period of economic prosperity, and if you are older you more likely faced economic deprivations in your pre-adult years. Because our basic values are formed by the time we reach adulthood, whether or not we face economic scarcity or social upheavals in our youth matters. As we age, our orientations fluctuate to some extent with economic and social conditions, but our basic outlook does not change much. In explaining this position, Inglehart offers a socialization hypothesis claiming that our basic value structure is formed in our youth, and a scarcity hypothesis proposing that our values will focus most heavily on those items we lack. If, for instance, our life is highly insecure when we are young, one of our highest priorities will always be a safe and secure social and material environment (Inglehart & Abramson, 1994). This is not to say that our values won’t change over time, but that our basic outlook will be strongly anchored by our coming of age experience. The result of this behavior pattern will be an increase in the extent of postmaterial values as younger generations replace older in the adult population (Abramson & Inglehart, 1995; Inglehart, 2008; Inglehart & Abramson, 1994, 1999). According to Inglehart, this inter-generational shift in value orientations can be ultimately explained in terms of Abraham Maslow’s famous theory of the hierarchy of human needs (Inglehart, 1971; Maslow, 1987). The hierarchy hypothesized by Maslow includes (1) the basic needs such as food, drink, sleep, and sex; (2) the need for safety; (3) the need for a sense of belongingness including love, affection, and acceptance in a community; (4) the need for self-esteem flowing from prestige and social status; and (5) the need for self-actualization including being creative or accomplishing worthwhile purposes in life. The central point of Inglehart’s research findings is that younger generations came of age farther up the hierarchy of needs than older and thus place relatively more importance on postmaterialist as opposed to materialists social goals. Moving up the needs hierarchy in effect shifts one in the direction of postmaterial experience as a more central focus and away from an emphasis on materialist economic experience.
Postmaterial Experience
While many of us are strongly oriented to expanding and reshaping our private world of material possession, some of us look increasingly to enjoying the publicly available experience of our cultural and natural legacy. The former among us I shall refer to as economic materialists, and the later as economic postmaterialists. If we are materialists our life’s focus is on gaining control over objects and transforming them to mirror our deepest wishes. Our experience of such control and its resulting manipulations of the material stuff of life is sensual and virtual, a product of our perception-driven, conscious thought process. Our desire to physically manipulate and alter objects as we find them in nature ultimately calls sometimes for huge transformations of the material world. Witness the transformation of the global environment following, first, the agricultural revolution and, second, the industrial revolution (Harari, 2015). For postmaterialists, the essential quest in life is experiences of the physical world apart from any requirements for ownership and private control of it. Some material ownership and control is inevitably a part of our lives—we all need our own private supply of food, clothing, living space, and such—but post materialists look increasingly for experiences not necessarily contingent on ownership of physical objects in our field of perception. To summarize, a materialist is someone who focuses on seeking out the ownership of objects as an essential ingredient in the mental satisfaction interactions with them bring. A postmaterialist to the contrary is someone whose basic need for feelings of control over objects has been met and is instead more directly oriented to the experiences of phenomena in the physical, social, and cultural world (Booth, 2018).
Ecological Release, Experience, and Entropy
In a strictly biological conception of economic behavior, mental experience drives material acquisitions. A feeling of hunger pushes us to acquire and consume food; cold temperatures, wind, and rain stimulate us to gain protective clothing or cover; sexual and family love cause us to copulate, reproduce, and acquire the material requirements for nurturing, protecting, and defending our lovers and kin. Mental motivations combined with the contingencies of daily experience drive our accumulation of control over material goods essential for long-term survival. We humans in contrast to other species enjoy the privilege of ecological release, meaning that we need not spend every waking hour in the satisfaction of our material necessities (Sahlins, 1974). This privilege comes to us by virtue of our special mental faculties that permit us to exploit nature’s resources at uniquely high rates of economic efficiency. As a consequence, we can of course engage in the production of material goods well beyond our basic needs, or we can hang out and contemplate the beauties of the world around us, sing songs, or think the big thoughts. We can produce more than we need and use it to pay others to entertain us with stories or dance, teach us how to do mathematics, or to take us on guided nature walks. Economics doesn’t distinguish between baking bread and presenting Shakespeare’s Richard the III; both are economic goods for which people are willing to pay, and both offer mental stimuli and satisfaction. There is an important difference between them, however; bread is enjoyed in an act of physical consumption, and the pleasure of Richard the III is a shared perceptual and mental experience. The loaf of sourdough French bread I gobble down becomes unavailable to you, but we can both experience Shakespeare together without detracting from each other’s pleasure. The experience of consuming a loaf of bread involves a using up of a material good, and the experience of consuming Richard the III does not. Experience requires stimulus from the physical world, but not necessarily a substantial physical transformation of that world. Experiences can be placed on a spectrum, heavily dependent on altering the material world at one end (eating bread and drinking wine or driving your Cadillac Escalade SUV around town), and not requiring any alteration at all on the other (enjoying a sunset or Shakespeare in the park). At one end you and I cannot consume the same exact material thing (a particular glass of wine), and at the other we can (a sunset). The first activity is relatively more entropic than the second. The first absorbs nature’s energy and reduces the chemical bonds of it’s material being and the second does not.
Complications do arise. We can share a Shakespeare play, but if the audience is too big, some of us will not be able to get close enough to perceive all the action on the stage. In sharing a physical phenomenon, crowding can be a problem. Too many people detract from the experience. In some cases, such as a rock concert, where audience reaction is part of the experience, too few people instead can be a problem. In wilderness hiking, where the act of it does little to modify the physical world, the sharing of it can detract from the experience if one is running into someone on the trail too often or if all the good campsites are taken. In short, the number of people sharing an otherwise benign experience (i.e. with an innocuous physical impact) matters. In some cases the more the merrier, and in some more is bad (Olson, 1965).
While the direct enjoyment of a Shakespeare play is physically and entropically benign, its production is not. The stage, the costumes, and all the other necessary paraphernalia of making a play happen re-arrange the physical world just as does making loaves of bread. The difference between the two goods is that consuming the play is benign and the bread entropic. You and I can’t consume the same loaf of bread but we can the same play. Some things in life are actually entropically free: you and I can enjoy the same sunset and the physical world is unchanged from what it otherwise would be. Of course, if the sunset is over Sonoran desert mountains, you and I will have used up material resources in our travels and caused some physical entropy, but once on the scene the extra physical changes we cause in watching the sunset becomes vanishingly small. And, of course, just walking around the desert will have some impact, but not much, especially if we step with care. In practice, experiences lay on a spectrum from heavily entropic to completely benign (causing near-zero entropy).
Entropy and the Form of Life
Richard Florida, a regional science professor, has gained star standing among urban planners for his book, The Rise of the Creative Class (Florida, 2002). Florida presents evidence for the emergence of an economically important group of individuals who play a driving role in a renaissance of downtown urban revitalization and have a new take on life that bears the marks of post-materialist thinking. According to Florida, this creative class is compose of professionals, such as scientists, engineers, university professors, poets, novelists, entertainers, designers, architects, and opinion-makers who conceive new intellectual or artistic forms of economic or public value. Its members are at once bohemian and conformist. They have an intense desire for personal self-expression, which includes body-piercing jewelry and tattoos, but also possess a powerful work ethic and passion for personal accomplishment, especially in the digital arena doing software development or graphic arts. These are the people one increasingly sees sitting around gourmet coffee shops huddled over their computers or conversing in small groups about website design, solving a computer software problem, pulling off the conversion of an old commercial building into condominiums, or getting someone elected to political office. They don’t like bureaucratic hierarchy, but believe strongly in being recognized for their work on its creative merits. They especially believe in social diversity of all kinds, and feel comfortable working with others of different races or sexual orientations. Members of the creative class both work and play hard, and express only limited interest in accumulating material possessions and are especially oriented to consuming individual and shared “experiences” such as adventure travel, road biking or rock climbing or other vigorous activities, offbeat theater performances, cutting edge studio art, or experimental musical events. While Silicon Valley is a suburban bastion for such individuals, they increasingly find urban centers such as downtown San Francisco, Seattle, or Minneapolis to be exciting places to live and work.
Youthful creative types, along with the return of aging suburban expats, fuel much of the boom in condominium construction and conversion of distinctive older commercial buildings to residences in downtowns around the country. Both groups are attracted to the excitement of urban street life in neighborhoods with concentrations of trendy restaurants, theaters, art galleries, espresso shops, brew pubs, bookstores, and entertainment venues. Retailing matters, but its orientation is to specialty foods or wines, boutiques, and outdoor stores that serve the active life of the new inner city residents.
The interest of affluent young professionals in downtown living finds confirmation in a Brookings Institution study of census data by Eugenie Birch, Professor of City and Regional Planning at the University of Pennsylvania (Birch, 2005). In a sample of 44 cities, downtown population grew by ten percent in the 1990s and the number of households expanded 13 percent, a substantial recovery after years of decline. In 2000 25 to 34 year olds compose a quarter of downtown populations, up from 13 percent 30 years earlier. The proportion of downtowners having a bachelor’s degree rose to 44 percent, a figure that exceeds both that for cities as a whole and their suburbs. The young and the educated moving downtown are exactly those groups where post-material values predominate.
Not all the creative occupations referred to by Florida in his writings enjoy the affluence of the creative class as a whole. True creativity doesn’t necessarily bring wealth as the artists of the world historically discover repeatedly. Yet it is this group that concentrates most heavily among all occupations in the central city today and serves as a driving force for neighborhood renewal (Ann Markusen & Schrock, 2006; Strom, 2010). The popular image of starving artists or aspiring actors living in garrets and waiting tables for their living stands up to academic scrutiny. Artists (defined broadly to include actors and directors, announcers, architects, drama and music teachers, authors, dancers, designers, musicians and composers, painters, sculptors, craft artists and printmakers, and photographers), in comparison to other professionals, are highly educated but poorly paid (Alper & Wassall, 2006). They often hold multiple jobs in a given year, work outside their chosen occupation to make ends meet, face frequent periods of unemployment, and contend with an income distribution highly skewed towards the relatively few who experience substantial success. Financial accomplishment as an artist is a ‘winner take all’ gamble that very few achieve. Nonetheless, the number of artists has grown more than twice as fast as the labor force in recent decades, reflecting an expansion in public demand for the products and experiences artists have to offer as a well as a continued willingness of many artists to endure a lower income for the intrinsic rewards of creative work.
Given their economic vulnerability, artists normally choose to locate in inner city neighborhoods with inexpensive rents (A. Markusen & Gadwa, 2010). For those who require studios or places to rehearse, declining, seedy commercial or industrial areas often provide affordable space in which to both work and live. Artists concentrate in central cities to a greater degree than most other occupations and tend to cluster together in neighborhoods that best suit their needs for expansive but cheap workspace, artistic community connections, and access to customers. Clustering enables interactions, from which spring ideas and information on economic opportunities, and the concentration of supporting art galleries and display spaces or performance venues.
A modest trend towards high-density city living in the U.S. and other auto-centric countries may not seem like much, but if it continues it will be a big deal. A shift to living at higher densities along European lines may well come in the nick of time to help reverse our ominous march to climatic warming (Newman & Kenworthy, 1999). If you live in a densely packed urban setting instead of a spatially expansive suburb, you move around much less to get to work, for shopping, and doing all the other things you love to do. When you do move around, chances are greater that you will walk, bike, or take public transit than if you live in a low-density suburb where odds are that you would drive everywhere because everything is so far apart. In short, if you move from suburb to city, you will cut back on your driving and the volume of auto-related greenhouse gas emissions you cause. Also in the city, chances are you will live in a smaller dwelling that requires much less greenhouse gas-emitting energy for heat and light, and if you live in a multi-family unit and share heat-emitting exterior walls and roof areas with others, your dwelling will be much more energy efficient than a single family, low rise house in the suburbs. By deciding to live in the city, you will do the environment a big favor whether you think much about it or not. If you are a post-material environmentalist, you might even decide to live in the city to live out your own philosophical values apart from realizing the benefits of city living.
Evidence for Postmaterial Values and Experience
The form that one’s life takes matters for its use of material resources and impact on the environment. Living in a high-density city with multiple modes of transportation in general will be less entropic than life in a low-density suburban environment. The experience of life will differ as well in the former than the latter. In the central city, more of daily life will be spent in the public arena moving around, strolling in parks, hanging out at sidewalk cafes, and enjoying various cultural amenities that concentrate at urban centers. Suburban living with its heavy auto-dependency will be intrinsically more entropic than daily being in the central city. The density at which individuals live around the world truly matters for environmental sustainability as outline in the works of Peter Newman and Jeffrey Kenworthy (Newman & Kenworthy, 1999, 2015).
What one does in that daily life matters as well. The life of a postmaterial urban artist whose labor constitutes the vast bulk of an art object’s economic value will be less entropic than, say, a highway engineer who designs freeway ramps and bridges. By the simple act of living a central city with all its opportunities for post material experiences, one lives less entropically than would be the case in a suburban location. While how one lives and what one does intuitively matters for environmental sustainability, direct empirical evidence on the values individuals possesses and their effect on the environment is only just beginning to be accumulated.
Inglehart Postmaterial Values
A lengthy literature exists on the global presence and effects of Inglehart postmaterial values and is summarized in a variety of sources (Abramson & Inglehart, 1995; Booth, 2017; Inglehart, 2008; Welzel & Inglehart, 2008; Welzel, Inglehart, & Deutsch, 2005). Such values have expanded their presence over time in both Europe and the U.S., although they may have suffered a setback more recently as a consequence of the recent growing popularity of conservative populist politics in many countries (Inglehart & Norris, 2016, 2017). An extensive literature using the World Values Survey and other survey data confirms that postmaterial values positively predict political support for environmental protection as well as public action in support of the environment (Booth, 2016, 2017). In my own research, a measure of environmental concern is taken from a two-part question that requires a trade-off between environmental protection and economic growth. Each respondent chooses one of the following two statements that best reflects their attitude: (1) Protecting the environment should be given priority, even if it causes slower economic growth and some loss of jobs; (2) Economic growth and creating jobs should be the top priority, even if the environment suffers to some extent. Three different questions provide measures of actual respondent behaviors directed at environmental protection, including whether the respondent (1) is an inactive or active member of an environmental organization, (2) has recently given money to an ecological organization, or (3) has recently participated in a demonstration for some environmental cause. In all cases, an index of Inglehart postmaterial values predicts environmental support and environmental action in the U.S. as well as for a global sample that includes 60 countries. To the extent that such individual attitudes and actions get translated into government action in the political arena, postmaterial values contribute to environmental sustainability.
Postmaterial Experience
The effect of postmaterial values on political support and actions in favor of the environment matters only if such support and actions get translated into actual government policies that diminish environmental pollution and increase environmental sustainability in practice. So far the evidence for this being the case is fairly limited although convincing (Gerhards & Lengfeld, 2008; Tjernstrom & Tietenberg, 2012; Zahran, Kim, Chen, & Lubell, 2007). A shift in favor of an increased orientation to postmaterial experience could lead more directly to environmental sustainability by reducing the entropy of daily human activities as explained above. These activities depend first and foremost on the reality of postmaterial experiences in everyday life.
The presence of postmaterialist experience on a global basis has only just begun to be investigated empirically. In my own work, using data from the World Values Survey, I have found evidence that global participation in such experiences as (1) membership in voluntary organizations, (2) participation in work that offers creative tasks and independence such as that undertaken by artists, and (3) participation in political action to be relatively extensive in a large global sample covering 60 countries (Booth, 2018; World Values Survey Association, 2015). I also find using regression analysis that a desire for riches fundamental to the accumulation of material possessions fails to predict memberships in voluntary organizations, and is a negative predictor of creative and independent work and participation in political action. In sum, those who focus on accumulating material possessions lack an interest in post material experiences. Positive statistical predictors for all three forms of experience activities include the importance to the respondent of thinking up new ideas and being creative, doing something for society, and looking after the environment. The nature of the three types of activities themselves matter for participation, as opposed to any private material benefits they confer.
These three forms of individual activity typically lack an orientation to the accumulation of material possessions or an extensive incremental need for material possessions beyond a basic threshold. There are, of course, exceptions. The creative highway engineer who thinks up new ways to build freeway overpasses and bridges would be engaged in an activity that supports a highly entropic activity, motor vehicle travel. This would be much less the case for the musician or landscape photographer. Nonetheless, statistical predictors suggest that those engaged in creative and independent work are less orientated than others to the accumulation of material possessions and are more likely to possess a desire to do something for the environment. In addition to possible positive consequences for the politics of environmental protection, the expansion of a postmaterial outlook on life can cause a shift to a less entropic and more environmentally sustainable way of life. Instead of spending our days worried about accumulating more material possessions, we can focus on the daily experiences of life embodied in social interactions, cultural activities, and the wonders of the natural world. To do this we indeed require basic economic and physical security, but once accomplished we have the ecological luxury of focusing our attention on the existing wonders we encounter in daily life without adding much to the material transformation of the world.
An expansion of postmaterialism globally could in theory have a direct positive effect on environmental sustainability, but this proposition remains an untested hypothesis. Environmental economists have, however, invested heavily in a testing a related somewhat more general hypothesis that rising per capita income in individual countries ultimately leads to a reduction in per capita pollution emissions. In short, economic development in itself constitutes the final solution to environmental problems. If this is the case, then an expansion of postmaterialism contingent on rising individual economic security would accelerate that trend. Unfortunately the validity of this more general hypothesis remains to be settled, as we will now see.
Postmaterialism and Environmental Kuznets Curves
The gold standard for investigating the link between affluence and the environment is something called an “Environmental Kuznets Curve”, named for an economist, Simon Kuznets, who discovered the presence of such a curve in the case of income inequality (Kuznets, 1955), a conclusion that only recently has come under challenge in the works of Thomas Piketty (Piketty, 2014). According to environmental Kuznets curve theory, as an economy advances from an agricultural to a modern industrial and digital economy, and as per capita incomes grow, environmental problems such as water and air pollution increase, but at some point such problems begin to diminish because of advances in pollution control technology and increased environment regulation fostered by a rising middle class with political demands for a higher quality environment. In brief, plotted against a country’s per capita income over time, the curve of pollution emissions per person has an inverted U-shape. The hypothesis remains controversial and has generated numerous research papers in environmental economics, some finding empirical support for the it, and others denying its existence (Ben Jebli, Ben Yousseff, & Ozturk, 2016; Galeotti, Lanza, & Pauli, 2006; Stern, 2004). The controversy continues, especially for greenhouse emissions such as carbon dioxide. The best one can say is that the curve may exist for relatively wealthy countries such as those belonging to the OECD, but there is little evidence for it outside the OECD. In short, poor countries of the world face environmental deterioration as they develop under prevailing economic arrangements, and the rich have achieved stability and perhaps modest reductions in their environmental impacts. In the case of greenhouse gases, the rich, western industrialized countries of the world of course bear most of the responsibility historically for cumulative greenhouse gas emissions, most of which continue to persist in the atmosphere to this day (Freidrich & Damassa 2014).
To put it in Kuznets curve lingo, a turn to postmaterialism bends the curve downward more quickly than otherwise by increasing political support for the environment and shifting human activities in a less entropic direction. The problem with the rise of postmaterialism is that its advance occurs at a fairly glacial pace (Inglehart & Norris, 2017) while such environmental problems as climate change and natural habitat degradation are advancing much more rapidly (Intergovernmental Panel on Climate Change, 2015).
Population and Postmaterialism
In contrast to the modest pace of postmaterialism, global human fertility has plummeted from around 6 children per female to about 2.5 in the last 75 years (World Bank, 2017), an amazing drop by historical standards, but substantial population growth yet remains in the pipeline (World Bank Population Blog, 2015). Before global population begins to stabilize due to reduced fertility, still more downward pressure on environmental sustainability will occur in the near future as added individuals expand global material consumption. Whether a shift to postmaterialism and a less entropic way of life also operates to increase sustainability by fostering an added reduction in human fertility and ultimately population growth remains an open question yet to be explored empirically. Across countries, post-material values are more extensive on average in high- than low-income countries as confirmed by data from a sixty-country sample from the latest World Values Survey (World Values Survey Association, 2015). Population fertility for these same countries, is negatively correlated to per capita income as can be expected in light of the “demographic transition” (Kirk, 2010; World Bank, 2017a; World Values Survey Association, 2015). Postmaterial values and reductions in fertility are thus correlated, but correlation, of course, is not the same thing as causation. The reduced emphasis on economic accomplishment in a postmaterial way of life may, or may not result in a reduced desire to procreate. This question has yet to be investigated. In the U.S., fertility is declining among younger women who are delaying getting married, having children later in life, and having fewer children (Stone 2018). Since postmaterialism is relatively higher among younger people worldwide, such a decline in fertility may well be attributable to a postmaterial way of life. If so, then postmaterialism will indeed lead to a demographic shift reducing human fertility and increasing environmental sustainability. By decreasing the number of children they have, couples can have a profound long-term effect on the environment, especially for reducing greenhouse gas emissions (Wynes & Nicholas 2017).
Whatever the actual relationship between postmaterialism and human fertility, a rise in global per capita income does nonetheless have a double effect as described above: (1) a shift to less entropic postmaterial values and experience, and (2) a decline in human fertility. Both ultimately benefit global environmental sustainability.
Conclusion
A problem for sustainability yet arises because the shift to postmaterialism and reduced human fertility, each beneficial to the environment, are both advanced by an increase in per capita living standards on a global basis that can itself cause a decline in environmental sustainability. This is the critical dilemma of economic development as a way out of the environmental crisis.
To moderate such a decline, public efforts are essential that shift the global economy to clean energy and bring a halt to habitat degradation for all of the world’s species. While optimism in today’s political arena on the face of it seems unwarranted, an advance in postmaterialism could in the end make a difference given the current relatively even split between forces for and against public action addressing climate change. A few more young postmaterialists in the political mix, especially in the USA, could tip the balance for the outcome of future elections in the favor of political actions that mitigate environmental degradation, but this remains to be seen (Booth, 2017). The one other hope is the downward plunge in clean energy unit costs will continue and eventually force fossil fuels out of the global energy market (Lazard, 2017). This could be a big bonus for solar-rich less developed countries arrayed around the equator. These same countries possess some of the highest population fertility rates in the world that could be dampened by solar-driven economic development to the benefit of our environmental future. Moreover, such development will skip over environmentally damaging fossil fuels, a primary source of pollution historically, and go directly to environmentally sustainable renewable energy. Sliding down the rightward side of the environmental Kuznets curve for the world as a whole is a possibility, but doing so in time to forestall climate change and degradation of the global environment requires concerted public action to accelerate the trend to clean energy and sustainability around the world.
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Douglas E. Booth
Class Struggle and Class Compromise in the Era of Stagnation and Crisis
19 September 2019
For Erik Olin Wright, our greatest chance at developing non-capitalist economic institutions may be in periods of class compromise initiated from below. The question is what it would take – or even whether or not it is possible – to rebuild such conditions in the present.
In the decades following WWII, Social Democracy (broadly understood)2 built and consolidated three main achievements:
- A system of various forms of publicly supported social insurance to deal with a range of risks people experience in their lives, especially around health, employment, and income.
- A tax regime sufficient to provide funding by the state for a fairly expansive set of public goods, including basic and higher education, vocational skill formation, public transportation, cultural activities, recreational facilities, research and development, macro-economic stability, etc.
- A regulatory regime for the capitalist economy that curtailed a range of negative externalities of capitalist markets: pollution, product and workplace hazards, predatory market behavior, etc.
These achievements were, at least in part, the result of what might be termed a positive class compromise between the capitalist class and popular social forces.3 Capitalists were basically left free to allocate capital on the basis of profit-making opportunities in the market, while the state took responsibility for correcting the three principle failures of capitalist markets: individual vulnerability to risks, under-provision of public goods, and negative externalities of private profit-maximizing economic activity. While it would be an exaggeration to say that there was no contestation over these achievements – even in the most robust social democracies there was conflict over the scale and scope of each of these elements – nevertheless there was a loose consensus that these were legitimate activities of the state and that they were broadly compatible with a robust capitalist economy.
This consensus no longer exists, even the social democratic heartland of Northern Europe. Everywhere there are calls for rollbacks of the “entitlements” connected to social insurance, reductions of taxes and the associated provision of public goods, and deregulation of capitalist markets. This assault on the affirmative state has intensified in the face of the economic crisis that has gripped global capitalism in recent years. The rhythm and intensity of the crisis has varied from place to place: in the United States it was most severe in 2008-2009, while in 2012 it is most sharply present in Greece and other countries on the periphery of Europe. The details of this economic turmoil also vary considerably across capitalist countries, but there is near universal sense that economic prospects are bleak, that life under capitalism for most people has become more precarious and is likely to stay that way for some time to come, and that in the wake of this crisis the state must retreat from its earlier expansive role.
So far the political Left has not managed anywhere to mobilize a coherent positive response to the crisis. To be sure, there have been protests, sometimes massive protests, and some of these have unquestionably had an important impact on public debate; some may even have had a significant impact on elites, impeding their strategies for dealing with the crisis on their own terms. The protests have, however, mostly been defensive in nature – resisting draconian cuts to the social safety net, pensions, health, education, and other public programs – rather than mobilizations around a positive project for overcoming the crisis through a reconstruction or transformation of the economic and political conditions for social democratic ideals.
In this paper I will explore the broad contours of what such a positive project for a new progressive politics might look like. I will build the analysis around a contrast between the conditions facing progressive politics in what is sometimes called the “Golden Era” of capitalist development in most advanced capitalist countries in the decades following the Second World War during which the social democratic achievements were built and the conditions in the current era of stagnation and crisis. The central argument will be that the Left has had its greatest durable successes when it is able to forge what I will call a positive class compromise within capitalism. The question, then, is what it would take – or even whether or not it is possible – to rebuild such a class compromise in the present.
The paper is organized as follows. Section I will present the theoretical tools needed for the analysis of positive class compromise. Section II will compare the conditions for class compromise in the relatively favorable era of the third quarter of the 20th century with the much less favorable conditions at the beginning of the 21st. Section III will discuss the kinds of transformations needed to reconstruct on a new basis such favorable conditions. Section IV will conclude by examining how a positive class compromise within capitalism might also help point the way beyond capitalism.
I. Class Compromise: Theoretical tools
The idea of “class compromise” generally has a negative connotation on the Left, especially among Marxists. It suggests opportunism and collaboration rather than militancy and struggle. This objection is grounded in the view that efforts to create class compromise block more radical transformations that would ultimately move us beyond capitalism in ways that would better serve the interests of the working class and other popular social forces. This objection will be addressed in section IV below. For the moment I will simply assume that for the foreseeable future it is not possible to break with capitalism, and thus improving the conditions of life for ordinary people depends upon forging the best conditions possible within the constraints of capitalism, and this depends upon the viability of class compromise.
To understand the idea of class compromise it is useful to begin by distinguishing between what can be called “negative class compromise” and “positive class compromise.” Negative class compromise refers to a situation in which there is a kind of balance of opposing class forces each capable of inflicting considerable costs on the other, but neither capable of decisively defeating the opponent. In such a situation it may be possible for the contending forces to accept a compromise in which each makes concessions in exchange for refraining from imposing damage on the other. “Compromise” in this case means that the outcome of struggles for each party falls somewhere between complete victory and complete defeat.
Positive class compromise means something quite different. In a positive compromise, in spite of their opposing interests, the contending forces find a way to actively cooperate in ways that open up some space for non-zero-sum gains. Active forms of mutual cooperation help both workers and capitalists to better realize their interests than is possible by simply extracting concessions through confrontation.
There is very good reason to be highly skeptical of this possibility. Descriptions of capitalism as a positive-sum game are typically made by defenders of capitalism who deny the fundamental antagonism of interests between capitalists and workers and who see class struggles as irrational and counter-productive. This kind of rhetoric is found in “trickle down” economics accounts of capitalist investment and inequality: “a rising tide lifts all boats,” and this depends upon stable investments by capitalists, which depends upon profits, etc. Nevertheless, I will argue as a broad generalization that the Left has been most successful in robustly institutionalizing its gains for ordinary people when these gains have been consolidated within positive class compromises.
To understand the reasoning behind this argument, we need to examine the relationship between class interests and popular power.5 For simplicity I will focus on the interests of workers and capitalists, and ignore the complexity of various categories lumped together under the rubric “middle class” and various social categories that are marginalized from the main axis of the capitalist class structure.6 The relationship between the realization of working class interests and popular power is straightforward, as illustrated in Figure 1: as popular power increases from weak levels of power to strong levels of power, the realization of working class interests increases, at first slowly, then more rapidly. What is much less obvious is the relationship between the realization of capitalist class interests and popular power. This is illustrated in Figure 2: Initial increases in popular power interfere with the realization of capitalist interests.
Indeed, initially, increases in popular power harm capitalists much more than it helps workers, reflecting the fact that in social conflicts it is generally easier to impose harm on one’s opponents than actually deliver benefits for one’s supporters. Once popular power reaches a certain intermediary level, however, further increases of popular power are associated with increased realization of the interests of capital. This upward sloping part of the curve is the crucial region of positive class compromise.
How is it possible that increases in popular power could be beneficial for capitalists? The core idea here is that certain kinds of problems faced by capitalists and capitalism are more easily solved under conditions of relatively strong popular power than under conditions of weak and disorganized popular power. The classic example of this is the role of organized labor – one of the key bases for popular power – in helping to solve certain problems posed by Keynesian macro-economic policy. Full employment, insofar as it implies high levels of capacity-utilization and higher aggregate demand for the products of capitalist firms, potentially serves the interests of capitalists. But it also risks a profit squeeze from rapidly rising wages and spiraling levels of inflation. Keynes himself recognized this as a serious problem: “I do not doubt that a serious problem will arise as to how wages are to be restrained when we have a combination of collective bargaining and full employment.”7 The emergence and consolidation in a number of countries of strong, centralized unions capable of imposing wage restraint on both workers and employers was perhaps the most successful solution to this problem.8 In this sense, a powerful labor movement need not simply constitute the basis for a negative class compromise, extracting benefits for workers through threats to capital. If a labor movement is sufficiently disciplined, particularly when it is linked to a sympathetic state, it can positively contribute to the realization of capitalist interests by helping to solve such macroeconomic problems.
Many other concrete examples of how relatively strong popular power helps solve problems faced by capitalists. Because of pressures of profit maximization, capitalists often operate under short time horizons that are sub-optimal for their interests in the long-term. Short time horizons reduce the willingness of capitalists to support levels of taxation needed for the funding of public goods, including things that are critical for long-term productivity – education, training, infrastructure, basic research. High levels of popular power within the state can increase the production of public goods that are critical for training, innovation, and other elements of high productivity. Strong popular power can also potentially help block narrow rent-seeking behavior by capitalists in the state, reduce corruption, and in other ways improve government performance.9
I assume that the basic shape of this curve linking popular power to capitalist interests is a reverse-J rather than either a symmetrical U-curve or J-curve. If the shape was a J-curve, then capitalists would have a strong, active interest in increasing popular power to the maximum possible. Opposition to doing so would reflect false consciousness on their part. If the curve were U-shaped, then capitalists would be generally indifferent about being on the left or right hand extremes of the curve. They certainly would have no reason to strongly oppose movements to high levels of popular power once a moderate level had been reached. The fact that historically capitalists generally do resist expansions of popular power to high levels is evidence that the underlying curve has a reverse-J shape. What this means is that there are real costs imposed on capital by strong popular power – higher levels of income redistribution than capitalists would prefer, for example, or the creation of extensive public goods that may improve social wellbeing without directly benefiting capital accumulation – but that the stability of the economy and productivity-enhancing characteristics of positive class compromise make these trade-offs acceptable.
The reverse-J shape of the curve in Figure 2 assumes that popular power is not so strong as to call into question the foundations of capitalist power. If this were to occur, popular power would itself potentially become the dominant form of power. This would mean that the working class and other popular social forces would not simply be in a position to forge a positive class compromise with capital, but to subordinate capital. Such a situation would clearly threaten capitalist interests. This is illustrated in Figure 3.
In actual capitalist economies – or, at least in stable developed capitalism – the extremes of the curve are excluded by strong institutions that constrain the scope of popular power. On the one hand, the legal rules and public policies that protect private property exclude the right hand region of the curves. Given the effective enforcement of capitalist property rights by the state, popular power cannot develop to the point where it can become dominant. On the other hand, legal rules and policies around civil liberties, rights of association, labor rights and the welfare state exclude the extreme left hand region of the curve. The stable existence of these institutional conditions assures at least some capacity for popular mobilization and power. The historically accessible region of the curve, as illustrated in Figure 4, thus covers the middle regions of popular power, from moderate to strong.
II. Conditions for class compromise in the Golden Age and the early 21st century
The relationships portrayed in Figure 4 provide a way of comparing the conditions for class compromise across time and place. A number of things in this figure can vary: the shape of the curve itself can vary, with more or less favorable slopes in the positive class compromise region of the curve; the parts of the curve that are excluded by legal rules and public policy can vary, creating a more or less favorable region of the curve that is historically accessible; and the specific location of a country within that historically accessible region can vary depending on the balance of forces. It is, of course, an extremely demanding research task to give precision to any of these forms of variation. There are no easy metrics for any of the dimensions, nor any way (that I know of) really to measure variation over time in things like the shape of the curve or the zones of exclusion. The purpose of the figure, therefore, is to clarify theoretical arguments and provide a way of more systematically formulating claims about changes over time. What follows, then, is a suggestive way of framing the contrast in the central conditions for class compromise in the highly favorable situation of the Golden Age of post-WWII capitalism and the much more difficult context of the current era of crisis and stagnation.
Figure 5 presents the class compromise curve in the Golden Age for the modal country in the developed capitalist world. Because of the strong institutionalization of labor rights and the stable and relatively generous welfare state promoted by various forms of social democracy, the left-region of exclusion was quite broad. So long as these rules of the game were in place, it was relatively easy for the labor movement and other popular social forces to achieve at least moderate levels of popular power. In terms of the shape of the curve, because of relatively positive conditions for capitalist growth and profitability, the upward slopping part of the curve rises to a fairly high level. From the point of view of capitalist interests, therefore, the class compromise part of the curve looks pretty attractive; it is certainly better to be somewhere on the upward sloping part of the curve than in the valley. While capitalists might still prefer to be well to the left, high on the downward sloping part of the curve, this region is – at least in short-run – inaccessible because of stable institutional rules. So, all things considered, a positive class compromise is a tolerable modus vivendi: capitalists make adequate profits; popular power exercised through the state creates public goods that strengthen capitalism and provide employment and income security; and labor movement power in the economy stabilizes employment relations and supports strong productivity growth.
While the configuration in Figure 5 may have been acceptable for capital, it wasn’t optimal, or at least over time it came to be seen as suboptimal.10 In the course of the 1960s and early 1970s a series of contradictions in the regime of accumulation began to intensify and gradually made the positive class compromise less secure, especially in the United States: the welfare state expanded to the point where it began to absorb too much of the social surplus (from the capitalist point of view); wages were sticky downward and began to create a profit squeeze; global competition intensified with the development of Japan and Europe, which undermined the specific advantages of the US and the global financial system which it anchored. Into this mix, the debacle of the Vietnam War intensified fiscal problems for the US. And, to top it off, there was the Oil price shock in 1973. Taken together these economic and political processes eroded the stability of the Golden Age equilibrium in the United States and elsewhere.
These economic developments helped create the political context for the assault on the institutional foundations of class compromise beginning in the 1980s, an assault which came to be known as neoliberalism.11 Neoliberalism, in turn, opened the door for a number of other dynamic developments which accelerated in the last decades of the 20th century. Two are particularly important in the present context: globalization and financialization.
The globalization of capitalism intensified along its many dimensions. This meant that the economic conditions in particular places and regions became less autonomously determined by what was happening in those places and more dependent upon what was happening elsewhere in the world. Of particular importance was the emergence of a global labor force that includes hundreds of millions of very low paid workers in developing countries competing within a relatively integrated global system of production in manufacturing and some kinds of services. Globalization also contributed to the dramatic increase in immigration to the developed countries and the increased ethnic heterogeneity of their popular social forces.
The dramatic financialization of capitalist economies in the rich countries meant that capital accumulation became rooted in much more volatile speculative processes and less connected to the development of the real economy than in the past.12 The globalization of financial markets further intensified the potentially destabilizing effects of the shift of capital accumulation towards the financial sector. The combination of globalization and financialization meant that from the early 1980s the interests of the wealthiest and most powerful segments of the capitalist class in many developed capitalist countries, especially perhaps in the United States, became increasingly anchored in global financial transactions and speculation and less connected to the economic conditions and rhythms of their national bases.
The result of these structural developments was a transformation of the class compromise curve and the regions of exclusion as illustrated in Figure 6. The critical developments are the following:
1) The financialization and globalization of capitalism pushed the right hand peak of the class compromise curve downward. Basically, the value for many capitalists of a positive class compromise decline as the returns on their investments become less dependent upon the social and political conditions of any given place.
2) Neoliberalism shifts the regions of exclusion at both ends of the class compromise curve. On the one hand, the aggressive affirmation and enforcement of private property rights creates impediments to the enlargement of popular power. On the other hand, the erosion of labor law in some countries (especially the United States), and the partial dismantling of the safety-net of the welfare state, reduces the region of exclusion on the downward sloping part of the curve, making more of that region strategically accessible.
3) In the context of the above developments, the level of popular power within the modal country declines as a result of a number of interacting factors: the increasing competition for jobs within the working class as unemployment increases and job security declines; the increasing heterogeneity within popular social because of immigration which erodes mass based solidarities and open a political space for right-wing populism; austerity policies which increase the vulnerability of workers and make them more risk-averse; aggressive anti-labor strategies by employers who take advantage of this vulnerability.
Taken together, these forces pushed the balance of class forces into the adverse downward sloping region of the class compromise curve.
III. Restoring Conditions for Class Compromise
I assume that an exit from capitalism is not an option in the present historical period. This is not because of any qualms about the desirability of a break with capitalism as an economic system, but because of a belief in the impossibility of any kind of viable ruptural strategy. This belief is rooted in the central dilemma of revolutionary transformation of capitalist democracies: As Przeworski argued in the 1980s, if a ruptural break with capitalism is attempted under open democratic conditions, then even under the most optimistic of scenarios, it is extremely unlikely that a ruptural socialist political project could survive multiple elections.13 Because of the disruptions between the election of political forces attempting a break with capitalism and the stabilization of a socialist economy, any plausible transition will be marked by a “transition trough” of sharply declining material conditions of life for most people and considerable uncertainty about future prospects. Under open, competitive democratic conditions, it is implausible that solidarity in the heterogeneous coalition that initially supported the rupture is likely to be sustained over the number of election cycles needed to complete a transition. A ruptural break with capitalism, therefore, can only happen under nondemocratic conditions. But if a rupture with capitalism takes place under nondemocratic conditions it is extremely unlikely that it would result in creating democratic, egalitarian socialism, as suggested by the tragic history of attempts at nondemocratic revolutionary ruptures with capitalism in the 20th century. The only plausible ruptural scenarios are thus either a nondemocratic rupture with capitalism that results in authoritarian statism rather than democratic socialism, or an attempted democratic rupture with capitalism which is reversed during the extended transition period. For the foreseeable future, therefore, even if we retain revolutionary aspirations for a world beyond capitalism we will be living in an economic system dominated by capitalism. The question is, on whose terms and in what form.
So long as the working class and other popular social forces live in a capitalist world, a positive class compromise offers the best prospects for securing the material welfare for most people. This does not mean that no gains are ever possible without a positive compromise – concessions can sometimes be won through struggles that result in negative compromises. Socialist and social democratic parties can win elections and initiate progressive reforms even in the absence of positive class compromise. But such gains are always more precarious than gains under conditions of positive class compromise, both because they encounter greater resistance, and because they are more vulnerable to counteroffensives.
I will explore two broad responses to the erosion of conditions for positive class compromise: The first examines strategies which could potentially reverse the trends in Figure 6 and reconstruct the favorable conditions in Figure 5. The second explores ways of potentially making the welfare of ordinary people living in a capitalist economy less dependent on the prospects for a positive class compromise with the capitalist class. My thoughts on these issues are very incomplete and tentative; I do not have a well worked through analysis of strategies of social transformation in the present era. I offer these ideas in the hope of contributing to the discussion of the dilemmas and possibilities we face.
1. Strategies which try to recreate conditions for positive class compromise
Figure 7 presents a rough guide to the kinds of transformations needed to restore conditions for positive class compromise. Here I want to specifically focus on the problem of the shape of the curve itself: are there plausible strategies and public policies that could affect the shape of the underlying functional relation between popular power and elite interests in ways that would help to improve the prospects for stable positive class compromise? Or is the current deterioration of the underlying macro-economic conditions for class compromise simply the inexorable result of the dynamics of capitalism operating behind the backs of actors and not amenable to strategic intervention?14 It is possible that the few decades after WWII were a happy historical anomaly in which conditions just happened to be favorable for the positive class compromise that underwrote economic security and modest prosperity for most people in developed capitalist countries. We may now be in the more normal condition of capitalism in which the best that can be hoped for are occasional periods of negative class compromise and most people adopt, as best they can, individual strategies for coping with the risks and deprivations of life in capitalism.
What I want to explore here is the less pessimistic scenario in which it is possible to forge new structural conditions for a more robust positive class compromise. I will not address the narrower political question of the prospects for actually mobilizing the political forces with progressive ideological commitments necessary for implementing the policies required to create these conditions, but rather the question whether or not there are viable policies to be implemented – what policies should be implemented if progressive political forces were in a position to do so.15 If my diagnosis in Figure 6 is correct that the right-hand peak in the class compromise curve has declined because of forces unleashed by globalization and financialization, then what is needed are strategies which encourage geographically-rooted forms of capital accumulation and which impose effective democratic constraints on financial institutions.
Geographical rootedness
In terms of the problem of geographical rootedness, one promising line of thought on these issues is Joel Rogers’ proposals for what he terms “Productive Democracy” (which he earlier referred to as “high road capitalism”).16 Rogers argues for the importance of concentrating attention on regional economies anchored in metropolitan areas, rather than on the national economy, and especially on the role of the local state in building local public goods capable of supporting high productivity economic activities. The emphasis here is in producing a high density of productivity-enhancing infrastructures which creates incentives for capitalist firms to become more embedded locally: public transportation, education, research parks, energy efficiency, and much more. Strong local public goods are potentially particularly effective for small and medium sized firms, firms which are generally less geographically mobile and whose owners are more likely to have non-economic roots in the region.
A key element of these local public goods concerns training and skill formation, one of the classic collective action problems faced by capitalist firms (because of the temptation to free ride on the on-the-job training provided by other firms). Here is where strong unions can play an especially constructive role in the design of training programs and in coordinating skill standards that are essential for the portability of skills. Regional development strategies that focus on such public goods and that involve local collective actors (especially unions) in the deliberative problem-solving connected to those public goods could generate local conditions for positive class compromise with locally-rooted capital.
Changes in technology may make the anchoring of capitalist production in locally-rooted, high productivity small and medium enterprises more feasible. One of the critical features of the era of industrial capitalism is strongly increasing returns to scale in production and distribution, since steep increasing returns to scale give large corporations a competitive advantage. The deep transformation of the technological environment of economic activity in the digital age has significantly reduced these returns to scale in many sectors. Consider publishing. While large publishers still are important, the per unit costs of publishing are much less sensitive to scale than they were even a decade ago, especially with the advent of electronic books. New technologies on the horizon for manufacture also suggest the possibility of much more linear returns to scale, which in principle could make small and medium firms much more productive and competitive. All of this may increase the prospects a productive democracy underwritten by local and regional public goods.
Public goods, of course, require taxes, and one view is that the taxation capacity of the state is seriously undermined by globalization. If taxes rise, the argument goes, capital moves. This seems even more cogent an argument for local public goods: if local taxes rise to fund local public goods, then capitalist firms will simply move out of the jurisdiction of those taxes. Such arguments assume that taxation must always, directly or indirectly, raise the costs faced by capitalist firms. This, of course, may be the case, especially when the taxation is directly levied on profits. But in principle taxation can simply be a way of dividing the consumption of wage earners between their private consumption and their collective consumption through public goods and have little effect on profits of capitalist firms. Whether workers are willing to accept high or low taxation on wage earners depends, of course, on the degree of solidarity among wage earners and their confidence that the taxes so levied will be in fact used for such public goods. The tax constraint on creating the local public goods needed for a locally-rooted productive capitalism is thus much more political and ideological than narrowly economic.
Constraining Finance
In terms of the problem of financialization, two things seem especially important to accomplish: The first is to redirect finance from a central preoccupation with speculative activity to investment in the real economy. While there is often no unambiguous line of demarcation between these two faces of the allocation of capital, one of the things that detaches the interests of investors from the conditions of life of ordinary people and thus makes positive class compromise less likely is the disengagement of investment from the real economy. In order to redirect finance towards the real economy, the state has to be able to impose real constraints on investment activity, and this requires at least partially impeding the global flow of capital. So long as capital can easily exit the jurisdiction of political authority, such regulation will always be precarious. This, then, is the second critical task: reestablishing the capacity of the state to effectively regulate finance and hold it democratically accountable. There are many proposals on the table to move in this direction: breaking up the largest financial institutions, both to undermine their power to manipulate regulatory authority and to remove their willingness to engage in excessive risk because of their “too-big-to-fail” status; explicitly recognizing the public goods aspect of finance as grounds for creating a more vibrant sector of public and cooperative financial institutions – credit unions, cooperative banks, community banks; new forms of transactions taxes, like the Tobin tax, to impede the smooth global flow of finance for speculative purposes.
Taken together, public policies which help build a locally-rooted productive democracy and which render finance more democratically constrained would potentially move the class compromise curve in figure 6 in the direction of the Golden Age curve in Figure 5. Such policies, especially the ones that impinge on the power of finance, would certainly meet strong opposition by various elites. The problem, of course, is mobilizing sufficiently strong and resilient political forces to overcome such opposition. Many of the same political economic structural developments that have generated an unfavorable class compromise curve have also contributed to undermining the power of popular democratic forces needed to push for these kinds of public policies.
2. Strategies which strengthen non-capitalist economic domains
Because of the political difficulty of instituting policies that would change the conditions for class compromise curve as illustrated in Figure 7, it is worth exploring the possibility of strategies that respond to the adverse conditions for class compromise less by directly confronting the state and instead focus on ways of building alternatives in civil society and the economy itself. At the center of my analysis in Envisioning Real Utopias of socialist alternatives is the idea that all economies are hybrids of different kinds of economic relations. In particular I argued that modern capitalist economies should be viewed as hybrids of capitalist, statist, and socialist economic structures. The synoptic description of such a hybrid economy as “capitalism” implies that the capitalist component is “dominant.” The idea of positive class compromise is focused on power relations and class interests generated by the capitalist dynamics of the system. One way of approaching the problem of restoring conditions in which at least some of the benefits of positive class compromise can be realized is to strengthen the non-capitalist aspects of the economic structural hybrid.
Here are a few examples.
Worker cooperatives
By their very nature, worker-owned cooperative firms are geographically-rooted. The owner-employees in such firms have a stake in where they live, and thus they have a deep interest in creating locally-favorable economic conditions and supporting the public goods which make this possible. Although in most existing capitalist economies, worker cooperatives tend only to occupy small niches (in the United States in 2012 there were fewer than 400 worker cooperatives), there are instances of large, successful worker-owned cooperatives, most famously the group of over 100 cooperatives known as the Mondragon Cooperative Corporation.
Of particular relevance in the present context is the fact that in the current economic crisis in Spain, Mondragon has fared much better than most of the rest Spanish economy: only one of the over 100 cooperatives in the group has had to be dissolved.) Many issues are involved in explaining the durability of the Mondragon cooperatives in the face of the crisis. Among other things, the Mondragon structure includes a system of cross-subsidization of less profitable by more profitable cooperatives, which acts as a buffer when times are difficult. The common stakes of workers in the cooperatives and the relatively low level of internal inequality mean that the levels of solidarity and commitment among workers are quite high. The idea that “we are all in this together” is a reality, and thus workers are less resistant to the shared sacrifices needed to weather a crisis. But also, there are non-member employees in the cooperatives, and lay-offs of these employees also helped.
The existence of Mondragon as a successful, productive, large scale complex of cooperatives shows that worker cooperatives need not be restricted to small, artisanal firms in marginal parts of the economy. In any case, given the decline in capital intensity in many domains of economic activity (especially because of the development of digital technologies) and the increasing possibilities of modularized forms of production, the scale constraints on worker cooperatives in many sectors are decreasing. One way of fostering a more geographically-rooted structure of capital accumulation would be to encourage the development and expansion of worker cooperatives.
Worker cooperatives are founded mainly in two different ways: either by a group of people getting together and collectively starting a firm on a cooperative basis, or by the workers of an established capitalist firm buying out the owners of the firm. The latter strategy is particularly relevant in contexts where aging owners of family firms face a “succession crisis” in which no one in the younger generation of the family wishes to take over the firm. One option in such a situation is for the workers to buy the firm. The problem, however, is that workers generally do not have sufficient savings to do so and thus, to buy the firm, they have to take on levels of debt which then impose a significant burden on the subsequent viability of the firm. This problem is intensified in the broader context of macro-level economic stagnation.
What is needed for the co-operativization of small and medium sized family firms, therefore, is some way for workers to assume ownership of the firm on a collective basis without taking on excessive debt that undermines the future viability of the firm. One possible source for such support might come from the labor movement. Traditionally unions have been relatively hostile to worker cooperatives, seeing them as rivals for the allegiance of workers. In recent years there are indications of a change in this stance. In the United States the Steelworkers Union has been in discussions with Mondragon on the possibility of some kind of collaboration in creating worker cooperatives in the steel industry. In Cleveland, the initiative to create a cluster of cooperatives facilitated by the city government and other large public institutions has also received support from local unions. In Brazil unions have been broadly supportive of cooperatives as well. Rather than being rivals, worker cooperatives may have the potential of being a complementary basis for collective organization of workers power. In places where the labor movement remains relatively strong, unions could help mobilize the capital needed for worker-buy-outs of small and medium firms.17
If the problems of credit market failures and undercapitalization of cooperatives were solved, then it is possible over time not only for the number of cooperatives to increase, but for there to develop dense networks of cooperatives, meta-cooperatives (cooperatives-of-cooperatives), and other institutional arrangements of what can be termed a “cooperative market economy.” On a regional scale this is what the Mondragon cooperative Corporation has accomplished. Within the Mondragon complex there are a range of institutional devices which increase the viability of each of the individual cooperative enterprises: specialized research and development organizations; processes for cross-subsidization of profits from higher to lower profit cooperatives; training and education institutions oriented to cooperative management and other needs of the firms in the network; and so on. A dense network of cooperatives connected to this kind of elaborated environment of specialized institutions creates cooperative market economy enclave within the broader capitalist market.
Employee-majority ESOPs
ESOPs (Employee Stock Ownership Plans) are a hybrid form combining, in varying degrees, capitalist and participatory-democratic elements. There are approximately 4,000 firms in the United States with 100% employee owned ESOPs.18 In most firms with ESOPs, especially large firms, the employees only own a minority of shares, and often those shares a concentrated in management. Most 100% ESOPs are relatively small firms. Actual democratic governance rights vary across ESOPs, although in 100% ESOPs the employees do elect the board of directors of the firm (on a one-share one-vote basis). Nevertheless, ESOPs with a high percentage of employee shareowners are more geographically rooted than conventional capitalist firms. ESOPs can also be a transitional form between a conventional capitalist firm and a fully democratic worker cooperative (although, of course, worker cooperatives also, sometimes, convert to ESOPs), but they may also be a stable hybrid form that connects to the development of a substantial cooperative market economy sector much more amenable to the rehabilitation of the democratic affirmative state.
The social economy
The social economy constitutes economic activities organized by communities and various kinds of nonprofit organizations directly for the satisfaction of needs rather than for exchange and profit. Most often social economy organizations produce services, but in some contexts goods are produced in the social economy as well. The social economy has an ambiguous status with respect to the provision of public goods and reducing vulnerability, for often the social economy mainly serves to fill gaps caused by the retreat of the welfare state. This is one of the reasons why conservatives sometimes applaud the social economy (for example, in the advocacy of “faith based initiatives” in the United States). But the social economy can also be at the center of building an alternative structure of economic relations, anchored in popular mobilization and community solidarity, especially when it receives financial support from the state. The Quebec social economy is an example of a vibrant social economy involving community-based daycare centers, elder-care services, job-training-centers, social housing, and much more. In Quebec there also exists a democratically elected council, the chantier de l’economie sociale, with representatives from all of the different sectors of the social economy, which organizes initiatives to enhance the social economy, mediates its relation to the provincial government, and extend its role in the overall regional economy. The chantier enhances democratic-egalitarian principles by fostering economic activity organized around needs and by developing new forms democratic representation and coordination for the social economy.
Solidarity finance
Another way of strengthening non-capitalist elements within a capitalist economy is by expanding the ways in which popular organizations are involved in allocating capital. Unions and other organizations in civil society often manage pension funds for their members. In effect this is collectively controlled capital that can be allocated on various principles. An interesting example is the Quebec “Solidarity Fund” developed by the labor movement initially in the 1980s. The purpose of these funds is to use investments deliberately to protect and create jobs rather than simply to maximize returns for retirement. One way the Solidarity Fund accomplishes this is by directly investing in small and medium enterprises, either through private equity investment or loans. These investments are generally directed at firms that are strongly rooted in the region and satisfy various criteria in a social audit. The Solidarity Fund is also involved in the governance of the firms in which it invests, often by having representation on the board of directors. Typically the investments are made in firms with a significant union presence, since this helps solve information problems about the economic viability of the firm and facilitates the monitoring of firm compliance with the side-conditions of the investment. Solidarity finance thus goes considerably beyond ordinary “socially screened investments” in being much more actively and directly engaged the project of allocating capital on the basis of social priorities.
Solidarity finance can be considered a partial model for enhancing the geographic rootedness of regional market economies by tying investment more closely to people who live there. For this to be done at a scale that would make a significant difference, various kinds of support by the state may be important. In the Quebec Solidarity Fund there are generous tax incentives for people who invest through the fund, but a more vigorous form of solidarity finance could involve different kinds of direct subsidies to the fund by different levels of government. Such direct subsidy can be justified on the grounds that geographical-rootedness – rather than free-floating capital mobility – is a public good because of the ways this makes the regulation of negative externalities easier and creates greater space for linking the interests of owners, workers and citizens.
Solidarity funds need not, of course, be restricted to control by labor unions. Other associations in civil society and perhaps even municipalities could also organize solidarity funds. The key idea is to develop decentralized institutional devices that direct investment funds to those economic activities that are geographically rooted and whose long-term viability depends most upon the robustness of the regional economy. Solidarity funds can therefore be seen as a complement to the regional economic development strategies organized by the state advocated by Rogers.
Conclusion
Social democracy has, traditionally, not given much weight to strengthening non-capitalist forms of economic organization. Its core ideology was to support the smooth functioning of capitalism and then use part of the surplus generated within capitalism to fund social insurance and public goods. Capitalists were left relatively free to invest as they wished on the basis of private profit-maximizing criteria. The state provided incentives of various sorts to shape investment priorities and certainly the state tried to create the public goods and regulatory environment that would be congenial to capital accumulation, but it generally did not attempt to nurture non-capitalist sectors and practices. The mainstream Left throughout the developed capitalist world broadly supported these priorities.
It is uncertain whether or not it will be possible to reconstruct a political-economic equilibrium in which positive class compromise within capitalism could once again govern the terms in which the social surplus is allocated between private returns through capitalist investment and collective returns used to promote well-being through the affirmative state. But even if it is, given the long-term uncertainties of the trajectory of structural conditions in capitalism, the Left should begin to seriously think about the desirability and possibility of expanding the space for non-capitalist alternatives within capitalist economies.
Mr. Rows Namoura Coffee 
Capitalist Systems and Income Inequality
Similar levels of income inequality may coexist with completely different distributions of capital and labor incomes. This column introduces a new measure of compositional inequality, allowing the authors to distinguish between different capitalist societies. The analysis suggests that Latin America and India are rigid ‘class-based’ societies, whereas in most of Western European and North American economies (as well as in Japan and China), the split between capitalists and workers is less sharp and inequality is moderate or low. Nordic countries are ‘class-based’ yet fairly equal. Taiwan and Slovakia are closest to classless and low inequality societies.
Similar levels of income inequality may be characterised by completely different distributions of capital and labour. People who belonged to the highest income decile in the US before WWII received mainly capital incomes, whereas in 2010 people in the highest decile earned both high labour and capital incomes (Piketty 2014). Yet the difference in their total income shares was small.
Different distributions of capital and labour describe different economic systems. Two polar systems are particularly relevant. In classical capitalism – explicit in the writings of Ricardo (1994 [1817]) and Marx (1992 [1867], 1993 [1885]) ¬– a group of people receives incomes entirely from ownership of assets while another group’s income derives entirely from labour. The first group (capitalists) is generally small and rich; the latter (workers) is generally numerous and poor, or at best with middling income levels. The system is characterised by high income inequality.
In today’s liberal capitalism, however, a significant percentage of people receive incomes from both capital and labour (Milanovic 2019). It is still true that the share of one’s income derived from capital increases as we move higher in the income distribution, but very often the rich have both high capital and high labour incomes. While inter-personal income inequality may still be high, inequality in composition of income is much less.
The purpose of our study is to introduce a new way of looking at inequality that allows us to classify empirically different forms of capitalism. In addition to the usual inter-personal income inequality, we look at inequality in the factoral (capital or labour) composition of people’s incomes. The class analysis (where class is defined narrowly depending on the type of income one receives) is thus separated from the analysis of income inequality proper.
Which countries around the world are closer to classical, and which to liberal capitalism? Does classical capitalism display higher inter-personal income inequality than liberal capitalism? Can we find what we term ‘homoploutic’ societies – where everyone has approximately the same shares of capital and labour income? Would such homoploutic societies display high or low levels of income inequality?
To answer these questions, in Ranaldi and Milanovic (2020) we adopt a new statistic, recently developed by Ranaldi (2020), to estimate compositional inequality of incomes: the income-factor concentration (IFC) index. The income-factor concentration index is at the maximum when individuals at the top and at the bottom of the total income distribution earn two different types of income, and minimal when each individual has the same shares of capital and labour income. When the income-factor concentration index is close to one (maximal value), compositional inequality is high, and a society can be associated to classical capitalism. When the index is close to zero, compositional inequality is low and a society can be seen as homoploutic capitalism. Liberal capitalism would lie in-between. Negative values of the income-factor concentration index, which describe societies with poor capitalists and rich workers, are unlikely to be found in practice.
By applying this methodology to 47 countries with micro data provided by Luxembourg Income Study from Europe, North America, Oceania, Asia, and Latin America in the last 25 years and covering approximately the 80% of world output, three main empirical findings emerge.
First, classical capitalism tends to be associated with higher income inequality than liberal capitalism (see Figure 1). Although this relationship was implicit in the minds of classical authors like Ricardo and Marx, as well as in recent studies of pre-WWI inequality in countries that are thought to have had strong class divisions (Bartels et al. 2020, Gómes Léon and de Jong 2018), it was never tested empirically.
Second, three major clusters emerge at the global scale. The first cluster is the one of advanced economies, which includes Western Europe, North America, and Oceania. Relatively low to moderate levels of both income and compositional inequality characterize this cluster. The US and Israel stand somewhat apart from the core countries since they display higher inequality in both dimensions.
Latin American countries represent the second cluster, and are, on average, characterised by high levels in both inequality dimensions.
The third cluster is composed of Nordic countries and is exceptional insofar as it combines low levels of income inequality with high compositional inequality. This is not entirely surprising: Nordic countries are known to combine wage compressions with ‘socially acceptable’ high returns to capital (Moene and Wallerstein 2003, Moene 2016). Such compromise between capital and labour (reached in the early 1930s) has put a cap on earning inequality within the region (Fochesato and Bowles 2015) but has left wealth inequality untouched (Davies et al. 2012). By drastically reducing the progressivity of capital income taxation (Iacono and Palagi 2020), income tax reforms during the 1990s have worked in the same direction.
Several other results are found. Many Eastern European countries are close to the Nordic cluster. Some (Lithuania and Romania) have very high compositional inequality, likely the product of concentrated privatisation of state assets. India is very similar to the Latin American cluster, displaying a class-based structure with high levels of income inequality.
Taiwan and Slovakia are, instead, the most ‘classless’ societies of all. They combine very low levels of income and compositional inequality. This makes them ‘inequality-resistant’ to the increase in the capital share of income. In other words, if capital share continues to rise due to further automation and robotics (Baldwin 2019, Marin 2014), it will not push inter-personal inequality up: everybody’s income would increase by the same percentage. The link between the functional and personal income distribution in such societies is weak – the topic of a previous VoxEU column by Milanovic (2017b). It is also interesting that Taiwan is both more ‘classless’ and less unequal than China.
The third, and perhaps most striking result that emerges from our analysis is that no one country in our sample occupies the north-west part of the diagram. We find no evidence of countries combining low levels of compositional inequality (like those of Taiwan and Slovakia) with extremely high levels of income inequality (like in Latin America).
To conclude, we propose a novel taxonomy of varieties of capitalism on the basis of the two inequality dimensions (Table 1). We believe such taxonomy brings a strong empirical and distributional focus into the literature on the varieties of capitalism, as well as a larger geographical coverage.
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