How Capitalism Became a Threat to Democracy

Mordecai Kurz at Project Syndicate: Does free-market capitalism buttress democracy, or does it unleash anti-democratic forces? This question first emerged in the Age of Enlightenment, when capitalism was viewed optimistically and welcomed as a vehicle of liberation from the rigid feudal order. Many envisioned an equal-opportunity society of small producers and consumers, where no one would have undue market power, and where prices would be determined by the “invisible hand.” Under such conditions, democracy and capitalism are two sides of the same coin.

Since the 1980s, American capitalism has been transformed into a winner-takes-all economy in which one or a few technologically dominant firms monopolize each sector at the expense of consumers, workers, and overall growth. And with permanent market power comes the kind of political power that is antithetical to democracy.

Domestic propaganda in the United States has pushed the same optimistic vision over the past century, aiming to convince voters that free-market capitalism is essential to the “American Way,” and that their liberty depends on supporting unfettered free enterprise and distrusting government. But economic developments in recent decades suggest that we should re-examine such beliefs.

To see why, allow me first to clarify some background ideas about what I call technological competition among innovating companies seeking to amass market power. Such competition differs from conventional price competition by producing only one or a few winners, rather than permitting all firms to survive with lower profits.

The winners of technology races are uniquely positioned to consolidate their market power through diverse strategies – including issuing periodic technology updates, acquiring competitors, or erecting barriers to entry with patents (often attaining far greater market power than intended by patent legislation). Technological domination thus is the basis for achieving market power over products sold to consumers, which in turn allows a company to extract monopoly profits. In such situations market power becomes so entrenched that potential rivals prefer to cooperate with the top firm rather than compete with it. Laissez-faire policies that permit the growth of monopolies only enhance such power. As a result, market power becomes a permanent feature of a capitalist economy. Technological competition is ineffective, and creative destruction does not restore economic efficiency. Permanent market power alters capitalism by ushering in a winner-takes-all economy in which one or a few technologically dominant firms monopolize each sector. Such an economy not only deploys resources inefficiently; it also produces a concentration of economic and political power that threatens democracy, whose survival then becomes dependent on the creation of new policy tools to protect it.

The Second Gilded Age

The First Gilded Age (1870-1914) is an essential reference point for comprehending the current moment, because its anti-democratic worship of business power undermined the optimistic Enlightenment view of markets. True, it was a period of extraordinary technological and economic progress, delivering most of the major twentieth-century innovations. Between 1895 and 1904, however, more than 2,000 firms were merged into 157 large conglomerates, leaving virtually every sector of the US economy dominated by a powerful monopolist. Those who created these trusts believed they were doing God’s work of strengthening the economy by saving it from “ruinous” competition. Supported by the ideas of the eugenicist Francis Galton and Herbert Spencer’s theory of social Darwinism, business leaders saw themselves as the superior, intelligent men who had prevailed in the process of natural selection.

This selection process also applied to their firms, through which they were building a new society in which a few strong men would lead. It followed that small and weak firms must be eliminated or swallowed up within strong monopolies. The latter were seen as superior to all the unfit firms that were going bankrupt in frequent depressions. The big monopolies were also considered progressive organizations. As John D. Rockefeller put it, monopolization was unstoppable because it was “the law of God.” These ideas were rejected by Progressive reformers and those pursuing antitrust enforcement under President Theodore Roosevelt after 1901, and under President Franklin Roosevelt in the New Deal era. Americans in these periods chose democracy and rejected the power-worshiping oligarchy, resulting in a long era of economic growth with shared prosperity. But that story ended in 1981, when renewed laissez-faire economic policy led to the contemporary techno-winner-takes-all economy. In this Second Gilded Age, the worship of power and wealth has returned with a vengeance. Capitalism’s strong incentives for innovation and growth remain, but the survival of democracy hinges on whether the system’s most destructive effects can be contained. In a techno-winner-takes-all economy, the market power conferred by innovation leads to one or a few firms monopolizing each industry. One firm might offer costly products of high quality, while a second may offer low-cost products of adequate quality. All these products are trademarked, and all monopoly profits are considered “innocent” by law, because they result from “spontaneous” innovations and are not subject to antitrust enforcement. In this environment, small firms on the margin are vulnerable to either hostile acts or acquisition by larger firms. Dominant firms find it easy to snatch up competing innovative technologies, because small firms are reluctant to risk losing an economic war against powerful incumbents. When a firm increases its price and earns monopoly profits, that leads to inefficient use of its economic resources, ultimately resulting in significantly lower output and lower demand for labor and capital inputs. As an approximation, a monopoly firm’s output and inputs might be reduced by as much as half. When market power is widespread, this results in lower investment, lower wages, and a lower rate of wage growth. The aggregate outcome is lower levels of income, consumption, and capital stock. Moreover, when prices are too high, too few consumers will benefit from new innovations – as one often sees with costly drugs. There is substantial evidence that market power leads to extensive abuses of power more broadly. These might include the erection of high entry barriers to would-be competitors, suppression of competing innovations, efforts to compel acquisition of competitors, and so forth. The result is a gross national product that grows more slowly than is technologically feasible.

Capital Income and Monopoly Profits

The existence of monopoly profits changes business accounting. Under competitive conditions, the income created by a firm is divided into a labor share and a capital share. But with permanent market power, a firm’s income is divided into three shares: labor, capital, and monopoly profits. This distinction between capital income and monopoly profits is central to techno-winner-takes-all capitalism. Net income paid to capital consists of interest payments at the prevailing market rates, whereas monopoly profits extracted by pricing higher than incremental costs are paid to the source of market power: mostly privately owned technology and other intellectual-property rights.

More here.