Democracy

 

Which Economic/Political System Do You Favor?

04.04.2019

 

Political discussions often get embroiled in argument because of the varying views held about the names and meaning of different economic/political systems.  Recently U.S. President Donald Trump said, “We are alarmed by the new calls to adopt socialism in our country.”   U.S. Vice President Michael Pence added more.  “Under the guise of Medicare for All and a Green New Deal, Democrats are embracing the same tired economic theories that have impoverished nations and stifled the liberties of millions over the last century. That system is socialism,” he said.  He added that voters must choose “between freedom and socialism, between personal responsibility and government dependence,” Pence warned that Venezuela’s crisis is the result of socialist rule.

 

Clearly these two leaders are indulging in the classic Red Scare.  Their job is not to serve the citizens as much as to protect the wealthy and the powerful.  Pence doesn’t mention that the successful Nordic countries and Canada have a socialist type system that has produced a higher level of happiness and wellbeing in these countries than in most free market Capitalist economies. 

 

Our nation badly needs to get better definitions and clearer thinking about the variety of economic/political systems and their major differences.  Republican conservatives have for generations sought to present the options as dictatorial communism vs. something close to laissez faire capitalism. There is actually a large spectrum of options, and this paper will seek to clarify notable points along this spectrum.   

 

Here are six economic/political systems stretching from highly individualistic to highly collectivistic systems.

  1. Laissez Faire Capitalism
  2. Financial Capitalism
  3. Welfare Capitalism
  4. Social Democracy
  5. Democratic Socialism
  6. Communism

 

 

  1. Laissez Faire Capitalism

 

This is an economic/political system that leaves all decisions on product development, production, marketing, finance and distribution in private hands.  Private property and ownership is paramount and are protected by the legal system. Persons possessing or borrowing sufficient capital can start legitimate businesses with the aim of profit-making.

 

Sometimes called Free Market Capitalism, advocates of laissez faire capitalism defend it on the grounds that it maximizes individual liberty and the individual’s pursuit of happiness.  The most salient current manifestations include (1) avoidance of government action to regulate negative externalities such as air and water pollution, (2) avoidance of antitrust and other regulatory measures to prevent competitive capitalism degenerating into monopoly capitalism, (3) avoidance of progressive taxation and a preference for minimal taxation and minimal public services, (4) privatization of even the most popular social services such as social security, and (5) all avoidance of redistributive programs. This version also favors privatization of otherwise public functions such as prisons, schools, and the military (and its immense current reliance on private contractors).

 

The government’s role is seen as minimal, namely to provide police, firefighters, defense, and courts.  The government runs no industries and keeps regulations to a minimum.  In a Laissez Faire system, there is a tendency toward Monopoly Capitalism in the absence of strong government countermeasures.   When allied with powerful government forces and private financing of the political system, Capitalism can turn into Fascism, as it did in Hitler’s Germany.

 

 

  1. Financial Capitalism

 

Financial Capitalism is a further evolutionary phase of Laissez Faire Capitalism. Financial institutions such as banks, private lenders, insurance firms, a stock market, and other financial profit-seeking institutions assume a growing role in the economy.  In 2006, the financial sector accounted for 8 percent of the GDP and averaged a whopping 41 percent of the profits earned by U.S. business.   

 

The financial sector makes it profits not from production but from financial dealings.  Financial firms make money charging interest on their loans, rent on owned property, and on speculative investments.  Financial firms and individuals search for opportunities to enhance the value of their assets.  They buy and sell stocks hoping to make a big gain.  They lend money to ambitious entrepreneurs hoping for a big win.  They hope for substantial gains that will cover the risks that they are taking.  Because much speculative betting occurs, the system is sometimes called Casino Capitalism.  Because many investors rely on friends’ tips and the trading of favors, the system has also been labeled Crony Capitalism.

 

For a wonderful discussion of the role of finance in the modern economy, see Adam Tooze, Crashed – an insightful study of the 2008 crash, its causes and the worldwide government responses to it.   A key theme: the financial institutions had been clamoring, with great success, for government to get out of the way.  And governments largely had done so.    A consequence was the crash, the Great Recession, that in its early months was promising to be as severe as that of 1929.  It gradually became apparent that the system could be saved only by massive government intervention.  The US Federal Reserve Bank extended credit amounting to more than 7 trillion dollars to financial institutions both in the US and abroad, thereby saving the financial institutions and their enormous compensation schemes, while leaving ordinary homeowners to sink or swim.  There were reasonable arguments in favor of this course of action.  Buying up a massive amount of bonds would keep the interest rate low and encourage further investment. But this extreme action starkly revealed the hollowness of the financiers’ avowed preference for an approximation of laissez faire.   Rather, what they wanted and got was: heads we win, tails we win again (as a result of massive government intervention).

 

 

  1. Welfare Capitalism

 

Welfare Capitalism finally admits some role to government in mitigating the tendencies of Laissez Faire Capitalism to produce extreme inequality and some horrendous externalities in the realms of public health and safety.  Laissez Faire Capitalism and Financial Capitalism will result in winners and losers.  The winners are those who made good economic decisions or who were lucky in their bets or who had the benefits of good parentage.  The losers are those without capital who rely solely on minimum wages and those who lose their jobs as industrial fortunes change and as recessions occur every five to ten years.

 

Here the government builds a social cushion to help those who lose through no fault of their own or through poor decisions.  The cushion consists of unemployment insurance, food stamps, food kitchens for the homeless, poverty assistance and grants, health care assistance, housing assistance and work projects initiated by the government.  Welfare Capitalism aims to add “heart and humanity” into the lives of those who have been hurt by Capitalism’s shifting sands.  The aim is to preserve the benefits of Capitalism by reforming and softening some of its features.  The reforms may include two additional steps. One is passing higher income taxes and/or wealth taxes on the rich to pay for the social cushion.  The other is to encourage more trade unions or workers’ councils to give a voice and power to labor to counter the dominance of capital. 

 

Welfare Capitalism gives rise to the concept of Mixed Economy Capitalism – the idea that successful societies need both strong public and private sectors, and that the public sector often needs to have a larger role than just welfare and the regulation of major externalities.  This helps to explain why, even in the U.S., the pillar of world capitalism, government is the financier of most basic science, why it has spawned some of the most important technological advances of recent generations (e.g., the internet), why we rely on government to finance most education and health care, and why the great private institutions rely on government to stabilize markets when the great private financiers would otherwise face ruin. The success of capitalism depends critically on the actions of strong, honest, highly competent government.

 

Under Welfare Capitalism, private enterprise is still in control of economic development.  But the government might act to encourage businesses to invest in new industries that have a promising future.  The U.S. government helped developed the Internet and strongly encouraged the development of solar and wind energy.  U.S. military contracts were critical to the development of U.S. commercial aviation. U.S. Government patent policy and international negotiations to protect intellectual property have been critical for the pharmaceutical and quite a few other industries.  U.S. preferential taxation has been important in the history of the oil industry.   

 

In some nations, government exerts even stronger guidance.  Many years ago, the Japanese government pushed its business community to develop the automobile industry and the electronics industry.  The governments of France, Germany and Spain developed the Airbus to provide Europe with more transportation alternatives. Some industries worth developing are too big for any company or consortium of companies to develop. Government can play a beneficial role in encouraging public/private partnerships.

 

Yet the U.S., compared to other developed countries, is highly averse to government guidance.  American conservatives are quick to point to past failures and to keep government out of influencing where private entrepreneurs should invest their money.

 

 

  1. Social Democracy

 

Social Democracy is a form of mixed economy where private enterprise runs most businesses but the State reserves the right to regulate business so that it is competitive and serves the public interest.  The State also may participate or operate in a few industries that greatly impact the public’s welfare.  The State might also provide universal health insurance. It might regulate prescription drug prices to balance the aims of affordability and of incentivizing innovation.

 

The State might control prices on pharmaceutical drugs to be sure that citizens can afford the drugs that they need.

 

The State also makes sure that the system provides a social cushion to help those who experience hardships beyond their control.  The State also favors labor unions and work councils so that workers have a say in how business is conducted.  In large German companies, about 40 percent of the directors are nominated by the trade union.

 

Democratic socialism is an apt description of the economic system in the Nordic countries.  These countries have less income inequality than other countries, higher livable wages for the working class, and less extreme pay for CEOs and top managers. The citizens in these countries score higher in national happiness and well-being.  Citizens prefer to describe their system as a Social Democracy rather than Democratic Socialism.

 

A key point is that social democracy took on a meaning in Europe following World War II.  A parallel, by the way, was Christian Democracy.    Social democracy described a mixed economy that highlighted the importance of public welfare and macroeconomic management.  The early WW2 postwar years led to the nationalization in Europe of certain industries such as steel and the railroads.  These public ownership experiments did not pan out well.  Social democrats in Europe have generally backed off nationalization as a productive strategy – but they are still identified with strong public macroeconomic and welfare state leadership, along with a very large role for government in such fields of health, education, and support for science.  There remains a widespread belief that most industry and business should be privately owned and run.

 

 

  1. Democratic Socialism

 

Democratic Socialism involves the Marxian concept of public ownership of all major industries. In the extreme, the State manages most or all production, finance and distribution. 

 

This system came out of Marxist-Leninist theory about class conflict and the oppression and exploitation of the working class by the capitalists.  Marx and Lenin called for a revolution where the proletariat would take over the government, expropriate the wealth of capitalists, and run industry to meet the needs of the people, instead of profits for the capitalists.  The aim was to produce eventually a classless and stateless society.  All people would be equal and enjoy all the same rights and benefits.  The system would run on the rule “From each according to his ability, to each according to his needs.”  Marx explained his belief that each person would be motivated to work for the good of society because work would have become a pleasurable and creative activity.

 

The Democratic Socialist economy could be run in one of two ways.  One is where each major industry is run by a ministry devoted to that industry.  Thus, the minister of the Coal Industry will work with the minister of the Steel industry to determine how much coal with be needed to produce the projected amount of steel.

 

The other model is Centralized Planning. A huge State bureaucracy determines what to produce, in what quantities, at what prices, and how the goods and services are to be allocated to different buying groups in the society.  The aim is to make the goods and services that serve the Common Good.

 

Can democracy operate long in a system of Democratic Socialism?  In postwar Britain, democratic parties such as British Labor openly voted for nationalizing major industries. The British public remained free to assemble, vote, speak freely, practice their religion, have basic rights, and follow the rule of law. Because democracy remained robust in Britain, socialism went into reverse before long, with the denationalization of some industries and determination to let new industries develop along capitalist lines. However, many other countries following nationalization of their major industries often don’t remain democratic.

 

In a Socialist system, it is very hard to produce good consistent quality and quantity. Goods are often scarce or shoddy. First, management decisions tend to be highly politicized.  Second, there is a strong tendency to protect old industries and its many workers at the expense of emerging ones. 

 

 

  1. Communism

 

Communism came to Russia in the 1917 October Revolution. Several different power groups fought each other to install their version of the system. Communism passed through many iterations.  Lenin defined the early system and Stalin morphed it into a totalitarian, tyrannical system in which millions died from mass killings, famine, and incarceration in gulags.

 

All enterprise is owned and run by the State that itself is run by a powerful clique and leader.  The self-selected group eliminates all opposition.  The dictatorship of the proletariat becomes a tyrannical dictatorship run by a strong leader for whom total obedience and deference is expected and demanded.  The leader may not be charismatic but nevertheless will be portrayed that way.  if elections are held, the purpose is to select the leaders, officials and bureaucrats of the one-party system of the State.  Under Communism, individual liberties and rights are severely repressed.

 

The State runs a propaganda system internally and externally to present a picture of a happy creative society.  The educational system glorifies the state, its leaders and its history and produces an exaggerated official view of its accomplishments and its enemies.  The State invests in a health care system and in science and technology. It also builds a strong defense force to protect the State from internal or external opposition.

 

The two strongest current examples of a Communist system are Russia under Vladimer Putin and China under Xi Jinping.  The irony is that these two nations claim to be communist but they now operate large capitalist sectors.  It seems that their system passed through the stage of full-blown communism to a successor stage in which the dictatorship component remains unalloyed but the economic component include a very substantial amount of capitalism subject to very close government oversight. China today is commonly described by scholars as a State Capitalist system even though it continues to label itself a communist system.  Russia ended up putting many of its industries into private hands and management with strong supervision by the State and continues to label itself as a communist system.

 

 

Conclusion

 

Hopefully a review of these six economic/political systems will help individuals decide which system they prefer to live under and advocate.  All systems involve tradeoffs.  Currently in the U.S., the economic/political system with the most support is Welfare Capitalism.  Yet to some citizens, this doesn’t go far enough.  They point out that 15% of the country’s citizens still live in poverty. Many Americans can’t afford healthcare. Wages have stagnated for 50 years. The highest income tax rate has fallen from 70% to 37%, creating trillions of savings for the wealthy. Shared prosperity is not occurring.  Working class incomes have stagnated while incomes at the top have soared.

 

There is a growing interest, especially among millennials, in Social Democracy. There is very little interest in Classic Socialism where the State would take over and run industry. Progressive Democrats in the Democratic party favor Social Democracy. They don’t want government to run Industry. They want businesses to invest more in better health, education, and social welfare. They want higher income taxes to be paid by the wealthy, and some advocate a wealth tax.  Social Democrats want a Green New Deal to address climate change.  They want to reduce coal and other polluting industries, favor electrically driven cars and trucks and more public transportation.

 

So, the issue in the end will be Laissez Faire Capitalism, Welfare Capitalism or Social Democracy (in its Nordic form).  Republicans favor a return to Laissez Faire Capitalism. Democrats are split between those favoring Welfare Capitalism and those pushing for Social Democracy.  The danger is that those pushing for very rapid dramatic progress toward increased Welfare State and Social Democracy policies will generate a backlash that could easily cost the Democrats the emerging majority that appeared to be developing for them in 2018.  There is a danger that those pushing for Social Democracy policies will be smeared as Socialists and lose support from large segments of the American public who are not ready to understand Social Democracy, let alone know that it would serve their interests better.

 

Thanks to Professor Alan A. Altshuler, professor emeritus at Harvard University’s Kennedy School of Government, for his valuable comments on drafts of this article.

 

PROVOCATIVE, FORWARD THINKING WHITEPAPERS

2 comments

 

2 responses to “Which Economic/Political System Do You Favor?”

  1. Avatar Jeff Werner says:

    Phil-
    The labels of Social Democracy and Democratic Socialism are extremely confusing. Many favor the former but few favor the latter. Perhaps we need to drop the word “Democratic” from Democratic Socialism, even though in some forms it may have some democratic aspects. It’s a lot easier to respond that Social Democracy IS our democracy with some additions and it is not socialism. Perhaps you could develop this to aid our presidential candidates.

  2. Avatar Paul H. Rubin says:

    My friend Phil Kotler has written a post, “Which Economic/Political System Do You Favor?” for this forum. Phil is a liberal, and his analysis presents the analysis from a liberal perspective. I am a conservative (worked in the Reagan White House Council of Economic Advisers, supporter of President Trump) and I thought it might be worth examining the same issue from a more conservative viewpoint.
    In the Introduction, Phil makes several points that indicate his liberal perspective. First, he quotes President Trump and Vice President Pence on socialism, and then indicates that this is the “classic Red Scare.” However, the language of Socialism is not Trump’s or Pence’s; it is Bernie Sanders’, who is in fact a member of the Socialist party running as a Democrat. As Phil discusses later in his essay socialism requires the State run most industries in the economy. Almost all economists agree that this system would be extremely inefficient. But it is Bernie Sanders and his followers who have advocated Socialism, and Trump and Pence are merely pointing out the implications of socialism. If Sanders does not mean socialism as usually defined, he should not say so. He has given the Republicans a huge club, and it is not surprising that they will use it. Moreover, the Socialist Party USA indicates that its goal is that “the people own and control the means of production and distribution,” which is the classic definition of socialism.
    Moreover, it is surprising that Phil accuses Trump and Pence of “protect[ing] the wealthy and powerful” when a major result of the Trump economic program has been to provide jobs to all, including the poor and non-powerful. Unemployment rates of all –whites, African-Americans, women, Hispanics – are at historic lows, and wages are beginning to increase. If Trump’s goal is to protect the wealthy at the expense of the weak and powerless, then he has done a remarkably poor job.
    Phil also claims that Canada and the Nordic countries have “socialist type” systems. This is patently false. Canada and the Nordic countries have capitalist systems with a relatively large welfare component, but they rely on private enterprise to produce goods and services and the income that is taxed to support their welfare systems. Moreover, these countries (and indeed, the entire world) rely on items created in the U.S. – by Microsoft, Apple, Google and others.
    Finally, he accuses conservatives of creating a false dichotomy between what he calls “Laissez Faire Capitalism” versus dictatorial communism. As I show below, he has himself created a caricature of free market capitalism which few if any would advocate, and then sets this caricature against his view of welfare capitalism.
    Capitalism
    Phil’s initial definition of capitalism is mostly correct: “This is an economic/political system that leaves all decisions on product development, production, marketing, finance and distribution in private hands. Private property and ownership is paramount and are protected by the legal system. Persons possessing or borrowing sufficient capital can start legitimate businesses with the aim of profit-making.”
    But from there he goes off the rails. To my knowledge no one advocates the extreme system that he attributes to conservative capitalists. For example, I was a senior official in two regulatory agencies in the Reagan Administration (Federal Trade Commission, Consumer Product Safety Commission) and in both we advocated cost-benefit analysis of regulation, not minimization of regulation. In this, we were following President Reagan’s guidance in Executive Order 12291. Phil also claims that advocates of laissez faire capitalism want to avoid all redistribution, perhaps forgetting that Milton Friedman was an early advocate of a “negative income tax” as a form of redistribution.
    Phil also claims that laissez faire capitalism can turn into fascism, and that this happened in Nazi Germany. Perhaps the best discussion of the origin of the Nazi party is from Hayek’s Road To Serfdom as Hayek was a brilliant economist and had also lived through the Nazi Revolution. Hayek’s main point was that by increasing government regulation and thus the power of government, it became easier for Hitler to gain power. President Trump is sometimes accused of seeking to become a dictator, but by reducing government regulation he has in fact made dictatorship more difficult. For example, by eliminating Net Neutrality, the FCC has made government control of the Internet and communications much more difficult, and such control is something that greatly facilitates dictatorship.
    Phil discusses what he calls “Financial Capitalism.” He discusses ways in which financial firms make money. However. He does not discuss the purpose of the financial sector. The purpose and main function is to allocate capital to the most productive uses. Just as the market economy in general allocates resources to their best uses, so does the financial system. The payoffs from such allocation can be very high, and so the returns to financial allocation can also be very high.
    Phil then discusses what he calls “Welfare Capitalism” and “Social Democracy.” In Phil’s view these are capitalist systems but with additional government regulation, including income redistribution. It is not clear what the difference is between these systems, except for degree. Both of them allow more government involvement in the economy than does his view of Laissez Faire Capitalism, with Social Democracy allowing more interference than Welfare Capitalism.
    The main problem with Phil’s analysis is that he views the various policies as discrete, when in fact there is a continuum. Policies are “more or less” rather than “either-or”. All systems of capitalism allow for some role for government. Traditionally, Republicans have favored relatively less government and Democrats relatively more. The system tends to move incrementally, with Democrats increasing regulation and Republicans reducing it.
    Unfortunately, we now seem to be faced with a Democratic party which wants to move more than incrementally – which proposes a radical change in the American economic system. In the past, voters have rejected parties advocating such radical change – Eugene McCarthy or George McGovern from the left, Barry Goldwater from the right. Time will tell if this political preference continues.

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