Are Democracy and Capitalism Compatible?
By Malcolm Salter: Sometimes you don’t know what you’ve got till it’s gone
Malcolm Salter is the James J. Hill Professor of Business Administration, Emeritus, at Harvard Business School. This is the second in a series of columns by Professor Salter on renovating democratic capitalism. These columns were adapted from his book, “The Fading Light of Democratic Capitalism,” published by Cambridge University Press in 2024.
To save the system of democratic capitalism that has brought so much liberty and prosperity to America, it’s important to make sure we understand what it is. Democratic capitalism is like the air – we live and breathe it every day, but it’s not something that can be seen. Most Americans probably take it for granted most of the time.
So let’s pause to define our terms:
The phrase “democratic capitalism” refers to a system of relationships and rules that determines how markets and businesses are structured, sustained, regulated, and held accountable. Nothing about markets and their governance is a natural phenomenon, after all. As characterized by the late Harvard professor Bruce Scott, this system is a social construct worked out by democratically elected representatives whose primary responsibility is to the will of the people.
This governance system has a pretty important job: When played out in a civil society capable of compromise and peaceful negotiations -- and where political power is diffused among the public, rather than concentrated in the few – it provides a way to align competing priorities and distribute the benefits of economic activity according to society’s collective will.
How does it do that? Well, as the phrase suggests, “democratic capitalism” relies crucially on two sub-governance regimes: Economic and political.
Economic governance encompasses the ways that open markets enable the supply and demand for goods and services to be matched with consumer needs through the price mechanism; coordinate the decisions of savers and investors; and, in the end, allocate resources to their most productive uses. Actors are granted the legal right to own, trade, and control property according to their interests. They can invest capital as they see fit. And they reap the bulk of subsequent returns. These property rights were established for all citizens by our Constitution -- specifically, its 5th and 14th Amendments.
Economic governance also serves a vital creative function by providing strong incentives for innovation and making the benefits of that innovation widely available.
In theory, the capitalist form of economic governance presumes a minimalist role for government in regulating markets and the allocation of capital, giving people the freedom to buy and sell anything they have created or own. In practice, however, there is great variety around the world in the government’s level of involvement. This variability reflects different preferences related to individual freedoms, the degree of private ownership of capital, public authorities’ regulatory intervention, the nature of social security systems, the incentives for risk-taking, the tolerance level of economic inequality, taxation and much more.
Which takes us to the second regime. Political governance encompasses the mix of political processes, laws and regulations that set the rules of the game for decentralized decision-making throughout the economy.
In a functioning democracy, it’s the people who hold the ultimate power to determine these rules and to decide when they might need to be changed. In other words, under democratic capitalism, economic activity is accountable to political authority. And the necessary condition for such democratic oversight and control is full access and participation rights for citizens in the political process -- starting with the right to vote and to run for political office.
Despite the apparent compatibility of these two components of democratic capitalism, it has always been a fragile operation. Things can easily unravel if it misused or corrupted – as we are, alas, discovering.
How America has proved Marx wrong (so far)
There is tension at the heart of democratic capitalism that will be all-too-familiar to those of use living through the present moment.
The primary reason for the fragility described above is that the interests and desired outcomes of the two components of democratic capitalism – the economic and the political -- can pull in different directions.
In capitalism, the desired outcome is private financial gain. In democracy, community welfare is the goal. Reconciling these differences is a continuing challenge.
A second reason for the fragility is that policy- and decision-making processes differ markedly in the two spheres. Capitalism vests decision-making authority in a limited cadre of owners and their agents pursuing private gains. Thus, capitalism is an exclusive governance regime, under most circumstances.
Democracy, meanwhile, places decision-making authority in electorates comprised of citizens. Democracy, therefore, is an inclusive governance regime.
Reconciling this difference is a second challenge.
One can easily imagine that a governance system reflecting these conflicting desired outcomes and decision-making modes would be unstable. Indeed, Karl Marx argued in “The Communist Manifesto” that a combination of democracy and capitalism could never work, because democracy would always be sacrificed to protect the interest of capitalism.
In other words: If one wants true democracy, forget capitalism. And if one wants capitalism, forget democracy.
Marx has been proven wrong by the American experience – so far.
Reconciling democracy and capitalism
Through many years of compromise, cooperation, and sacrifice, the United States has managed to reconcile many conflicting features of democracy and capitalism into a “cooperative marriage” between “complementary opposites” in the words of Martin Wolf, the longtime chief economic commentator at the Financial Times.
As noted in the first column of this series, this was achieved through a combination of market and financial regulations aimed at minimizing ills of capitalism associated with unbridled personal gain, monopoly, securities manipulation, environmental degradation, and the like.
The introduction of maximum working hours and minimum wage legislation, anti-discrimination measures, and safety nets for people injured by economic dislocation and bad luck also served to temper the ills of market capitalism.
In addition, both our Constitution and legislated rules and processes for establishing national goals and policies, resolving conflicts, and implementing policy decisions provided the administrative infrastructure upon which our society was built.
All of this is good news -- except when the discipline required to make this governance system work politically and economically breaks down.
Today, this breakdown takes two major forms -- pervasive cronyism and increasingly restricted suffrage. The result is that the capitalist component of our governance system is fast losing its perceived legitimacy as citizen influence is curtailed. Similarly, the democratic component is fast losing its ability to represent the will of the people through the electoral process.
Together these losses are undermining the value of democratic capitalism as an aspirational ideal.
And that, in a nutshell, is what’s been happening to us in recent decades. Which leads urgently to the question of how we can reverse the corrosion of democratic capitalism -- and what principles should guide a recovery project.
This is the important work before us, and it will be the subject of my next column.