Capitalism may rule the world – but it needs to become a better version of itself!

The Covid19 crisis has made inequality scholar Branko Milanovic’s 2019 book more relevant. He describes capitalism’s ubiquity and its implications for society with a sobering economic analysis.

Observation: capitalism is the only game in town, but it comes in two distinct variations

In 1989, Francis Fukuyama’s “The end of history” claimed that democracy WOULD gradually become the dominant POLITICAL system in the world. 30 years later, Branko Milanovic observes that capitalism HAS become the dominant ECONOMIC system in the world – with no viable alternative in sight.

He defines a society as capitalist when most means of production are in private hands, most workers are employed as wage-laborers, and most decisions of production are made in a decentralized manner. While it may be the only current system, he observes that it comes in two distinct types.

On the one hand, there is liberal meritocratic capitalism, as exemplified by the United States. On the other hand, there is political (authoritarian) capitalism as practiced in China.

Variation #1: liberal meritocratic capitalism

In this variation, there are no legal constraints to prevent jobs from being open to the most talented (meritocracy.) There is, however, a distributional framework – including, for instance, free public schooling – that ensures basic social mobility (liberal).Despite these guardrails, Milanovic diagnoses, liberal capitalism has systemic features that increase inequality and threaten social cohesion.

Capital income, for example, is highly concentrated and received mostly by the rich (cf. Thomas Piketty). However, as liberal capitalism goes hand in hand with democracy, mechanisms to correct for trends that are detrimental to public welfare are fortunately built into the system.

Overall, liberal meritocratic capitalism’s advantages are natural: For its adherents, it is worth preserving not only for the sake of good social outcomes but because of its normative superiority.

Variation #2: political capitalism

Usually built on the bedrock of a strong state of formerly communist societies, this variation is characterized by a bureaucracy that focuses on realizing high economic growth, the absence of a binding rule of law, and the state’s ability to control the private sector and steer it in the national interest.

Milanovic highlights the inherent contradictions of these features: a highly-skilled technocratic elite is supposed to apply the rules  unequally; the discretionary power of the bureaucracy leads to corruption, which exacerbates inequality.

As a result, political capitalism’s advantages are instrumental: It constantly needs to demonstrate good social outcomes. Most recently, its exponents have been very successful in doing so: According to Milanovic’s calculations, their share of world output almost quadrupled in the past thirty years, making the model attractive enough to undermine the West’s universal appeal.

Intervention: enter globalization

According to Milanovic, globalization – defined in Baldwinian terms as the declining costs of transporting goods, information, and people and the resulting global economic integration arising thereof – has greatly advanced capitalism’s global success.

The ability to unbundle the production of goods into ever more complex cross-border value chains offered a new irresistible growth and development paradigm: The South became part of the North’s global value chain network.

The upside is plain to see: It has allowed both the South and the North to increase their societies’ overall welfare by exploiting their respective comparative advantages. As the South has registered even higher growth rates than the North, it has also significantly decreased global inequality – the overarching theme of Milanovic’s research and his acclaimed 2016 book.

Implication #1: capitalism pervades everything

Capitalism, Milanovic explains, has not only gone global. In essence, it has become ubiquitous:

“The ultimate success of capitalism is to have transformed human nature such that everyone has become an excellent calculator of pain and pleasure, gain and loss (…); eventually we shall become companies ourselves.”

In the constant pursuit of monetary optimization, people commodify their free-time and their personal assets (e.g., by offering an Uber ride or renting their apartment via Airbnb).

Commodification goes hand in hand with a fully flexible job market (rise in the number of temporary jobs) and atomization (rise in the number of single households). In Milanovic’s unemotional terms: Families have by-and-large outlived their economic advantages as the services they used to perform exclusively, such as household work, have become cheap tradeable products.

Implication #2: liberal meritocratic capitalism comes under stress

Milanovic points out that as people can hardly afford to spend time on things that do not produce monetary gain, ubiquitous capitalism stands in the way of the ideal of the informed citizen that a vital democracy – and thus liberal capitalism – presupposes. Global capitalism also produces increased domestic social inequality because the rich and skilled disproportionally profit from it.

It undermines social cohesion as it leads the well-off to conclude that it is better for them to have their own private insurance systems than transferring their income via a mass system to the poor. Milanovic is rather skeptical that a universal basic income could be a solution. In any case, he finds it to be a paradigmatic deviation of the welfare state as we know it: Instead of insuring against risks, it simply ignores them.

Implication #3: liberal meritocratic capitalism grows more protectionist

There is not just a domestic form of adverse selection – rich people opting out of the welfare system at the expense of the poor. There is an international one: Western states grow wary of outflowing capital, which decreases their own comparative advantage (knowledge and investment) and inflowing labor, which increases the stress on their welfare states (low-skill migrants).

Applying economic logic to migration and corruption in developing states, Milanovic finds them both to be means to convert a citizenship penalty into a premium. What a migrant tries to gain in additional income and wealth by moving to a more prosperous country, a corrupt official tries to gain by exploiting his badly paid position – with globalization increasing both the inclination to and the opportunities for engaging in such behavior.

Conclusion: the light and the dark side of capitalism

Milanovic concludes with capitalism’s central dilemma:

“This may be, perhaps, one of the key features of the human condition: that we cannot improve our material way of life without giving full play to some of the most unpleasant traits of our nature.”

On the one hand, commercialization makes for more awareness of other people’s preferences and interests, thus increasing not only wealth but also understanding.

On the other hand, it stimulates the most selfish and greedy behavior, thus not only straining domestic but also international relations. Reminiscent of Christopher Clark, Milanovic points out the worst-case scenario: Globalization may once again unintentionally lead into the abyss it helped produce in 1914 when it reached its previous peak of spread and power.

Recommendation: Strive for “people’s capitalism.”

To improve global capitalism and prevent liberal meritocratic capitalism from becoming more plutocratic and unequal, Milanovic argues that capitalism will have to move to a more advanced stage. This is both visionary and timely advice given the profound impact of the current Covid 19 crisis.

His “people’s capitalism” features a lower concentration of capital incomes and ownership of wealth, lower income inequality, and more intergenerational income mobility. In line with Dani Rodrik, he proposes to focus on the national level to come closer to this vision.

His recommendations:

  • 1) reduce the concentration of wealth by increasing taxation of the rich and implement tax advantages for the middle class;
  • 2) enhance intergenerational mobility by improving the funding and quality of public schools;
  • 3) reduce nationalist backlashes by introducing “citizenship light” for immigrants;
  • 4) defuse the threat of a durable upper class by restricting the financing of political campaigns to public funds.

GED Take: Don’t forget about the global governance of capitalism!

Searching for a “new normal” after the crisis, policymakers are well advised to seriously consider Milanovic’s recommendations. But given that he is a former World Bank economist, it is quite striking that he does not spare a thought or two more on the global governance of capitalism. Any version of people’s capitalism will not only need strong national norms and institutions as guardrails but also a  supportive set of global rules and regulations.

Milanovic’s first recommendation, for instance, hinges on the international coordination of national policies in order to prevent tax evasion – a main driver of corruption and international inequality. While negotiating free trade agreements or reforming the World Trade Organization (WTO), states could also take a closer look at the distributional consequences of their actions, instead of focusing only on maximizing overall welfare effects. Making trade more beneficial for middle and lower income classes would be an important step toward people’s capitalism.