Capitalism, the state, and the underlying drivers of human development By Michael Walton, UNDP, Human Development Research Paper, 2010

Michael Walton goes beyond the polemical dichotomies of state versus markets or growth versus equity to focus on what makes for a dynamic economy combined with adequate social provision for the needy.

He starts by noting that capitalism is the only economic system that has delivered sustainable growth.

But capitalism has many variations and not all capitalist economies have been capable of sustained growth, nor have they been equitable.

He cites the example of Brazil and Mexico, both countries that had “miraculous" growth spurts that petered out.

Illustration: Jayachandran/Mint

He points out that “in Mexico, for example, oligarchic business structures dominate formal production, and are a source of high costs and restricted supply in many sectors". These distinctions are a matter of degree and there can be many forms and levels of oligarchy.

The process of “creative destruction" must be allowed to operate, so that monopoly rents, or the excess profits created by barriers to entry and exit, are pulled down and replaced by dynamic Schumpeterian rents, or the excess profits that arise as a result of innovation and are competed away as more firms enter the sector.

It’s also important to have the right institutions and the capacity for capitalist development in the shape of entrepreneurial traditions.

The institution that underpins the economic system and has a very important effect on human development is the state. Walton classifies states too along the oligarchic-inclusive axes. He says, “The real, long-term question concerns the nature of the political equilibrium, the social contract between political and economic elites, and between the elites and various social groups, and whether this is consistent with state behaviour that delivers on public goods and services that expand opportunity for all; or not, but encourages extractive, predatory, or conflictive behaviours."

Walton says that populist pressures play an important part in social provision, irrespective of whether the state is democratic or not. He says that in the Indian states of Tamil Nadu and Kerala, where the social transformation had been more effective, so was social provision more extensive. Yet, it can also be very unequal, especially between the formal and informal sectors of the economy.

History and local context are also very important—one has only to consider the numerous examples of well-intentioned programmes in India that have failed to be implemented. Walton points to the “ambiguous effects" of the panchayati raj system in India.

In sum, Walton says that human development is the joint effort of capitalism and the state.

But the key question is: “What can be done that could shift the overall political equilibrium to one that is more favourable to equitable development, in the sense of fostering Schumpeterian rent-creation, dynamic, inclusive, well-regulated capitalism and good enough states in terms of service provision, innovation and accountability?"

Walton cites India’s experience with economic liberalization since 1991 as an example of how gradual changes can, over time, effect changes in how capitalism or the state functions. Another example is perhaps the first steps towards creating a social security net in India through MGNREGA (Mahatma Gandhi National Rural Employment Gurantee Act), the Right to Food and other programmes. The kind of capitalism or the kind of state a nation has, therefore, determines human development. But what determines the form of capitalism or the type of state? Walton says that depends on “the underlying social contract within societies". That’s another way of saying it depends on the power of various classes, elites and groups within a nation. As a 19th century economist once said, “The point, however, is to change it."