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Has Western-style democracy
become too expensive a luxury for capitalism?

Michael Power, Strategist
We ponder the options for capitalism in the future, and put democracy under the spotlight

Much ink has been spilt on the significance of 2016’s one-two populist punches as thrown by Brexit then Trump. What does it mean for the West? Most analysis concludes that parts of the West are having second thoughts about globalisation, and there is undoubted – if only partial – merit in this assessment.

The increasing free flow of trade, labour, and capital that define globalisation have conspired to contain income growth of Western middle classes since 2000. But even more significantly, the Internet Age has facilitated the income dampening effects of technological advances and the globalisation of knowledge and knowhow.

When historians look back on 2017 in a 100 years’ time, in addition to the “too-much-globalisation” explanation, two even more important mega trends will be identified as the main causes of this current upheaval.

Whilst each cause is distinct, both are connected. The first is that democracy’s lifecycle is aging. The second is that the centre of economic gravity is shifting back from West to East. The connection between these two mega trends is that, although the East has flirted with democracy, its new champions are not democratic nor are there indications that they are likely to be, at least in the sense that the West regards the concept. Only India’s ascendancy might yet give Western-style democracy a second chance and a new lease on life.

High-maintenance’ democracy proving problematic for capitalism

The central reason why Western democracy is in decline is that its capitalist bed-fellow can no longer afford the financial demands that full-blown democracy is placing upon it. History has shown that capitalism can adapt, mutating through many political systems in the past 5000 years. Looking ahead, it will likely find another political host to aid its survival. Democracy – capitalism’s host in the past century – is far more brittle.

Democracy’s political demands have productively cohabited with the economics of capitalism for a century because the economic largesse that this arrangement produced was partially redistributed via the tax-the-winners and spend-on-the-falling-behinds mechanisms of social democracy. This convinced those whose livelihoods have required subsidisation to support this marriage of convenience. The rise of populism and of anti-establishment political movements – as reflected by Brexit, Trump and even the recent Dutch elections – suggest this grand bargain may be losing its attraction. This cohabitation is threatened because the economic surpluses generated can no longer cover the level of political demands for subsidisation.

In fact, these surpluses have been insufficient since before WWII. But the stop-gap measures of Keynesian-inspired budget deficits – the glue of democratic capitalist cohabitation – have made up the necessary differences even if these debt-financed transfers inexorably added to overall national debt.

This subsidisation process has become so ingrained in the DNA of modern Western social democracy that few can imagine a world without it. What was originally a stop-gap measure has morphed into an addiction, one of chronic proportions. And, as Rogoff and Reinhart have shown, once government debt exceeds around 90% of GDP, it clogs up the arteries of growth. Once the ensuing slowdown of GDP growth happens, the growth in the surpluses available for redistribution shrinks too.

Fundamentally the surpluses furnished by GDP growth are the product of just two inputs: the number of hours worked – a function of demographics – and the quality of work done in each of those hours – a function of labour productivity. Both demographic and productivity contributions to GDP growth are, in the West, now gravitating towards zero and, in some countries, are even below it. Even in the US, the structural underpins of GDP growth are now waning.

Rising cost of financing ageing democracies to take its toll on Europe and North America

The demographic aging of democratic societies was first recorded in Japan. It is now spreading to Europe, Canada and the US. The number of hours worked per annum are not growing as fast as they were from 1945 to 2000, when the population growth of the 50s and 60s Baby Boom was being absorbed into the workforce.

Meanwhile, the second driver of GDP growth, increasing productivity, is also barely positive, even in the US. (Note that economists focus on labour productivity, which is closely linked to average wages, and not capital productivity, which is best reflected in corporate profits). Non-farm productivity growth has stalled, especially since 2000, with wage growth weighed down by the twin forces of supply chain globalisation and technological progress.

Donald Trump maintained that factories translocated from the US to Mexico and China “stole” middle class jobs from Middle America. He won the Presidential Election last November by convincing disgruntled former factory workers in the Rust Belt states of Michigan, Wisconsin, Ohio and Pennsylvania of this interpretation. A few factories have migrated, though the main effect of Asian and Mexican competition has been to limit wage increases much more than “steal” jobs.Rather than foreign competition, technological advance has destroyed most jobs. A study by Ball State University’s Michael Hicks found that 88% of manufacturing job losses can be traced not to plants moving to Mexico or China, but to robots moving into U.S. factories.

This combination of falling rate of growth in the number of hours worked and in the productivity achieved in those hours – reflected in a 12% decline in real median US household incomes since 2000 – has mechanically weighed upon GDP growth while trend growth has fallen from 3.5% to blow 2% in two decades.

With GDP growth surpluses barely growing, the glue of social democracy has been mostly financed by debt. In 1980, the US National Debt was US$1 trillion; in 2000, it was US$6 trillion; today it is US$20 trillion.

Globalisation and the great divide caused by advancing technologies has – as Piketty has shown – massively increased inequality throughout the West. Thomas Edison once noted that genius was 1% inspiration and 99% perspiration. Today’s digital divide is separating the former 1% – the inspired thinkers – from the latter 99% – the perspiring workers. Rewards in income terms have flowed disproportionally towards the former and, given time, that divide is reflected in wealth distribution too.

This trend threatens the very fabric of democracy because the latter is predicated on the assumption that a clear majority of citizens must think that the democratic system works for them if they are to continue supporting it. In the US, with a majority of its citizens now predicting that their children’s generation will be worse off than their own, the American Dream is faltering.

The East finds itself in a position of relative economic strength

As Western democracy stumbles, the East makes progress. With faster GDP growth, it generates the world’s most sizeable economic surpluses, even though – Japan excepted – Asia has a far less sophisticated surplus redistribution mechanism embedded in its various political systems. Asian demographics are generally supportive whilst labour productivity growth is still materially positive, driven by its rising service economy and its labour moving up the value-added ladder.

The phrase “Cometh the hour, cometh the man” is usually meant as a compliment. But this is not so when applied to Donald Trump’s ascendancy to power in the US. Just as the West’s democratic dream is faltering and the US’s position as the world’s leading economic power is a decade away from being eclipsed, the US has elected a president who seems intent on withdrawing the US into its fortress and, by doing so, hastening both those declines.

2017 may well mark the year when the politics underlying the primacy of democracy and the economics underlying the primacy of the US both took decisive turns in new directions. It is distinctly possible that these developments will disadvantage both the US and the West at large.


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