Why capitalism needs populism

Published on May 22, 2019

This article appeared in Finanz und Wirtschaft, May 21, 2019

The pressure on governments to keep capitalism competitive and prevent monopolies often comes from simple people who democratically organize themselves. A comment by Raghuram G. Rajan.

In the US, the big corporations are under attack. Amazon has abandoned the plans for a new headquarters in New York's Queens district in the face of strong local resistance. South Carolina Republican Senator Lindsey Graham voices concerns about Facebook's undisputed market position, and Democratic Sen. Col. Elizabeth Warren of Massachusetts calls for the crushing of the company. Warren has also put forward a bill that states that 40% of the seats in the respective management should be reserved for employees.

Such proposals may seem out of place in the land of free market capitalism, but this debate is necessary in America. Throughout the history of the country, it has been the critics of capitalism who ensured its proper functioning as they fought against the concentration of economic power and its associated political influence. If the economy is dominated by a few corporations, it inevitably closes with the instruments of state control, forming an unholy alliance between the private and public sector elite.

This is exactly what happened in Russia, which is democratic and capitalistic only on paper. Due to its complete control over the extraction of raw materials and banking, an oligarchy engaged in the Kremlin has ruled out the possibility of meaningful economic and political competition. In fact, Russia embodies the image of the problem that President Dwight D. Eisenhower described in his farewell address in 1961 when he warned Americans "to face the appropriation of unjustified influence by the military-industrial complex" and "the potential for a catastrophic rise of misguided power" to protect.

Dominance of the superstar companies

Since many industries in the US are already dominated by a few superstar companies, we should be glad that "democratically socialist" activists and protesters pay attention to Eisenhower's warnings. But unlike in Russia, where the oligarchs derived their wealth from the acquisition of state assets in the 1990s, America's superstar companies have reached their present position because they are more productive. This means that regulatory efforts must be more differentiated - scalpel instead of sledgehammer to a certain extent.

Especially in the era of global supply chains, US corporations have profited tremendously from economies of scale, network effects, and the use of real-time data to improve their performance and efficiency at all levels of the production process. A company like Amazon is constantly learning from its data to keep delivery times as short as possible and improve the quality of its services. Because they know their supremacy over the competition, the corporation relies on the goodwill of the government on a small scale - that is one reason why Amazon founder Jeff Bezos can support the "Washington Post", which often criticizes the US administration faces.

But just because superstar companies are extremely efficient today does not mean that they will stay that way, especially when there is no meaningful competition. The established corporations will always be tempted to maintain their positions with anticompetitive means. Supported by laws such as the Computer Fraud and Abuse Act of 1984 and the Digital Millennium Copyright Act of 1998, leading Internet companies ensure that competitors can not connect to their platforms, as well as user-generated network effects benefit. Similarly, after the financial crisis of 2009, the big banks accepted the inevitable tightening of regulatory requirements, but then backed rules, which coincidentally increased the compliance costs and thus disadvantaged the smaller competitors. Now that the Trump administration is threatening import duties everywhere, well-connected companies can influence who gets protected and who bears the costs.

As early as 1900

More generally, the more a company's profit relies on government-owned intellectual property rights, regulations and tariffs, the more dependent it becomes on the goodwill of the government. The only guarantee of the efficiency and independence of tomorrow's companies is today's competition. The pressure on the government to keep capitalism competitive and to prevent its natural tendency to dominate fewer companies usually comes from simple people who democratically organize themselves in their communities. Lacking elite influence, they often demand more competition and open access. In the US, the populist movement of the late nineteenth century and the progressive movement of the early twentieth century were reactions to monopolization in crucial sectors such as railways and banking. This grassroots mobilization led to laws such as the Sherman Antitrust Act of 1890, the Glass-Steagall Act of 1933 (albeit less directly), and measures to improve access to education, health, Loans and business opportunities. By strengthening competition, these movements have not only kept capitalism alive, but have also averted the danger of corporate authoritarianism.

Not revolution, but compensation

Today, as the best jobs are created in superstar companies, which recruit their staff mainly among the graduates of a few prestigious universities, as small and medium-sized companies find their growth path full of hurdles that the dominant companies put in their way, and small towns and semi-rural areas struggle to emigrate to the big cities, populism is on the rise again. The politicians hurry to find an answer, but there is no guarantee that their proposals are pointing in the right direction. As was clearly seen in the thirties, there are very dire alternatives to the status quo. If voters in desperate French villages and small-town America are carried away by desperation and lose hope of the market economy, they become vulnerable to the siren songs of ethnic nationalism or unrestrained socialism, and both would create a delicate balance between markets and the state to destroy. Then it would be over with prosperity and with democracy.

The correct answer is not revolution, but renewed balance. Capitalism needs top-down reforms - such as an updated antitrust legislation - to ensure that the economic sectors remain efficient and open to newcomers, and that they do not create monopolies. But bottom-up political policies are also needed to help communities who are economically devastated create new opportunities and enable them to maintain confidence in the market economy. Populist criticism must be respected, even if the radical proposals of populist leaders are not slavishly followed. This is central to preserving both dynamic markets and democracy.