As sociologists, we view capitalism and its optimal needs differently from conventional economists. Ironically, however, our own perspective draws on the work of well-known early economists – sociologically astute, but often misunderstood or neglected in economics today. Those earlier economists provide us with most of the important building blocks for our argument. They also remind us that the foundations of economics are fundamentally different from the widespread contemporary belief that markets work best when political and social forces do not interfere with them. The historical perspective suggests that this contemporary view is wrong and that putting it into practice has caused serious economic damage. We will show that capitalism performs best when states possess the intellectual and institutional capacities to manage their economies effectively and when societies are blessed with basic social cohesion, so that the interests of the many in widespread prosperity are not outweighed by those of the privileged few. Our concern, however, is that state capacity and social cohesion are in short supply these days because their conditions of existence have been badly damaged; hence our plea to reverse this situation is quixotic. We do not suffer from the illusion that a better way will necessarily be found that will realize our desires. But we do believe that, without a better understanding of what makes capitalism work well, the situation will not improve.
Sociologists see capitalism as a much more complex system of social relations than do most economists. Economic activity is based not only on people pursuing their economic interests but also on trust, historical tradition, and personal identity. Sociologists also recognize that capitalism is embedded in a wide variety of institutions – political and cultural, as well as economic. And sociologists understand that the way in which capitalism operates varies significantly across countries and over time. But what is perhaps most noticeable about sociology is its fundamental criticism of capitalism. The greatest sociologists on the subject spoke of the alienation, anomie, and disenchantment associated with capitalism. There is nothing inherently wrong with this view, given the exploitation of workers in many capitalist societies both past and present, and we really speak warmly in this book only about the Golden Age of capitalism – that is, the first few decades following the Second World War – when, by contemporary standards, the interests of the many carried greater weight relative to those of the few. To be sure, those economists whose thought we admire had their own reservations about capitalism. But they differ from the sociologists in two ways: First, they were aware of and appreciated the dynamism and prosperity that capitalism can produce; second, they provided useful sociological insights about the mechanisms of capitalism and the institutions needed to make it work – and whose absence brings chaos. It is for this reason that we rely on the work of six historically eminent economists: Adam Smith, Albert Hirschman, Friedrich List, John Maynard Keynes, Joseph Schumpeter, and Karl Polanyi. Many of their insights have been forgotten; we resurrect and expand them here.
It might seem strange to focus on this group of economists. After all, they lived during very different eras of capitalism and, as a result, had very different views of capitalism. Smith was a leading member of the eighteenth-century Scottish Enlightenment, writing during the early years of capitalism when the factory system was just emerging, with the logistics of transportation and communication still essentially primitive. List lived in the early nineteenth century, when tariff barriers inside Germany were being torn down so as to increase specialization and trade. Keynes lived through the Great Depression and two world wars. He died just after the Second World War and lived in Britain as its power in the world was diminishing. Schumpeter, an Austrian, lived during the same period, but he spent the last two decades of his life in the United States at a time when its hegemonic power was blossoming. This latter pair witnessed the rise of multinational corporations, steam ships, automobiles, air travel, and telephones. Polanyi was another mid-twentieth-century economist, but he was one who lived in Austria, Britain, the United States, and Canada, and who lived long enough to see the emergence of the Cold War, the European Economic Community (forerunner to the European Union), and the full weight of the United States as an international superpower. Finally, Hirschman, the youngest member of our group, was born during the First World War in Berlin, where he witnessed Hitler’s rise to power, before fleeing to France. Hirschman fought on behalf of the Spanish Republic in the Spanish Civil War, helped Jews and others to escape Nazi-occupied France, and eventually emigrated to the United States, where he died in 2012 having seen the moon landing, the globalization of capitalism, the collapse of the Soviet Union, the birth of the Internet, and the emergence of China as a leading economic player on the world stage. Yet, despite their different experiences, these economists shared two things in common: Each developed views of economics that were unorthodox for their time, and each appreciated in varying degree how important social cohesion and state capacities are if capitalist societies are to prosper.
Contemporary economists tend to forget the lessons learned by their predecessors. This is unfortunate because taking that intellectual heritage seriously can inform a more complete understanding of how capitalism works – one that incorporates the important roles that states and social relations play in capitalism both domestically and internationally. In this regard, it is worth remembering that some of the economists we discuss did not describe their work as the study of economics at all but rather as the study of political economy – a much more encompassing approach to the analysis of capitalism than is typical of most economists today.1 There are some exceptions to this generalization – notably, institutional economists and those concerned recently with economic inequality.2 But modern economics evolved from a discipline based on institutional, historical, and comparative analysis to one based on formal mathematical modeling and parsimonious explanation – and then, as one economist told us, to narrow-minded empiricism focusing on small questions, thanks to the rise of computers and large data sets.3
Mainstream economists, as well as the policymakers and media pundits who heed their advice, take a very different view from ours. They believe that markets work best if politicians do not “interfere” with market processes. Perhaps most famously, former University of Chicago economist Milton Friedman argued, in his bestselling Capitalism and Freedom, that maximizing shareholder wealth through markets is the best way of delivering prosperity, and that most attempts by government to improve markets are doomed to failure and may even make things worse. He believed that the government should refrain from imposing tariffs, setting minimum wage rates, regulating industries, and requiring people to contribute to social security programs. Nor should the government license particular enterprises, occupations or professions, operate national parks or toll roads, redistribute income or provide social services to alleviate poverty.4 Friedman won the Nobel Prize in Economics for his work. Other influential schools of economic thought held similar views. Rational expectations theory suggested that people anticipate the government’s economic policies and then behave proactively in ways that nullify the intended effects of those policies; the efficient market hypothesis maintained that unfettered markets are the best way of establishing value and setting prices. Friedman’s view and that of his likeminded compatriots is mistaken. Yet it is their perspective that helped to pave the way for the neoliberal (sometimes called free-market or laissez-faire) economic reforms that led to the 2008 financial crisis, perpetuated much of the economic misery that followed, and which may yet exacerbate the disastrous economic fallout of the coronavirus pandemic.
Some economists disagree with this orthodox view of what makes capitalism work well. Some even point occasionally to the importance of our two key variables, state capacities and social cohesion. Joseph Stiglitz complains that, in the mainstream view, “there is little need for community and no need for trust. Government is a hindrance; it is the problem, not the solution.”5 Paul Krugman scolds his fellow economists for neglecting that “economics inevitably takes place in a political context.”6 Stiglitz and Krugman, also both Nobel Prize winners, have concluded that the economics profession went astray when it followed orthodoxy, ignoring mountains of evidence indicating that it was the wrong path to follow, and that, as a result, it succumbed to a flawed ideology rather than subscribed to reasoned argument.7 We agree, but we will have much more to say about how state capacities and social cohesion affect capitalism.
Before going any further, we must point to complexities in the character of capitalism. Every economist would agree that a minimal definition begins with the presence of private property, production for the market, and the principle of profit maximization by rational means. But, as noted, there is more to it than that, as becomes obvious once we ask ourselves about the nature of the society in which we live. Countries are marked not only by capitalism but also by national sentiment and by the character of their political regime. You cannot understand capitalism without understanding what unites or divides a society. Nor can you understand capitalism without understanding how the economy and state engage each other. Then, there is the fact that what happens inside a country often depends on events in the external world. The larger world is, of course, capitalist too, and nation-states must navigate within it. As a result, domestic political and social arrangements are subject to economic pressure from that larger world. But the larger world involves geopolitics that also affect capitalism inside countries.
Two implications follow from this last point. First, capitalism changes because of geopolitics, just as geopolitics change because of developments within capitalism. When the Chinese invented gunpowder, they banned its use for military production, limiting it instead to fireworks, because they had no geopolitical rivals. In Europe, where states were often at each other’s throats, that move was not possible: it would have led to the destruction of any state that tried, because its rivals would not have done the same thing. Equally, the geopolitical agreement among members of the Organization of the Petroleum Exporting Countries (OPEC) to increase oil prices in the 1970s sent shock waves through the world’s capitalist economies. In turn, this escalated geopolitical tensions between these capitalist countries and the OPEC cartel. Second, changes within international capitalism have been managed differently by states over time. World capitalism is far from politically neutral. Notably, its postwar institutions were largely created by the United States, thanks to both its military and economic strength in 1945, and the role of this hegemonic power remains exceptionally important today, even though its character has changed. These considerations make for complexities that we cannot ignore. Nonetheless, our focus is on capitalism, whose geographic range and intensity of interaction have increased significantly since the Second World War – and all the more so in the decades that followed the collapse of the Soviet bloc.
We live life forward and understand it backward. We now possess enough hindsight to see that there was an exceptional postwar period in which the advanced core of the capitalist world benefited from peace and prosperity thanks largely to the United States setting the rules by which capitalism operated. That relatively benign era of stability has come to an end; history is on the move again, with destabilizing effects – in part, because the United States now chooses to use some of its power to renegotiate those rules, such as those it helped to establish for the General Agreement on Tariffs and Trade (GATT), now the World Trade Organization (WTO), and also because the international architecture of capitalism is changing, driven primarily by the rise of China.
We now turn to our general argument by describing our two variables, social cohesion and state capacity. We do this with help from the great economists mentioned earlier. Chapter 2 begins by examining the disasters of the mid-twentieth century in which capitalism was thoroughly disrupted by geopolitical forces. It then turns to the amazing postwar recovery – the Golden Age – that was made possible by geopolitical settlement. Chapter 3 chronicles the slow decline of the Golden Age; then, in the next two chapters, we consider capitalism’s contemporary difficulties. Chapter 4 looks at the deterioration of social cohesion. Growing economic inequality and stifled economic mobility, on the one hand, and rising nationalist discontent, on the other, are undermining social cohesion and therefore destabilizing politics and state capacity throughout the advanced capitalist world. Chapter 5 analyzes in detail this deterioration of state capacity. No description is neutral, so we will conclude in Chapter 6 by discussing prospects for the future, particularly in light of the unprecedented challenges to capitalism posed by the coronavirus pandemic, the digital information age, and climate crisis.
It makes sense to begin with Adam Smith, often seen as the founding father of economics. He favored competitive markets – an idea best captured in his notion of the “invisible hand,” a process that stems from individuals pursuing their economic interests by rationally calculating costs and benefits, then striking the best deals they can in the marketplace. In the aggregate, the accumulation of these many individual deals constitutes the forces of supply and demand, which express the general economic interests of society and increase national prosperity and wealth.8 This idea has become the foundation of today’s mainstream economics. However, mainstream economists forget that Smith had much more to say about all this. He also recognized the importance of social cohesion and state capacity for the development and success of capitalism.
Consider social cohesion first. As is well known, Smith argued in The Wealth of Nations that prosperity in capitalism stemmed from the division of labor – or, more precisely, the specialization, dexterity, and innovative powers of workers. His famous example was a pin factory: when the task of manufacturing pins was broken down into its component steps and each step was assigned to a different worker, pin manufacturing became much more efficient and productive. Smith shows here his continual sympathy for labor, his insistence being that high levels of human capital resulting from basic social cohesion underlie prosperity, which in turn increased social solidarity.
But there was another source of social cohesion of greater importance. While Smith praised the rational pursuit of self-interest in The Wealth of Nations, his earlier book The Theory of Moral Sentiments maintained that something else is the principal motivation of human behavior.9 The single most important human motivation was not the pursuit of material well-being but the longing to be loved, to which he added at the end of his life the desire to find oneself lovable. As he put it, “the chief part of human happiness arises from the consciousness of being beloved.”10 In other words, people are fundamentally social creatures driven by what other people think of them. Those around us serve as a looking-glass through which we can gauge and adjust our own behavior.11
From this, Smith derived a crucial point: we tend to admire success and often flaunt it. As a result, we are jealous of and want to catch up with those above us in the economic pecking order. For Smith, this is the most essential source of social cohesion – less a belief in capitalism in and of itself than an appreciation of the role that money-making has within the comparisons to others that marks social life.12 What this suggests metaphorically is an ascending escalator – one without end – on which people are aware of each other, constantly trying to catch up with those above them, running and running until their death. As long as you believe that you might catch up, cohesion is assured, even if the odds are against you, because everyone above and ahead of you is running too. If people cease to hold the belief that they can catch up, illusory though it may be, then trust in the system will decline, social cohesion will break down, and capitalism will run into trouble. For Smith, the illusion of the societal escalator keeps the wheels of capitalism turning even though it is neither morally admirable nor indeed sensible.
The point is that the founding father of economics recognized that social cohesion was a necessary condition for capitalist prosperity. For this reason, he insisted in The Wealth of Nations that “basic measures of equality” were important too. Smith believed that the rate of profit was “naturally low in rich [countries], and high in poor countries” and was always highest in countries that were “going fastest to ruin.”13 Countries in which capitalists hoarded too many of the profits for themselves and limited workers’ wages would fail to fulfill the promise of capitalism for greater national wealth and prosperity – the standard by which he felt a social order should be judged. He recognized that the interests of capitalists and those of the rest of society were frequently at odds with each other – particularly when it came to regulating monopoly and competition.14 Furthermore, The Wealth of Nations makes it clear that he admired a contractual world in which those at the bottom of society have the power to resist oppression from those above – a world that abolishes uncompensated apprenticeships, domestic servitude, and clerical domination – altogether destroying a world of hierarchy based on debt, favor, and gift.15 In short, Smith favored a certain measure of both economic and political equality.
But what about our second variable, state capacity? Smith described The Wealth of Nations as a handbook for the legislator – a guide for practical political action. He believed that such action was necessary because capitalists disliked competition, as noted, and were keen wherever possible to gain advantages, such as special licenses, subsidies, and tariff protection, that would help them to avoid the risks of competing in the marketplace.16 In other words, capitalists cannot be trusted with capitalism, so the market must be regulated and never captured by capitalists.
In Smith’s view, two sets of tasks confront the state elite. Book V of The Wealth of Nations is devoted to the positive functions of the state. The first set is domestic. The tasks include the protection of private property and the provision of public works and infrastructure. The state should not let inequality get out of hand, as noted, so Smith favored progressive tax regimes that recognize the limited incomes of the poor and avoid taxes on necessities such as food and clothing. The state should also guard against monopolies. Crucially, the state should provide basic education because both economy and society benefit from a well-trained population. There is absolutely no truth to the notion that Smith saw no positive role for the state, as Milton Friedman once maintained in a celebrated public lecture.17
The second set of tasks confronting the state is external. Smith was well aware of the importance of national defense, but he went well beyond this basic point. The traditional European attitude of the early modern period – mercantilism – had been to see economic affairs in zero-sum terms, with the gain for one state coming at the expense of a rival. This was a reason for war – something that should and could be avoided. Smith suggested that it was madness for each country to act independently like this; it was far better for countries to specialize and then to trade. Why produce terrible wine in England and poor-quality woolens in Portugal, when it was possible to obtain good Portuguese wine in return for high-quality English woolens? In this matter, Smith was arguing a normative, as well as a descriptive, case. The state should ensure free and open trade with its neighbors. Doing otherwise, Smith believed, leads to a world of high profits and low wages that he feared would diminish the benefits that capitalism can bring. It is not much of a stretch to infer from Smith that trade was a form of international social cohesion through which all capitalist nations could prosper.
Albert Hirschman adds something to the sources of cohesion that Smith identified. Hirschman explained that when people have voice in an organization or system, they are likely to be loyal to it; they will have a sense of belonging to it.18 Even when they perceive it as being poorly managed, unfair or oppressive, they will neither rebel nor leave as long as they believe that they can improve things through voice, by expressing their hopes and concerns to those in charge. In contrast, the denial of voice makes for anger and hence the desire to exit. Hirschman’s most famous book Exit, Voice, and Loyalty shows that these concepts are useful for understanding how capitalism works.19
We will show that the provision of voice is a way of facilitating a sense of social inclusion and, by extension, the social cohesion that is so important for capitalist prosperity. This was abundantly clear in Denmark and Switzerland, as we will see, where institutionalized voice helped policymakers to manage the 2008 financial crisis effectively. Voice increases the possibility for dialogue, negotiation, and cooperation among people in all quarters of the capitalist system. Workers, for instance, are more likely to cooperate with employers to solve problems, resolve their differences, and seek mutually acceptable responses to crises if they are organized and enjoy corporatist means of being heard in front offices and corporate board rooms. Similarly, employers can benefit from the knowledge and insights of their employees in improving the production process and quality of the products they produce. West Germany, Japan, and the Scandinavian countries took this lesson to heart with great success during the Golden Age of capitalism. When voice fails to work, people rebel against the system. This is clear from the history of many class, populist, and nationalist movements; they often began as vocal expressions of dissatisfaction that eventually morphed into exit.20
Hirschman would probably not have disagreed with Smith’s account of social cohesion – that is, the insistence that if inequality is minimized and people believe in the societal escalator, the cohesion will be maintained. But Hirschman went a step further, recognizing that political feelings mattered too. He suggested that political inclusion might work even in the absence of basic equality: “In societies which inhibit passage from one social stratum to another, resort to the voice option is automatically strengthened: everyone has a strong motivation to defend the quality of life at his own station.”21
An important part of our argument is that capitalism benefits from states with the capacities to promote development and manage the ups and downs that any capitalist economy is going to experience. Nineteenth-century economist Friedrich List offered a critique of Smith’s antimercantilist argument to make this point. In The National System of Political Economy, List insisted that, in addition to taking a role in training labor and creating social cohesion, the state needed to protect newly developing industries from international competition. List had spent several years in North America when he was young and was deeply impressed by Alexander Hamilton’s 1791 Report on Manufactures. The United States would always be subservient to Britain, Hamilton maintained, if it failed to develop its own industries. This was the consequence of Britain’s advanced economic status and its consequent ability to flood the American market with cheap goods. The only way for the United States to move forward was through protectionism – that is, import barriers that would give domestic producers time to improve their production processes and the quality of their products, and therefore to slowly create national comparative advantage. For a while, of course, consumers within such a regime would have to buy inferior domestic goods compared to those they might purchase from abroad. But, in List’s view, this short-term sacrifice would yield long-term benefits. Once domestic producers had improved the quality of their goods sufficiently to compete in the international market, protectionism could and should be abandoned. What we have here is nationalism from above: state leaders wanting to develop their societies not only to increase domestic wealth but also to ensure survival within the international economic and geopolitical system. We will have more to say about nationalism soon because that protean force can take different forms.
What List failed to realize, however, is that there can be a downside to protectionism. Protectionism diminishes trust among nations, which can cause conflict in a variety of ways. One is by enabling a country to become so powerful economically that it tips the balance of power internationally. That is the story of Germany in the nineteenth century. But another way in which protectionism may be disruptive is when a great power losing its predominance tries to maintain it through protectionist means – that is, protectionism to cling to power rather than to create it. This was the troubling case of the United States during Donald Trump’s presidency.
List recognized the virtues of state intervention for helping fledgling capitalist societies with their initial development. In contrast, John Maynard Keynes, the great twentieth-century British economist, saw the need for states to manage capitalist economies once they were mature. In this regard, Keynes disagreed with the economic orthodoxy of his day, which held that, if left to their own devices, markets would self-correct during booms and busts without government assistance. Keynes provided an analysis of capitalism’s tendency toward chronic market failure, reflected in unemployment. Although markets occasionally crash with disastrous consequences, he believed that even their normal condition was one of unnecessary unemployment.22
Keynes argued that unemployment was the result not of workers being lazy or poorly motivated but rather of insufficient aggregate demand for the things they produced. Crucially, demand tends to be insufficient because people tend to save more and consume and invest less than is needed to sustain full employment – especially with high levels of inequality when spending power is concentrated at the top.23 Wealthier people tend to save more than poorer people because the wealthy have more discretionary income. If the distributions of income and wealth are skewed too much in favor of the privileged few, aggregate spending and therefore aggregate demand in the economy will suffer, and chronic unemployment will result. To be blunt, excessive inequality will cripple capitalism.24
For Keynes, then, inequality was not so much a problem of social cohesion, as it was for Smith, but a problem of macroeconomic performance. He explained all this in his masterpiece The General Theory of Employment, Interest, and Money, published at the height of the Great Depression.25 The implication of this for orthodox economics was devastating: laissez-faire policies did not work.26 Accordingly, as one economist put it, the “essence of Keynes’s economics … was to save capitalism from the stupidity of its managers.”27 In this regard, the need for intellectually well-informed and institutionally well-resourced political elites was clear.
Keynes encouraged political leaders to use fiscal and monetary policy to regulate consumption, investment, and demand to achieve full employment.28 Policymakers could, for instance, cut taxes, reduce interest rates, and invest in the economy through public works projects or social welfare programs if they needed to stimulate demand and create jobs in a recession. They should do this, he maintained, even if it meant borrowing money and running up budget deficits in the short term. Once the economy recovered and unemployment declined, tax revenues would rise, and the government would be able to reduce those deficits and pay down its debt. Keynes saw wise political elites wielding the state’s policy tools, including deficit financing, as the fire brigade saving capitalism from itself.29 Living at a time when large portions of Europe were in the grips of Hitler and Stalin, Keynes hoped to make capitalism work better to avoid the two great alternative power systems of the day, fascism and communism. In his view, “It is better that a man should tyrannize over his bank balance than over his fellow-citizens.”30
Conventional economics assumes that markets tend toward equilibrium – that is, that problems such as slack demand, unemployment, or even financial crises such as that of 2008 will eventually resolve themselves. We do not share that assumption, which is why we believe that state capacities and social cohesion are necessary for capitalism’s well-being. Nor was that assumption shared by two of the great economists, Joseph Schumpeter and Karl Polanyi.
Schumpeter disagreed with most economists of his day because he saw capitalism as a process of continuous disruption, not equilibrium. He insisted in Capitalism, Socialism and Democracy that the hallmark of capitalism is inevitable change as entrepreneurs develop new products, technologies, and production methods that replace the old ones. He called this the process of “creative destruction” and viewed it as the routine essence of capitalism.31 He also believed that, as capitalism evolved, the process of creative destruction would shift from the hands of individual entrepreneurs to those of large, centralized corporations.32 So, for instance, Alexander Graham Bell invented the telephone, which begat the very innovative Bell Telephone Company (now AT&T) and Bell Labs, its phenomenally creative technology incubator.
As Schumpeter saw it, there were two problems here. First, with the development of larger, more bureaucratized firms, economic decision making would become routinized and rationalized, slowly extinguishing the creativity required for entrepreneurial breakthroughs. But the second and far more serious problem was that the growing dominance of ever larger corporations would eliminate small and medium-sized businesses, and eventually the innovative bourgeoisie, as a class. Their demise would pave the way for intellectuals advocating socialism.33 So creative destruction had revolutionary, as well as routine, implications for capitalism. His prediction that centralization would lead to socialism has proved to be essentially inaccurate. But the point that capitalism involves continual disruption has gained in salience since his death.
The thinker who most fully realized what the societal consequences of continual economic disturbance would mean was Karl Polanyi, who had also experienced the disruption of the First World War and the chaos of the interwar period. In The Great Transformation, published at the end of the Second World War, Polanyi argued that the development of capitalism involved a “double movement,” whereby the problems created by liberal capitalism, particularly for the working class, would create counter-movements to alleviate them. One such counter-movement was Soviet-style socialism, rooted in an antidemocratic Marxist-Leninist ideology.34 An alternative and wholly repulsive counter-movement on which the book concentrated most was fascism, as seen in Italy, Germany, and Japan.35 This involved the state cracking down on labor unions, intervening in the economy in harsh ways, and excluding religious and ethnic groups from politics and society. Fascism was thus firmly linked to nationalism of the worst kind, infused with deep distrust of other nations and international institutions. For Polanyi, “[f]ascism, like socialism, was rooted in a market society that refused to function.”36 He sought for a different type of counter-movement – one akin to what we would call social democracy. His hope was that a more benevolent type of capitalism would prevail, with democratic politics holding sway over the economy and mitigating its worst effects. In such a society, all social groups would be included in the political system, their voices heard and respected by elites. The state would respond to problems caused by the market by providing legal protections for workers and social welfare programs for the poor. President Franklin Roosevelt’s New Deal was one inspiration for his vision, but so was the democratic socialist movement he had seen in the 1920s in Vienna.
Polanyi argued that two things were required to mitigate the instabilities of market society: One was a state with the capacity to disarm capitalism’s self-destructive potential; the other was the sort of social cohesion afforded nations by institutions that provided voice for its many stakeholders and by the possibility for social mobility and economic prosperity. In this regard, Polanyi had a clearer reading of Smith than conventional economists – a reading that appreciated Smith’s recognition that the success of capitalism depended on more than the invisible hand of the market.37 Polanyi’s Jewish background certainly sensitized him to questions of inclusion and exclusion. In short, he recognized that the state was necessary for saving capitalism from itself and for facilitating social cohesion. Through institutionalized voice, the forces of social cohesion could help to ensure that the state did what was necessary to sustain capitalism and distribute its benefits widely throughout the population. This was the essence of what we would call his social democratic vision.
We must note that no book on the instabilities of capitalism could be complete without mentioning Karl Marx. No thinker exposed the cruelties of exploitation more graphically, while his emphasis on class structure remains at the core of any sociology of capitalism. But we do not base our argument on his work for several reasons. First, he refused to accept that state power can affect capitalist dynamics. He believed that capitalism always dominated the state, never the other way around. In this regard, he was simply wrong. Second, the experience of two world wars has made it obvious that peace among nation-states is a necessary condition for capitalist prosperity.38 Marx was silent on this issue. Third, Marx’s belief that capitalism was doomed and prone to revolution has also been proven to be wrong. The system can be and has been subject to reforms that have allowed it to survive for well over two centuries, albeit in different forms. In particular, the crucial problem of overproduction and underconsumption that Marx worried about can be counteracted in various ways, not least by the creation of new “needs” – that is, the creation of goods designed to achieve the status distinctions of the societal escalator, whose workings we have already discussed. Finally, Marx’s analysis of class conflict is flawed, as we will see shortly.
The International Architecture of Capitalism
The final lesson we take from the great economists comes once again from Keynes – although the spirit of his work at this point builds on the ideas of Smith. Bitter experience as a participant taught Keynes about the character of international capitalism, thereby giving his ideas range and power. He had attended the meetings at Versailles that followed the First World War, writing as a result his bestselling The Economic Consequences of the Peace. That book is a scathing condemnation of what he thought was the utter stupidity of French, British, and American political leaders in crafting the treaty – a treaty whose treatment of Germany (notably, its demand for exorbitant reparations) was so harsh that he predicted correctly that it would sow the seeds for another war. Furthermore, the protectionism that followed the Great Depression amplified the importance of international state leadership in Keynes’s thinking.
Keynes became an important political actor. As the British delegation’s leader at the meetings at Bretton Woods in July 1944, he played a major role in creating a new world economic order. His plan sought to provide rules by which the leading states could cooperate. In particular, he insisted that countries in fiscal trouble should be helped, while those with huge surpluses should be penalized, on the grounds that currency imbalances could cause serious difficulties for international capitalism. Imbalances like these became very important later, as we shall see – particularly those between China and the United States, as well as those between Germany and the other members of the eurozone. To solve this problem, Keynes proposed an international clearing union that would regulate international trade, credit, and exchange rates. Underscoring his concern about leaving economic policymaking to foolish politicians, the union would be run by impartial economic technocrats not swayed by narrow national interests. Keynes believed that this system would avoid conflict, mitigate crisis, and produce balanced economic trade across nations, as well as stable employment within them.39
But Keynes’s plan for the architecture of world capitalism was defeated at the hands of the U.S. representative Harry Dexter White, loath to accept any constraints on the United States. The institutions created at that time demonstrate that capitalism after 1945 has been American in character. Capitalism has lived under the hegemony of the United States, which was at first relatively benign but has recently become more predatory.40 Although Keynes may not have envisioned or applauded this outcome, he certainly appreciated that some sort of international state leadership – either by a single hegemon or a small group of states – was necessary to forge not only sound economic policy for the capitalist world but also a modicum of social cohesion and cooperation among the nation-states involved. In sum, he realized that state capacities and social cohesion mattered for capitalism at the international, as well as domestic, levels.
Our Argument Elaborated
We can now flesh out our argument about the sociology of capitalism using the conceptual building blocks given to us by these great economists. It is summarized schematically in Figure 1.1. Note immediately the presence of background forces that either strengthen or undermine social cohesion and state capacity. Our claim, of course, is that when these forces strengthen social cohesion and state capacity, capitalism works well; when they do not, things go badly. Smith was one of the first economists to recognize this. But it is also an acknowledgement of the arguments of Schumpeter and Polanyi that capitalism is an unstable system, prone to constant change and occasional crisis.
Social cohesion ensures the success of capitalism in three ways. First, social cohesion brings the political stability on which capitalism depends. The presence of voice creates loyalty because actors feel they are stakeholders in their society. The presence of voice rests on a shared national sense of solidarity and collective interest. This is most readily available when a population is ethnically, religiously, and linguistically homogeneous, but it can also be created by institutions that ensure that a more heterogeneous population feels included.
Second, a socially inclusive society provides all with access to educational and training opportunities. The high levels of human capital that result create prosperity. So, capitalism for the few is not only morally disturbing but also structurally dangerous for the entire system. This is why Smith favored a modicum of equality and why he argued that the ability of capitalists to gain special privileges would undermine competition, lower wages, and raise prices so as to increase profits in a way certain to lead a country quickly to economic ruin. Contemporary French economist Thomas Philippon makes this point about the American economy in recent decades.41 He explains that competition has declined, profits have risen, and the share of those profits going to labor has declined. Inequality has grown as a result. He calculates that “the lack of competition has deprived American workers of $1.5 trillion of income. More than the entire cumulative growth of real compensation between 2012 and 2018.”42 However normatively reprehensible this may be, the trouble does not end there. Philippon, like Smith, stresses that innovation – the root of capitalist growth – often comes from below, from talented people – that is, people with substantial human capital – and easy entry into the market. He argues that if competition is further reduced and labor’s share of the economic pie continues to shrink, then innovation will stall, market access for newcomers will be blocked, political instability will rise, and capitalism will suffer.
This brings us to the final point. Those at the bottom of capitalist society do not necessarily believe in the system; what usually matters more is their acceptance of what the system promises to bring – notably, upward economic mobility – combined with an absence of perceived alternatives.43 Social cohesion is, in a sense, blind, driven by conspicuous consumption and the desire to catch up with those ahead on the societal escalator. For this mechanism to work, there must be some general sense that one has a foot on the escalator, even if it is at the bottom of the conveyance in motion.
The intellectual and institutional capacities for flexible policymaking determine the resilience and effectiveness of the state. These capacities can be thick and abundant or thin and in short supply. Thick intellectual capacity includes well-trained elites blessed with an esprit de corps, a willingness to listen to qualified and experienced experts, and a reliance on well-established facts and data rather than ideology. Policymakers working in such an environment tend to be consensus-oriented and have an ability to think outside the box in innovative ways when necessary.44 We are not suggesting that this is simply a matter of smart versus stupid politicians or good versus bad political leadership; it is much more a matter of the conditions that bring people into political power who are more or less ideologically partisan and intellectually myopic. Thick institutional capacity includes a wide array of fiscal, monetary, and regulatory policy tools and the authority to use them when necessary – authority that is enhanced when it is derived from consensus-oriented political institutions. Where state capacities are thin, policymakers have fewer policy tools at their disposal, and policymaking tends to be partisan. It is also less data-driven, less attentive to expertise, and less innovative and flexible.
Polanyi saw that social cohesion and state capacities are very often linked in reciprocal fashion. When societies are not socially cohesive, state capacities tend to be thin, because policymaking is partisan and divisive. And when partisan leaders make policy that exacerbates inequality, not to mention racial and ethnic tensions, social cohesion suffers still more. This has happened recently in the United States, where society has become divided along economic, political, ideological and racial lines. As a result, voters have elected strikingly divisive and ill-informed politicians who have weakened the state’s fiscal and regulatory capacities, thereby further undermining social cohesion. This is happening in other countries where the deterioration of social cohesion, marked by rising economic inequality, ideological polarization, and distrust of government, has undermined the intellectual and institutional capacities of states to manage capitalism effectively, especially in times of crisis.45 As those capacities diminish, they further undermine social cohesion in a vicious feedback loop.
Social cohesion and state capacities are important not only at the domestic level but also for the external world, as Keynes realized. Geopolitical peace is fundamental. Beyond that, the more states cooperate with each other as a cohesive group through multilateral agreements, the better capitalism will perform. The thicker the capacity of states to manage international capitalism, either because they rely on skilled technocrats and advisers in international institutions such as the European Union or the WTO, or because they have their own expertise in international affairs, the more willing they are to set aside their national interests when necessary for the sake of the international capitalist system. This too helps capitalism to perform better. The degree to which the international community is cohesive and possesses transnational state capacities, in the form of organizations such as the WTO or World Bank, depends on a variety of historical factors, but the presence or absence of American hegemony since the Second World War has been particularly important.
Figure 1.1 is not a perfect model of reality; it is merely a tool to encourage thought. Two necessary clarifications make this clear. First, we need to go beyond the contrast between two simple self-reinforcing cycles – between, on the one hand, cohesive societies that allow intelligent political elites to serve them, not least by adding to social cohesion, and, on the other hand, acrimonious societies that breed opportunistic elites that play on and deepen the social divisions that already exist. There can be complexities involving opposing forces. A powerful leader can remind a potentially divided society of what holds it together, as has been true of the leadership of Jacinda Ardern in New Zealand, or do a great deal to create division in an otherwise relatively cohesive society, as has been true of Viktor Orbán in Hungary. But the reverse is also true: a socially cohesive society, especially if it rests on powerful national sentiment, can restrain a wayward leader, thereby preventing too much damage. Second, we recognize that the dynamics of capitalism can affect both the factors that concern us. Over time, the performance outcomes on the right side of Figure 1.1 may feed back, influencing the background factors on the left side of the figure. For example, unfettered capitalism tends to generate economic crises. How well states manage these crises affects social cohesion. If states are effective and social cohesion is maintained, then capitalism performs well, and the possibility of future crises diminishes; otherwise, crises are more likely in the future.
The problem for capitalism now is that, in many countries, social cohesion is being destroyed and state capacity undermined – contributing to the decline of the rate of economic growth in the Organisation for Economic Co-operation and Development (OECD) since the 1970s, as Figure 1.2 illustrates. Things were better during the postwar Golden Age. Mass participation in war had done much to equalize social conditions, although racial and gender inequality persisted in many countries. States were so aware of the disasters of two world wars and the Great Depression that they sought greater political inclusion and class compromise. But times have changed. Many capitalist societies have increased inequality and fostered exclusion, leading to politics that are less civil and more divisive. Moreover, these problems are reverberating internationally. For instance, rising inequality in the United Kingdom has undermined social cohesion, allowing the political and economic entrepreneurs who fostered it to come to power on the basis of wholly absurd fantasies and promises that fueled the desire for Brexit. This example adds nuance to our earlier point about the two-dimensional nature of state capacity. Certainly, the institutional capacities of policymakers are important: they need the right policy tools for the job at hand. But the state’s intellectual capacity matters too. Political entrepreneurs can have fantasies and ideas all of their own for which the people never voted; these can have a tremendous impact, not necessarily for the good. This is certainly true in the case of Brexit – for example in the neo-imperial illusions still very present in the English upper classes. Brexit is sure to damage the economy of the United Kingdom and is creating constitutional problems that threaten the unity of the country.
This example allows us to make another key point – the only one in this book not derived from great economists. In principle, all regimes can be overthrown from below, but this is especially likely in modern times when the masses enter politics. Accordingly, we have asked whether mechanisms of political inclusion are necessary for the stability of capitalism. This is most obviously a question for liberal democracy, which gives the vote to economic classes at the bottom of society. But the question also needs to be directed to groups with varying national identities within liberal democracies – particularly racial, ethnic, religious, and linguistic identities – because nationalism is the second equally vital form of popular politics. Does the stability and prosperity of capitalism also require the political inclusion of these distinct national groups? We believe it does. The long-term health of capitalism requires the political inclusion of all social classes and all significant national groups, presumably through democratic means. In this matter, we follow a central idea of Ernest Gellner, the great theorist of nationalism. Economic class conflict is real, and it matters – but it is the combination of class grievance with nationalist difference that produces real social dynamite.46 We see this throughout the capitalist world today, especially in the hostility shown to immigrants and minorities for general economic troubles. Recall that, for List, nationalism was about advancing and protecting the nation’s economic interests; as Gellner recognized, nationalism can also be about the nation’s political and cultural interests.
With that in mind, we need to make a few further clarifications about nationalism. First, at times, nationalist movements are instigated by an elite at the top, as we have seen; on other occasions, they may be a movement of the masses from below. Second, we must distinguish between those forms of nationalism that help to bolster capitalism and those that destabilize it. It is a major error to see nationalism always in negative terms, as a destructive force. It most certainly has that capacity, both domestically and internationally, but it can be positive as well, as a source of cohesion and vitality. A final point needs to be made here. Authoritarian capitalism, including capitalism managed by putatively socialist regimes, is not free from such pressures, despite its greater capacity for control. That said, capitalism combined with liberal democracy is our preferred system for two reasons. It is morally better than the alternatives because it is most likely to entail a measure of political inclusiveness, equality, and fairness that other forms of capitalism lack. And, as a result, it may be better equipped to contain social tensions and manage crises to the extent that the establishment of inclusiveness, equality, and fairness can enhance the possibility for individual self-sacrifice on behalf of the nation when trouble occurs.
One caveat is important. Economists recognize that many things affect the performance of capitalism, including natural disasters and technological change. We accept that without question. Our claim is that social cohesion and state capacities at both the domestic and international levels do so as well, and we insist firmly that mainstream economists largely ignore these factors.47 Neglecting these two things is a grave mistake if we want to understand the mechanisms of capitalism. The great forefathers of contemporary economics did not make this mistake.
The central plank of our argument has been that the societal escalator provides essential stability for capitalism. For this mechanism to work, the state must control the immediate interests of capitalists to protect the market mechanism from their depredations.
All of this varies by place and time. A quick look back at the fortunes of the working class makes this clear. Before 1914, a range of working-class activism could be detected across countries, from the United States and Britain at one end of the scale, marked by the relative passivity of trade unionism, to Imperial Germany and the Romanov Empire at the other end, marked by full revolutionary working-class consciousness. The reason for this variation is simple: social movements take on the character of the political regimes with which they interact. White American working-class men gained the vote as early as the 1830s and thereafter felt that the state was their own. As a result, their grievances and struggles were directed at employers not politicians; at industry not the state, and decentralized thanks to the state’s federalist structure that never produced a significant labor party. In Great Britain, a short-lived exclusion of trade union rights and a more centralized state helped to create a Labour Party, but the allegiance to socialist ideas remained very limited, as it did in America, because the state was essentially liberal.48 In contrast, at the other end of the spectrum, antisocialist laws at the end of the nineteenth century in Germany radicalized the working class, creating struggles not only at the industrial level but also politically – as was necessary given the way in which the state tried to stifle working-class voice.49 And in Imperial Russia the autocracy created a working class that became fully revolutionary, able to seize power in Saint Petersburg and Moscow in 1917.50
This analysis builds on Hirschman’s insights about voice. It amounts to saying that liberalism diffuses conflict throughout society, while authoritarianism tends to concentrate it. Some forms of state are more amenable to stabilizing capitalism than others.
Let us conclude this discussion of social cohesion by returning to the claim that class inequality alone is a much less powerful force than class inequality tied to ethnic difference. Over the last decades, economic inequality has certainly increased within countries, as has the debilitating speed of change of occupational structure. Those suffering from these developments have come to see themselves as a distinctly disadvantaged group. Their frustrations are twofold. First, they are opposed to the elite – that is, to the cosmopolitans of the upper level of society who can move easily beyond the nation-state in a globalized world. Yet, perhaps ironically, those who are stuck – that is, caged – within the nation-state are far more patriotic than the elite. Their desire to protect their nation involves wanting to rein in, to recage, or to renationalize the elite who have left it behind.51 Second, such antielitism is very often linked to worries about immigrants based on mistaken beliefs that these take away job opportunities that would otherwise have been the birthright of the “authentic” members of the nation. It is noticeable that elites favor such immigration because of the economic talent it brings, just as they tend to support affirmative action programs that often irritate those below who are excluded from such programs – people who feel that their place on the societal escalator has been taken by others who are culturally different from themselves, thereby limiting their prospects for the future.
Both frustrations constitute the origins of a new form of politics that pervades the contemporary capitalist world. This is best seen as a new form of nationalism, sometimes referred to as populism, nativist in character, replete with anxiety and rooted in people’s desire to “take back control” of their country from both the elite and those they perceive to be foreigners unlike themselves. The crucial point is that social cohesion is breaking down because this group feels excluded both economically and culturally. The sense of being part of a single national entity has gone; the desire to protect their society becomes visceral as a result. The radical political style that results is a major concern of this book.