Daniel Starr: What's Wrong with Democracy and Capitalism?

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May 26, 2005

What's Wrong with Democracy and Capitalism?

Simon asks: is there any hope for the transnational progressivists and the world's remaining communists, the folk who hope that Fukuyama is wrong when he says there will never be a system better than the combination of liberal democracy and free-market capitalism? Well, there is a little hope for the revolutionaries. We know a few well-established weak points for standard capitalism and standard democracy. Identifying those weak points isn't the same as coming up with a superior system, but if you want to make an effective complaint about capitalism or democracy, here's some things you can talk about -- the hidden problems with our system that are too deep for a simple change in business regulations or ruling political party to fix.

Improving on capitalism: standard free-market capitalism, as any economist will tell you, is reliably effective only when certain conditions are met. Mostly those conditions are things like "no stealing allowed", conditions that we can mostly rely on. But a couple of the key conditions break down fairly often in the modern world -- increasingly often, as technology accelerates.

Perhaps the most important capitalism condition under siege is "diminishing returns to increasing investments." "Diminishing returns" means that companies operate near equilibrium, in an environment of what engineers would call "negative feedback," an environment where step-by-step changes are more efficient than grand leaps. Increasing returns, where they occur, represent positive feedback, change that feeds on itself, instability -- and classical capitalism breaks down in that environment.

The case of "increasing returns" we're all familiar with is monopoly. Monopolies enjoy increasing returns to market share: the closer to 100% of the market a monopooly pushes, the more profitable its entire business becomes. Unsurprisingly, monopolies are inefficient and are hard for capitalism to handle. Fortunately, antitrust regulation exists. Unfortunately, the more important source of increasing returns in the economy is harder to solve: technological change.

Any change in technology produces a temporary period of increasing returns as companies and users climb the "learning curve" of the new equipment. As technology change happens faster, more and more of our economy is operating under increasing-returns rather than diminishing-returns rules, and standard capitalism is further and further from ideal. Of course, it still works pretty well. But we know it to be far from perfect. Brad Delong had a good essay touching some of these issues recently.

The other major endangered condition of capitalism is that goods are "rivalrous and excludable," that is, that if I buy something from a merchant, like a pair of shoes or a haircut, then it takes extra effort for the merchant to give you another pair of shoes or another haircut -- and equally the merchant can prevent you from using his shoes or his haircut without paying for it. Unfortunately, while shoes and haircuts are rivalrous and excludable, information goods are nonrivalrous and often nonexcludable -- and an increasing portion of the economy is information goods. I'm not just talking about MP3's or computer software: if you look at developments in, say, computer chip manufacturing or the emerging business options in nanotechnology, it's clear that information in the form of design patterns forms one of the key production goods of the present and future economy. Standard capitalism generally underproduces goods that are nonrivalrous or nonexcludable -- so the more our economy is dominated by information goods, the more we can expect there's room for improvement under some hypothetical superior system.

So those are some places where there's a large amount of room to improve on standard capitalism.

Improving on democracy: As for standard democracy, it too requires certain assumptions to work well. (This gets treatment in a couple of chapters of Fareed Zakaria's The Future of Freedom, a book you might find interesting anyway since it also has a level-headed discussion of the odds of democracy (or not) in places like the Middle East and China.) Despite its being the best system we have, there are two basic problems with democracy.

First, the goal of a politician is not to enact the best policy, just the policy that most reliably keeps him in office. Second, the goal of a politician is not to enact policies that are good for everyone, just policies that are satisfactory to a majority. In other words, democracy produces inferior policies either (A) when politicians can get away with presenting a mediocre plan as if it were really the best plan, or (B) when politicians can do well for the majority by totally screwing over a minority.

We see examples of "You're not in my majority, so I'll just ruin your life" in every democracy from time to time. It shows up in the less-developed countries as tolerance of anti-minority violence or expropriating legislation, as with anti-Chinese governance in some periods in Indonesia or anti-Muslim governance under the BJP in India. In a country like the United States it shows up in the way liberals and conservatives each make a show of oppressing the poster children of the other side whenever they get into power (conservatives versus gays, liberals versus big business), as well as in the way that billions of dollars are redirected to Republican/Democratic states whenever the Republicans/Democrats take power.

And we can all think of policy areas where the politicians engage in "mediocrity passed off as excellence" -- consider the tax code, or the not-so-impressive reforms of the CIA and the intelligence community, or any recent Congressional bill on health care. Most businesses face lots of competition and have to strive to continually improve their product. But most politicians have the luxury of setting their own agenda, and so don't have to endanger themselves by suggesting new policies until voters are absolutely disgusted with the old ones.

Now, just because democracies do a bad job at this doesn't mean anybody else does a good job. But let's be honest: we accept from politicians a degree of mediocrity we'd never accept from any business we dealt with. Maybe there's no superior way to do things; certainly nobody's demonstrated a superior way to do things. But we should be honest enough to admit that democracy does do a bad job at passing laws that are "the best reasonably possible" as opposed to "not quite a complete failure".

Democracy plus capitalism equals the best system we know. But in some ways that's only because, to borrow from Winston Churchill, democracy plus capitalism represents the worst possible system -- except for all the alternatives.

Posted by danielstarr at May 26, 2005 02:47 AM

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