Capitalisn’t: Why Capitalism Needs Democracy

Luigi: Hi, Capitalisn’t listeners. Like many of you, we are taking some time off to spend with our families, even if, in many cases, it is on a screen, but it still is quality time with our families. So, inspired by the recent elections, we decided to produce a very different podcast, different because it’s just Bethany and I discussing what we think about a topic. And, two, because the topic itself is quite different. Economic podcasts don’t talk about democracy, but I think democracy is very important, not just per se, but also for the functioning of the economic system.

Our best wishes for the best possible 2021. After a very difficult 2020, we’re looking forward to a fantastic 2021 together. Thank you.

So, Bethany, are you familiar with the Silk Road?

Bethany: Two different Silk Roads, right? There’s the one a colleague of mine at Vanity Fair wrote a book about, the infamous one. But then there’s the network of trade routes which connected China and Europe. So, which Silk Road do you mean?

Luigi: The infamous one.

Speaker 3: Silk Road first launched in 2011 as an underground website where users could browse anonymously for drugs. It was Amazon.com with a black-market bent.

Bethany: So, I have to confess, I never used it. Did you?

Luigi: No, I’m very boring. I don’t do that stuff. But I read a lot about it. So, I can tell you the fact that the founder was actually a libertarian follower of Rothbard.

Bethany: Murray Rothbard, you mean, the sort of economic father of libertarianism?

Luigi: Yeah. I would say that he’s the father of anarcho-capitalism, but, yes, his view was that for the market economy to work, this thing was not only unnecessary, it was detrimental.

Speaker 4: The stunning arrest of the drug kingpin who goes by the name Dread Pirate Roberts. He appears to have cornered the internet drug market. His real name is Ross Ulbricht.

Bethany: OK. I could talk forever about Silk Road. I think it’s a fascinating story, but I thought today we were going to talk about the relationship between capitalism and democracy.

Luigi: Indeed, we are. What we want to discuss in this episode is how capitalism and democracy relate to each other.

Bethany: I’m Bethany McLean.

Speaker 5: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Speaker 5: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Luigi: So, I think, unless you are an extremist anarcho-capitalist, you think that there is a role for the state to, at the very minimum, enforce property rights. Ulbricht thought that the Silk Road was a fantastic economic simulation that would let people see what it was like to live in a world without this systemic use of force. Because enforcement of property rights is generally enforced by the power of the state. And the power of the state is, ultimately, a monopoly. Famously, Max Weber said that what defines a state is their monopoly on the legitimate use of violence.

The problems started to arise when, because you have to actually deliver the drugs, the suppliers had a record of where the customers were living. That created the possibility of blackmail. So, at some point, Ulbricht was faced with blackmail that if he didn’t to pay a certain amount of money, then immediately the list of all his clients would be published, and that would destroy his website.

Bethany: What were his decisions? And what did he do?

Luigi: What would you do, Bethany?

Bethany: Well, I guess it would depend on how much I believed in a world without rules.

Luigi: He actually tried to hire a contract killer on the web. Like many more abstract philosophers, he wasn’t particularly good at it. So, he ended up hiring an FBI agent that reported him. And so, now he’s in jail, and that is the end of it.

Bethany: So, you think that this is a referendum on the anarcho-capitalist dream?

Luigi: No. It’s a proof of concept, rather than a referendum. I think it is clear, you do need rules. Very often, there is a perception that capitalism is just laissez-faire. If you just reduce to zero any form of government invention, naturally things would blossom in the perfect way. That’s not true. At the very minimum, even most of the laissez-faire people say you should enforce the law. But then, who enforces the law in the interest of whom? So, we have seen recently, for example, when it comes to race, that the history in America is terrible on this front as not being enforced in an impartial way.

Bethany: And how do you get an impartial enforcer of rules? Because it seems to me that in a democratic system, the enforcers are always partial. That’s almost as a matter of definition.

Luigi: You’re absolutely right that there is a natural tendency to try to influence who the referee is. The way in which you make a system very difficult to alter is by bringing in everybody as a referee. The reason why it is so hard to manipulate a bitcoin is because the system of verification relies on everybody being a verifier. At some level, democracy is exactly that. If I can bring in everybody to get involved, it’s too expensive to bribe everybody. We get a system that, as Churchill said, maybe is terrible, but it’s better than everything else that has been tried.

I am fairly unique, I think among economists, because I do believe that capitalism can only survive properly in a well-functioning democracy.

Bethany: So, it seems to me that that’s the theory of democracy but not the reality of it. Particularly, it seems to me, in a capitalist system where monetary rewards accrue to the victors.

Luigi: You’re absolutely right. Even within democracies, we have more or less imperfect democracy. So, John Matsusaka just came up with a book called Let Them Rule, looking at the experience of referenda in the United States. That’s the purest form of democracy, which is direct democracy. While even referenda can, of course, be influenced by money, I think it shows that they’re influenced by vested interests less than standard legislation. So, it’s a way to bypass a lot of the roadblocks that you have and have more of the people rule. After all, the reason why, in Florida, that felons have been reenfranchised is thanks to a referendum.

Speaker 8: Florida was one of only a few states that banned felons from voting for life, until 2018, when a majority of Floridians passed an initiative giving felons who had served their sentences the right to vote back.

Luigi: If you had to wait for the Florida legislature, they were still upholding a law that was coming from the Jim Crow era that did not allow convicted felons to vote, even after they served their terms.

Bethany: Right. So, other than a referendum, how do you find this impartial referee that you need to make the system work?

Luigi: So, I think that it is very, very difficult to get impartiality, but the idea of bringing in disinterested voters in the sense that . . . not disinterested in the sense that they don’t care, but disinterested because they don’t have any strong, vested interest one way or another, and so they’re more likely to side with what is the right thing to do. I think that this principle pervades the American system. I think it pervades, to a lesser extent, most of the Western democracies. And I think it’s the right principle. Unfortunately, in the United States, we have drifted a lot from this original principle. But the idea, I think, is a valid one.

Bethany: Yep. But in a way, isn’t this aspect of democracy almost antithetical to capitalism, in that, in capitalism, the rewards accrue to the owners of capital at the expense of the workers, and capitalism is sold to the highest bidder? And so, isn’t this in some ways the opposite of what a democracy strives to do?

Luigi: Yes. But I think that that’s exactly why they represent the perfect balance. You need a balancing act, a tension between a democratic system that tends to redistribute, taking away from the top and giving to the bottom, and a capitalist system that tends to reward disproportionately the people at the top. If you go too much in one direction, you have a populist system that does not reward enough enterprise and merit and so on and so forth. If you err too much in the opposite direction, you have a plutocracy that is extremely negative for a large fraction of the population. And my fear is that the pendulum has shifted too much in the direction of plutocracy in the last 20 years in the United States.

Bethany: So, capitalism taken to an extreme becomes undemocratic, and democracy taken to an extreme becomes uncapitalistic.

Luigi: At the end of the day, capitalism is trying to distribute power. In a system that is regulated, that tends to be more state-controlled, you have an enormous concentration of power. And I think that both in the economic system and in the political system, power corrupts, and absolute power corrupts absolutely. And so, the way to save both our democracy and our vibrant economic system is to fight against concentration of power in either of the two sectors.

Bethany: So, what do you think most often goes wrong? What are the capitalist forces that work against the ideal of democracy?

Luigi: One is very strong inequality. In a world in which you would redistribute from a large set of relatively rich people, you face, in a democratic system, a lot of resistance. But if you have to redistribute only from a few, that’s very, very tempting. And so, as a result, if I am a super-rich person, I start to build a system to protect me. And once I build that system, I not only protect my wealth, I also have a system that enhances my wealth. Take, for example, somebody like Carlos Slim, who used to be one of the richest men on earth. He lost $30 billion one year, simply as a result of deregulation in the telecommunication market in Mexico, because he made most of his money by having a very uncompetitive market and being the de facto monopolist in this noncompetitive market.

It is very hard, if you are Carlos Slim, and you are the richest man in Mexico and one of the richest in the world, not to use your power and influence to block that reform. And, actually, that reform was only made possible through the pressure of the OECD, and then I’m told by my Mexican friends that after it was passed and had a very positive effect, they started to roll it back step by step under pressure from Carlos Slim. And I had a former student who actually came to class and showed me a picture of the wedding of one, I think, of the daughters of Carlos Slim, and the head of their telecommunication authority was singing and dancing in church. The fact that, as a head of telecommunication, you are invited to the wedding of Carlos Slim’s daughter, and you go to that wedding is pretty scary to me.

Bethany: That is a wonderful and terrifying story, and perhaps indicative of similar situations in the US. Where do you think we are in that trajectory, where the people in power, those in charge of setting the rules and those who want to see the rules made in a certain way, are all sort of in it together, for lack of a better way of putting it?

Luigi: Bethany, what is your view of US democracy today?

Bethany: I think we’re at a point where the imbalance of money and power in the US is threatening US democracy. I think you can see it in a whole bunch of places, and the most obvious way you can see it is in the sheer amount of money that is thrown at elections. In a less obvious way, you can see it in the way lobbying forces distort decisions that come out of Washington. I think a way that has even more influence, but it’s harder to see, you can see it just in the influence that the very wealthy and that big business have on the rules that are in place in our democracy.

And you can even see it through charitable giving. Philanthropy, in large part, has become a reflection of the whims and wishes of the very wealthy, and those worlds are no longer in tension with each other. Philanthropy, I’m not sure, is really a countervailing force against capitalism. At its worst, it sort of serves perhaps to quiet protest. I’m influenced heavily by Anand Giridharadas’s great book on this, but I think it’s true. And so, I think the forces of money and power are eating away at some of the foundations of democracy.

Luigi: I think that the United States went through a gigantic swing. If you go back to the ’70s, there was this very strong antibusiness sense. There were price controls, wage controls, restrictions on capital movement, tax rates were extremely high, and so on and so forth. We have gone through 180 degrees of change. Now, we are the opposite, in which the influence of the wealthy in general, in academia, in the world of news and in politics, is gigantic. I’m sure you have seen recently the hearings of the four big tech titans in front of Congress. There was so much power concentrated in those four guys that it is pretty scary.

Bethany: Yes, it is. Why do you think that change came about? And I think we are maybe starting to see a return in the pendulum. But it’s interesting, my father and I were talking about this, in that when he was growing up, and even in his years as a young man, there was a respect for regulators. That was a job that you took on, and you being a civil servant was something that was highly regarded. And now, being a civil servant has almost become a door toward a job at a firm where you can then go on to make a great deal of money. I thought about that a lot during the financial crisis, when we looked at the people who were in charge of enforcing the rules and setting the rules, and they were basically the same people as the big bank CEOs and the titans of the financial world. They had all somehow melded into one.

And I thought about that also, when I thought about how New York City changed. And New York, in so many ways, is a bellwether of the country. But New York City changed over the course from the 1970s to today, where there used to be uptown and downtown, and they were two separate worlds. The artists and the bankers didn’t mix and match. And it became a world of oneness. And, in some ways, maybe just like with capitalism and democracy, maybe you need a tension between the people who enforce the rules and the people who are subject to the rules.

Luigi: I think, as is often the case, it was the result of a lot of factors moving at the same time. But I think one big factor is the fall of the Soviet Union and the fall of the Berlin Wall—

Ronald Reagan: As long as this scar of a wall is permitted to stand, it is not the German question alone that remains open, but the question of freedom for all mankind.

Luigi: —and the perception that capitalism has triumphed.

Speaker 10: Thousands of East Germans came across the border today. Thousands and thousands came to look, even gape, at this showcase of capitalism.

Luigi: As long as there was a communist alternative, even the more probusiness side felt the need to, for example, be more understanding of the situation of workers and afraid to appear too controlling of the electoral process. Part of the natural balance in the United States is clearly that Republicans had been the more probusiness party. The Democrats, especially in the ’70s, could easily be seen as an antibusiness party. But there was a bit of a check and balance in place. Why? Because the Republicans were kind of embarrassed to be completely in the pocket of business, because the Democrats could attack them. And with the fall of the Berlin Wall, they embraced business so much that they started to compete for the same funds. And so, there wasn’t a check and balance. There was a competition for who was getting more in bed with business to get the maximum amount of funding from business.

Bethany: That’s fascinating and points to a larger philosophical issue, I guess, which is the necessity of alternatives in life and the necessity of a certain kind of tension to keep the extremes in check.

Luigi: I completely agree. And I think that, actually, ideology played a very big role in keeping people honest. I grew up in a country that had the largest communist party in the West. For much of my early youth, the members of the communist party were incredibly honest, even when they took some local power position, et cetera, et cetera. And part of it is because they had this very strong ideological element. And then, once the ideological element collapsed, then it was a race of who was getting more money. You can see this also in US politics.

Bethany: I was thinking, when you were talking, it was fascinating, about the fall of the Soviet Union, because I’m thinking back to some reporting I did for the last big book I coauthored, All the Devils Are Here, which was about the financial crisis. And there’s a conversation I had that stuck in my mind, and it was with an old-school Republican strategist and operative. And he said to me, in old-school capitalism, there were just these guardrails on the sides of the road, you just didn’t go there. And it wasn’t that the laws told you not to go there, you just knew you didn’t, because if you got out of line, somebody was going to discipline you. And there was this moral dimension to what could and couldn’t be done. And I’ve wondered why that changed. And, to me, some of the biggest marks of how that changed were, obviously, the subprime mortgage crisis, where people had no compunction about giving mortgages to people who couldn’t pay them back, as long as they could get theirs and get out of the way.

And then I think about the game Valiant played and then copycat companies played with just raising drug prices as much as they possibly could without inventing anything new or creating anything. In other words, without even a cover of what it’s supposed to mean to be a capitalist. And I was wondering how that moral dimension got lost. And I think your point about there being the existence of an alternative, whether it was the alternative as the old Democratic Party or the alternative as the Soviet Union, that may be created what seemed like a moral fabric, more than any kind of moral fabric actually did. Does that make sense?

Luigi: Absolutely. But I will add another couple of things. And one is, the experience of World War II and, even afterward, the Cold War created a sense of togetherness of a country. You felt a loyalty to the country. By having a loyalty to the country, you had an obligation to the citizens of that country. And that was an important driving force. With the fall of the Berlin Wall, the end of the Cold War, we all became internationalist. And so, you don’t even know which country you belong to. And, certainly, you have much more allegiance to people that think like you around the world than your next-door neighbor or the person who cuts the grass for you. And I think that that’s where the cohesion started to fall apart.

Bethany: So, in an odd way, even though today we’re almost taught that nationalism is a bad thing or a dangerous thing, in an odd way, perhaps you need a certain level of nationalism to ensure that both capitalism stays within bounds and that democracy functions as we would like it to.

Luigi: Yeah. In fact, there is an economist, Dani Rodrik, that says that there is a trilemma, that you cannot have a nation-state, deep economic integration, and democracy at the same time. If you have a nation-state, you vote at the local level, and then this local level is not really represented when it comes to international choices. So, many international choices might be good for the world at large, but not for your little polity. And so, either you don’t let people vote, or you don’t have an open economy. It is hard to have all three at the same time. And I think that that’s very true.

Bethany: Where we’ve gotten to is that neither democracy nor capitalism are functioning as we would ideally like them to in the US, when you look at places around the world where there is capitalism without a democracy, what do you see? From China to Hungary, where you have an authoritarian government and a capitalist society? Are there any lessons there that you think apply to this conversation?

Luigi: The risk, of course, is to have some form of plutocracy in one way or another. Hungary is probably going in that direction, even if you have an appearance of some populist element. I don’t want to sound too pessimistic, but the combination that goes under the name of fascism that was invented, I’m sorry to say, by Mussolini, is exactly that direction. Because it has some of the appearances of a socialist politics. Let’s not forget that Mussolini was a socialist before he founded the Fascist Party.

So, it has some elements, and even the Nazis called it National Socialism, because it has some elements of socialism, but, in fact, it is very much directed, in terms of economic policy and interests, by the interests of the large establishment. And this spring at the Stigler Center, we did a series of lectures that were quite interesting about the role that concentrated ownership, in particular monopolies, plays in the rise of fascist movements, including the rise of Hitler in Germany. There is definitely some effect there. If you are afraid for your wealth, having a repressive regime that guarantees the protection of your wealth, at the end of the day, does not look too bad. Remember that Pinochet in Chile came after Allende was threatening the wealth of the Chilean elite. So, I think that that was clearly a cause-and-effect kind of relationship.

Bethany: It’s interesting. I’m in the early stages of The Third Reich, which is the best-known book about Hitler’s rise to power. It makes a fascinating point that Hitler also started with an appeal to the workers in a very socialistic policy. But as he started to get donations from big business in Germany, and often monopolies in Germany, and started to realize that that was the way to fill the campaign coffers, the rhetoric became increasingly empty. That was the basis of his rise to power, too.

Luigi: Yeah. I think that my understanding from the series of lectures is not necessarily that the monopolists helped him to get to power, but helped him in consolidating power very fast after he got it, which is something we often forget. I don’t think Hitler wasn’t necessarily inevitable. Even if you get somebody like Hitler in power, if you have a strong democracy, that should react and block his attempt to consolidate power. And, I think, in the Weimar Republic, this was not possible. And in part it is because power was so concentrated. So, the old American idea of checks and balances, and fragmented power, both politically and economically, I think is very powerful here. And it is a form of protection of democracy.

I think that we should not forget the American Revolution started not only as a revolt against the British, but also a revolt against the British monopolies. There was a very strong hate toward the monopoly position in American history.

Bethany: It’s interesting, because both in the narrower lens of America and in the broader lens of this conversation around the globe, I think we’ve come back to that key ideal of checks and balances. That’s what makes a system work in the end. It works when capitalism is a check on democracy, and it works when democracy is a check on capitalism. And it works when there are broader forces keeping the worst tendencies of each in check. And when those checks and balances start to get eaten away is when we start to have problems.