By Raghuram Rajan
A real debate is emerging in
America’s presidential election campaign. It is superficially about health care
and taxes. More fundamentally, it is about democracy and free enterprise.
Democracy and free enterprise appear to be mutually
reinforcing – it is hard to think of any flourishing democracy that is not a
market economy. Moreover, while a number of nominally socialist economies have
embraced free enterprise (or “socialism with Chinese characteristics,” as the
Chinese Communist Party would say), it seems to be only a matter of time before
they are forced to become more democratic.
Yet it is not clear a priori why democracy and free enterprise
should be mutually supportive. After all, democracy implies regarding
individuals as equal and treating them as such, with every adult getting an
equal vote, whereas free enterprise empowers individuals based on how much
economic value they create and how much property they own.
What prevents the median voter in a
democracy from voting to dispossess the rich and successful? And why do the
latter not erode the political power of the former? Echoes of such a tension
are playing out as President Barack Obama tries to tap into middle-class anger,
while former Massachusetts governor Mitt Romney appeals to disgruntled
businesspeople.
One reason that the median voter rationally
agrees to protect the property of the rich may be that she sees the rich as
more efficient managers of that property. So, to the extent that the rich are
self-made, and have come out winners in a fair, competitive, and transparent
market, society may be better off allowing them to own and manage their wealth,
while getting a reasonable share as taxes. The more, however, that the rich are
seen as idle or crooked – as having simply inherited or, worse, gained their
wealth nefariously – the more the median voter should be willing to vote for
tough regulations and punitive taxes on them.
In today’s Russia, for example, property
rights do not enjoy widespread popular support, because so many of the
country’s fabulously wealthy oligarchs are seen as having acquired their wealth
through dubious means. They grew rich because they managed the system, not
because they managed their businesses well. When the government goes after a
rich oil tycoon like Mikhail Khodorkovsky, few voices are raised in protest.
And, as the rich kowtow to the authorities to protect their wealth, a strong
check on official arbitrariness disappears. Government is free to become more
autocratic.
Now consider a competitive
free-enterprise system with a level playing field for all. Such a system
generally tends to permit the most efficient to acquire wealth. The fairness of
the competition improves perceptions of legitimacy.
Moreover, under conditions of fair
competition, the process of creative destruction tends to pull down badly
managed inherited wealth, replacing it with new and dynamic wealth. Great
inequality, built up over generations, does not become a source of great
popular resentment.
On the contrary, everyone can dream that they, too,
will become rich.
When such aspirations seem plausible,
the system gains added democratic support. The rich, confident of popular
legitimacy, can then use the independence that accompanies wealth to limit
arbitrary government and protect democracy. Free enterprise and democracy
sustain each other.
There is a popular belief that
democratic systems support property and enterprise because votes and
legislators can be bought, and the capitalists have the money. But that view is
probably wrong. As Russia suggests, without popular support, wealth is
protected only by increasingly coercive measures. Ultimately, such a system
loses any vestige of either democracy or free enterprise.
Back, then, to America’s
presidential election. The recent crisis, followed by huge bailouts of
financial institutions, has raised questions about how at least one segment of
business – the bankers – make their money. As the misdeeds of “banksters” come
to light, the system no longer seems fair.
Moreover, the American Dream
seems to be slipping out of reach, in part because a good education, which
seems to be the passport to prosperity, is increasingly unaffordable for many
in the middle class. This erodes support for the free-enterprise system.
Obama understands this,
which explains his appeal to, and focus on, the middle class. He is the
standard bearer for democracy.
On the other hand,
successful professionals and entrepreneurs believe that they have come by their
wealth legitimately. They are the working rich, and dislike the growing burden
of regulations and the prospect of higher taxes. They feel like they are being
blamed for their success, and they resent it. Romney understands that America’s
strength relies heavily on free enterprise.
Ordinarily, there would be
no contest here. The weight of votes in the middle class would carry the day.
The middle class, however, is divided: some want to protect whatever
entitlements and property they already have, while others want the government
to give them a fairer chance. Moreover, the Supreme Court’s Citizens United decision in 2010, which allows unlimited
independent political expenditure by organizations like corporations or unions,
has helped Romney more than Obama.
Whatever the outcome of the
election, the tension between democracy and free enterprise that is central to
it does not bode well for either. A free-enterprise system that is sustained
only by the moneyed power of the successful is not stable, and unlikely to
remain vibrant for long.
The United States needs to
restore the possibility of achieving the American Dream for its middle class,
even while it reaffirms the historically light regulation and relatively low
tax burden that have allowed enterprise to flourish. The virtue of democracy is
that debate may lead to just such a consensus. We can only hope.
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