The Future of History

Can Liberal Democracy Survive the Decline of the Middle Class?

Stagnating wages and growing inequality will soon threaten the stability of contemporary liberal democracies and dethrone democratic ideology as it is now understood. What is needed is a new populist ideology that offers a realistic path to healthy middle-class societies and robust democracies.

By Francis Fukuyama

Thought-provoking essay by Fukuyama, author of The End of History and the Last Man, published in Foreign Affairs journal. Link back here.

This essay is now a year old, but I’ll comment because ideas about “the future of history ” are not really time-sensitive. I’d agree with Mr. Fukuyama’s analysis of the failure of ideology at both ends of the spectrum. In particular, he is correct that:

  1. The Left is intellectually bankrupt, with state corporatism, postmodernism, and social welfare statism all running into their inevitable limitations, intellectually and economically.
  2. The Right has succeeded temporarily due to the failures of the Left combined with a simple return to pro-growth market-driven economic policies. But with imbalances created by globalization and technology, these policies are limited in effectiveness, with neoclassical growth policy merely perpetuating and amplifying the business cycle. Efforts to avoid the consequences of downturns have led to the explosion of public debt as the new policy norm.
  3. Inequality is being driven primarily by technology and globalization, which are symbiotic. Just take a look at the progression of baseball salaries. A world market driven by technology with increasing returns to scale has created a Winner-Take-All market-driven society, leading to economic imbalances and concentrations of power that have rendered existing paradigms ineffective and promoted political cronyism. Capital has enjoyed an increase in market power relative to labor.
  4. The answer to Mr. Fukuyama’s question “Can Liberal Democracy Survive the Decline of the Middle Class” is probably “No.” The adage is correct: “No bourgeois, no democracy.” The irony of the Obama administration’s state corporatism redux is its antipathy to the bourgeois—small business and entrepreneurs—with policies that reward big business, big labor, and big government and conflict with the aspirations of free people under free markets.

In closing his essay, Mr. Fukuyama suggests the need for a new ideology to deal with these failures but is less definitive on its features. In considering the trends cited above and the choices we must make, I think it helpful to first identify the true ideological differences between the Left and Right. The trade-off comes between freedom or security, meaning a society that enhances individual autonomy and the range of choices for its citizens versus a society that tries to insure their physical and economic security. The state cannot effectively deliver both. For example, the promise of universal entitlements means nobody gets to opt out, so it constrains the alternatives that free citizens might choose. Given the entitlement crises, it’s questionable whether the state can deliver true economic security at all.

Ideologues of the Right are strongly biased toward freedom, while those of the Left prioritize security in the form of social solidarity. But any new ideology will have to optimize the opportunities for both freedom and security, as both fulfill our emotional human needs to find meaning in our lives. We need to hope for the extraordinary that lies outside the boundaries of the norm, and we need to manage our fears of failure, uncertainty, and loss in order to venture out of our comfort zones.

There is a workable ideology, and it lies right under our noses. Economic markets and political democracy can deliver both freedom and security if we can think outside the dominant political and economic paradigms. To start, the policy challenges we face can best be classified as distributional. Income and wealth inequality, hunger, pollution, educational access, etc., are all distributional failures – our sciences have taught us how to maximize the production of goods, but not how to distribute them to insure market sustainability. Nature has solved this problem with its delicate balance, but man still struggles with skewed social outcomes. But there is a natural logic to the distributional effects of economic and political markets. To achieve sustainability and stability, policy must harness this logic rather than oppose it.

Finance and economics adheres to the ironclad law of risk and return to determine the natural distribution of returns. Those who assume the risks reap the rewards or the losses. Violating this law disrupts the risk-taking, wealth-creating activity on which a free society depends. Political cronyism that favors clients of the state, or tax and redistribution that is politically motivated, contradict the law of risk and return. To illustrate, one can consider the insidious immorality of “heads we win, tails you lose” as a stark example of the violation of natural distributive justice.

To fulfill this promise of a new ideology, we will need to pursue policies that promote the decentralization and diversification of power, both political and economic. (This need not impede the scale of enterprise.) In a capitalist society, the ownership and control of capital is key to participation in the system. The predominant focus on labor, an input cost to the production process, is misguided. Wage labor should be seen as a low risk, low return strategy whereby the worker sells his labor for a pre-determined wage, while the risk of business failure is assumed by the owners as residual claimants to profits. In a globalized world with an oversupply of labor and mobile capital, the relative shares of production strongly favor capital. The owners/managers of enterprises that outsource production increase their incomes, while those who rely solely on labor incomes suffer. The solution is not to restrict productive activity by punishing outsourcing, but to broaden ownership participation in capitalist enterprise.

Policywise, it is a mistake to superimpose capital and labor on citizens. Labor and capital should not be conceptualized as workers and capitalists, these are merely productive factors, like land and equipment. Any one of us can enjoy the returns to any of these factors through ownership and control. The ownership of free labor is obvious, but the ownership and control of capital is more determinant of the final distribution of returns. As the enterprise grows, owners receive greater returns, but workers get the pre-determined wage (plus a small bonus?). Stock options on equity capital is the cause of outsized management compensation where CEO pay is 400 times that of the average worker.

Now comes the kicker: The accumulation of capital also allows for the greater diversification of risk across different asset classes. For example, my labor is concentrated in my person, while my capital is diversified across the world economy. This helps diversify my risk of loss, while also enhancing my potential returns. The broad distribution of the ownership and control of productive assets is the only way to achieve the individual and social objective of freedom and economic security.

As Fukuyama explains, the main hurdle to any new ideological paradigm is political because the existing concentrations of power are self-reinforcing. We will not get policies that reinforce the bourgeois without grassroots mobilization for change. We need reforms of capital markets, corporate governance, the tax code, entitlements, public spending, campaign finance, electoral rules, etc. but existing power bases will vigorously defend the status quo. The only way to dislodge concentrations of power, short of a revolution, is through the power of numbers. Those who oppose change know this very well and expend most of their political energies on divide-and-conquer strategies that target ideological identities. Thus, the Tea Party and Occupy Wall Street were pitted against each other, even though they had compatible interests. Breaking out of this pattern at the grassroots level will take seemingly impossible effort, but the alternative will be recurrent crises and failure.