The Third Pillar

by Raghuram Rajan

  Karl Marx was wrong in some ways, especially in his economic theories, but he was one of the greatest social thinkers of modern times. He recognized that society adapts to, and is therefore shaped, by the underlying production technologies of the time. “The hand mill gives you society with the feudal lord; the steam mill society with the industrial capitalist,” he wrote.17 Subsistence agriculture bred feudal arrangements, while industrialization and machines facilitated capitalistic corporations run by the emerging bourgeoisie. The technology of production did not fully determine the nature of society, of course, but Marx was right in that it was influential.

  Unlike Rockefeller, who wanted capital to be left alone to create its monopolies, or utopian socialists like Robert Owen who, touched by the plight of the worker, called for a responsible, sharing, capitalism, Marx and his long time coauthor, Frederick Engels, were convinced that capitalism itself was fundamentally flawed and would collapse because of its own contradictions. Moreover, instead of appealing to the social conscience of the elite, Marx wanted to eliminate them. He believed that it was both morally right and economically beneficial for property to be commonly owned. Marxists did not look for crumbs off the capitalist’s table, they wanted the whole table itself to belong to those they thought were its rightful owners, the community of workers.

  In their view, the industrialist exploited the worker through his ownership of the fixed plant and equipment of the factory, its capital, which was also why capitalism contained the seeds of its eventual downfall. Marx believed labor was the source of all value, and the only reason the industrialist made a profit was because the industrialist’s ownership of the means of production gave him bargaining power over workers. Any worker could go off on her own and become self-employed, but without the machines she would be unproductive. The industrialist would pay her a better wage than the self-employment alternative, but less than the value she produced for him. The difference between the value she produced working for the industrialist and her wage was the surplus value accruing to the industrialist, the source of his profits.

  The more unemployed workers there were—the so-called reserve army, set adrift as enclosures rendered agricultural labor redundant and better machines rendered industrial workers redundant—the lower would be the employed worker’s alternative options, her bargaining power, and hence her wage. The industrialist’s profits would rise. By emphasizing labor as the only source of value, Marx was wrong, but not out of line with economic thinkers of his time. This theorizing also meant that all profits ought morally to belong to labor, and the profits accruing to the industrialist were mere exploitation, made possible by his property rights over capital.

  But Marx went further to say that the capitalist structure of ownership was economically unsound, and the world should change for this reason only, even if it was not convinced by the moral argument. Essentially, competition would force the profit accumulated by the industrialist to be reinvested in yet more productive machines, forcing more workers out of the labor force, pushing wages further down. Crises, where product prices collapsed and industrial losses exploded, could arise for a variety of reasons. Along the lines of Rockefeller’s thinking, it could stem from the myopic greed or irrational exuberance of industrialists, pushing to get a greater share of the market, and ending up overinvesting and overproducing. It could arise when overindebted industrialists, pressed by bankers to repay, dumped their excess inventory and machines on the market. Most important, it could arise because the true source of industrial profits was appropriating the surplus value of labor. As the quantity of labor fell relative to accumulated capital machinery, Marx believed it was inevitable that the rate of profit would also fall, and hence the susceptibility of the system to accidents and crises would rise. A more modern version would be that as labor’s wages were squeezed, the ability of workers as consumers to buy what was produced would fall, leading to overproduction and crises.18

  When crisis hit, the Rockefellers of the industrial world would buy up failing competitors, close them down and fire their workers, and eventually restore equilibrium between supply and demand, but with much distress for all. The collapse of capitalism was not inevitable—it might be stuck in perpetual torment. As the Russian revolutionary Leon Trotsky wrote, “capitalism does live by crises and booms, just as a human being lives by inhaling and exhaling. First there is a boom in industry, then a stoppage, next a crisis, followed by a stoppage in the crisis, then an improvement, another boom, another stoppage, and so on. . . . The fact that capitalism continues to oscillate cyclically . . . merely signifies that capitalism is not yet dead, that we are not dealing with a corpse. So long as capitalism is not overthrown by proletarian revolution, it will continue to live in cycles, swinging up and down. Crises and booms were inherent in capitalism at its very birth; they will accompany it to its grave.”19

  The Marxist solution to the problem—ending competition—resembled Rockefeller’s, except Marxists wanted to replace the monopolist capitalist with the dictatorship of the proletariat. Since they argued capital was essentially accumulated profit extracted by squeezing labor (or amassed from other dishonorable activities buried in a typical family enterprise’s past like smuggling, bootlegging, usury, war profiteering and outright theft), the capitalist should be expropriated. All property would be held by the state in the name of the working proletariat, and a centralized bureaucracy would make production decisions. As Frederick Engels wrote, “If the producers as such knew how much the consumers required, if they were to organize production, if they were to share it out amongst themselves, then the fluctuations of competition and its tendency to crisis would be impossible.”20

  Therefore, instead of the benevolent Rockefeller directing production and prices, it would be the benevolent revolutionary turned bureaucrat. Once again, what would prevent the benevolent from becoming self-interested? No amount of idealistic Marxist literature prevented the chosen elite, the nomenklatura, a superclass that had access to the best shops and the choicest luxuries, from emerging in every Marxist country, even as the fundamental inefficiencies of centralized monopolistic production slowed growth. Without competition to show up inefficiencies and penalize the merely greedy, and without the decentralized decision making that Adam Smith and later Friedrich Hayek thought was essential to make best use of local information, centralized monopolies eventually ended up as a sclerotic mess, as exemplified by the former Soviet Union.

  In a sense, though, revolutionary Marxism had the potential to be much worse than monopoly capitalism, for it eliminated political competition explicitly, concentrating political power and economic decision making in the same hands. Anarchists like Mikhail Bakunin fought against the centralized state implied by Marxism, and argued for decentralized self-governing structures, only to see their influence in radical Left circles diminish. The communists, like Rockefeller, wanted to retain all the power to decide for themselves.

  Fortunately, neither Rockefeller’s nor Marx’s vision was realized in the industrializing West. Democracy preserved market competition, and market competition preserved democracy. That is what we will examine in the remainder of this chapter, and in the next one, focusing on the special role played by the community.

  EXTENDING THE FRANCHISE

  Early in their industrialization, most market economies concentrated economic and political power in the same hands—even in the middle of the nineteenth century, British cabinets were dominated by the landed peerage. However, as the dissatisfaction of the working classes mounted, the elite recognized that while their explicit responsibility for the rest had evaporated with the end of feudalism, some accountability had to be restored for the nation as a whole to function with more cohesion. The centralized government of the nation-state had stripped the community of some of the powers to determine local policies, even while the Industrial Revolution and the changing market brought many new pressures that the community needed addressing. Those lowe
r down on the economic pyramid demanded a political say—else their plight would simply be dismissed, as it always has been, as the unpleasant but unavoidable consequences of progress. Undoubtedly, if the state was weak and ineffective, a coup or revolution from below was always a possibility. If it was stronger, though, the underprivileged had to stay broadly within the system to change it. In nascent democracies, this meant pushing for broader enfranchisement.

  In feudal England, the right to vote was reserved for male “freeholders,” that is, those who had independent ownership of land.21 Ostensibly, these would have a long-term interest in the well-being of the community.22 More plausibly, property holders believed that by keeping the vote restricted to people like themselves, they would protect their property from the poor. They would also prevent the state from expropriating their wealth to finance imprudent spending. Indeed, despite a war of independence against the British in which Americans from all economic strata participated, the newly independent colonies of the United States typically restricted the right to vote to those men with property, with only Pennsylvania and South Carolina going further to allow all men who paid taxes to vote. In all these would-be states, women and slaves were excluded.

  Over time, the vote was extended. None of the states that joined the Union after the original thirteen had property requirements restricting voting eligibility. Even the majority of the original thirteen colonies that entered the Union eliminated the property requirement by the middle of the nineteenth century, with the battle over economic-based restrictions on franchise waged seriously only in the older states like Massachusetts, New York, and Virginia, where land or wealth inequality was more pronounced, and populations more diverse.23 Even in venerable old England, suffrage steadily expanded during the nineteenth century as property requirements for eligibility were whittled down, in 1832 to include the middle class, in 1867 the urban worker, and in 1884 rural workers.24

  The expansion of the suffrage was typically followed, both in the United States and the United Kingdom, by an increase in local public spending: on local schools open to all, on health care and public heath necessities like sewerage systems and public toilets in urban areas, and on local support systems for the indigent and elderly.25 Thus community powers and activity centering on local spending strengthened as the voting franchise broadened.

  The expansion of the suffrage was rarely linear. For instance, in the United States, at the same time as economic-based restrictions on voting eligibility were abandoned under the populist president Andrew Jackson, groups that were deemed unsuitable for participation in community decisions, such as blacks, women, Native Americans, the mentally incompetent, criminals, and the newly resident, were explicitly excluded.26 Indeed, on the eve of the Civil War, only the five New England states where blacks were few, and New York, which had a $250 property requirement applied only to blacks, still allowed blacks to vote. When Southern blacks obtained the right to vote after the Civil War, they started being excluded again through a variety of targeted measures such as literacy and residency tests.

  Latin America also followed a similar pattern, starting with strict property requirements, followed by an extension of the franchise as pressure on landowners came from other citizens of European descent, and eventually a replacement of economic restrictions with literacy tests so as to specifically exclude workers and the poor, especially Native Americans. By the end of the nineteenth century, suffrage was still far from universal in much of Western Europe and North America, with women and minorities generally excluded (New Zealand was the first modern country to let women vote in 1893). However, there had been a substantial expansion in the electoral franchise to nearly all white men, a significant broadening of the franchise since the minuscule electorates at the beginning of the century. Why did this happen?

  WHY WAS THE FRANCHISE EXTENDED?

  As markets became more integrated, both nationally and internationally, economic adversity from far away could affect a community, and disproportionately the less well-to-do. In the same way that a free market decentralized economic decision making, a more democratic structure would allow many more voices to be heard, allow the local community to influence their representatives and the federal government, and allow people to feel more in control of their destinies. Political empowerment could compensate, in a small way, for the lack of economic empowerment.

  Why did legislators, whose allegiance was to those who already had the vote, extend the franchise? After all, few who have power want to share it. We can dismiss the possibility that the legislators suddenly absorbed the spirit of the Enlightenment, believing that in the interests of fairness, suffrage should become universal, and in the interests of legitimacy, every one among the ruled should have a voice in government. While the rallying cry of the American Revolution was “no taxation without representation,” it said nothing about the representation of those who did not pay taxes. In fact, the franchise was typically extended in steps, not in one go (as might have been the case if legislators became suddenly enlightened). Therefore, we have to look elsewhere for explanations.

  FEAR

  Economist Daron Acemoglu and political scientist James Robinson argue that an important reason for the elite to extend the franchise was perhaps the fear that if it were not extended, the unwashed masses might revolt.27 The French Revolution was a warning to those in power that if they were not careful, many of their heads could end up mounted on pikes. And yet the Revolution could also be read as a cautionary tale of what could happen if revolutionaries were given a role in government. The archconservative Edmund Burke warned “the occupation of a hair-dresser . . . cannot be a matter of honor to any person . . . Such descriptions of men ought not to suffer oppression from the state, but the state suffers oppression if such as they . . . are permitted to rule. In this you think you are combating prejudice, but you are at war with nature.”28 This then was the dilemma that tormented the guardians of political power: Should the masses be kept outside the gate, with the hope that the gate would withstand their anger, or should they be let inside with the hope that they would be tamed?

  Widespread economic adversity did certainly precipitate violent political agitation for greater inclusion. For instance, after the failure of the harvests of 1829 and 1830 in England, agricultural laborers burned the fields of the gentry under the orders of a mysterious Captain Swing and destroyed threshing machines.29 Some argue that this led to the first voting Reform Act of 1832. Yet the state repressed the agitation fiercely, with over two thousand people arrested, five hundred transported to Australia, six hundred imprisoned, and nineteen executed. Moreover, the Reform Act gave the vote to those with property having a rental equivalent of 10 pounds a year, a sum far outside the reach of the laborer. It was widely alleged that the elite were buying off the middle class. At any rate, the newly enfranchised certainly were not in the crowd with pitchforks.

  Strong incumbent governments might well resist acquiescing to the expansion of the franchise at the point of a gun; this could enhance the prestige and following of the opposing radical leadership, as well as lead to significant changes in the nature of government and of property rights as the followers of the radicals voted them into power. That is often why the threat of violence was, and is, met with savage police and judicial repression, as was the case again in Britain in 1839 when the pro-vote militant Chartist movement gathered revolutionary steam. The Chartist movement failed, in part because as Lord Russell—a Whig leader who favored expanding the suffrage—indicated, to give in to a demand backed by the threat of force would undermine the authority of the state.30

  Nonviolent agitations for voting rights have indeed been successful. Those in power find sustained civilized protests—sometimes through economic channels like national strikes—unpleasant, morally deflating, and economically costly. Such protests also typically mean no dramatic change in the fundamental nature of the government and property rights when the demands ar
e acceded to. While greater enfranchisement has typically been followed by greater spending on public services, it has not been followed immediately by drastic “soak the rich” policies, suggesting it stems from a compromise between those in power and the moderates among the protesters.31

  Put differently, the violent excluded have seized power and fundamentally changed the nature of government, as in the American, French, or Russian revolutions. They have also been crushed, as in England. However, their movements may have shaken those in authority enough that it allowed their calmer cousins to negotiate their own participation in democratic governance, as in the expansion of the electorate in England. Fear played a role but did not always empower the violent.

  NECESSITY

  In some countries, those in power were convinced to share it because of sheer economic necessity. As economic historians Stanley Engerman and Ken Sokoloff argue, in frontier areas of the United States, land was plentiful, the existing population was few in number, and there was a great need to attract more settlers.32 Perhaps this was why none of the states that entered the Union after the initial thirteen had a property requirement for voters—would-be settlers usually came without property. Moreover, as states competed for people, even the original thirteen were forced to weaken their voting requirements so as to not lose people.