Democratic capitalism and economic crises

Political paralysis is a disease not confined to India alone. Europe is an obvious example. So is the US, where a stalemate between the administration and Congress could lead to the economy plunging off a “fiscal cliff”, as spending cuts start taking effect. A political battle has broken out about which sections of the population will bear the costs of the financial crisis. The struggle has become desperate because growth has slowed and there is no longer a surplus that can be redistributed to keep the masses happy.

A recent paper by sociologist Wolfgang Streeck, of the Max Planck Institute for the Study of Societies at Cologne, argues that the financial crisis is the direct outcome of this tension between capitalism and democracy. The paper, “The Crisis in Context: Democratic Capitalism and its Contradictions”, traces the conflict to the establishment of fully democratic nation-states in Western Europe and in the US after the World War II. Streeck says that at the end of the war, a social compact was made between the demands of labour and capital. This “post-war settlement” included an expanding welfare state, collective bargaining and a political guarantee of full employment underwritten by governments applying Keynesian economic policies. He was, of course, referring to the developed economies and not to nations like India, which had no such commitment to full employment.

The arrangement worked well for a while, resulting in a steadily rising standard of living for all classes in the developed countries. In the late 1960s, however, the social compact broke down, partly because of ever-increasing demands from trade unions. The Keynesian policies became increasingly dysfunctional and resulted in high inflation. The oil shock of the early 1970s compounded the problem, leading to a combination of low growth and high inflation dubbed “stagflation”. Perceptively, Streeck says that inflation “may also be considered an expression of anomie in a society which for structural reasons cannot agree on common criteria of social justice.”

But you cannot increase public debt beyond a limit and the 1992 presidential election in the US, which Clinton won, was dominated by debate on the twin deficits—the fiscal and the current account deficits. The old question returned: if public debt was to be pruned, how could the masses be kept happy? Governments looked for new sops to give their electorate, while at the same time maximizing growth. The solution was found in increasing private debt and especially in financing housing. Here’s Streeck in his own words: “The Clinton policy of fiscal consolidation and economic revitalization through financial deregulation had many beneficiaries. The rich were spared higher taxes while those among them—a fast-growing number—who had been wise enough to move their interests into the financial sector, were making huge profits on the ever more complicated so-called “financial services” that they now had an almost unlimited license to sell. But the poor also prospered, at least some of them and for a while. Subprime mortgages became a substitute, however illusory in the end, for the social policy that was simultaneously being scrapped, as well as for the wage increases that were no longer forthcoming at the lower end of a more and more flexible labour market.” This was what British political scientist Colin Crouch called “privatized Keynesianism”—the replacement of public with private debt.

That policy, of course, led directly to the financial crisis. Governments used the public purse to bail out their banks, thereby socializing private debt. But that again has led to governments over-extending themselves and markets are demanding a return to “sound money” and fiscal austerity.

Streeck argues that the Keynesian consensus, the recourse to government borrowing to push growth and the deregulation and encouragement of private credit were all stop-gap solutions adopted to reconcile the conflicts between society and markets. These solutions resulted in more problems indicates that “a lasting reconciliation of social and economic stability in capitalist democracies is no more than a utopian project.”

In India, where the government has to manage the competing demands of many communities and castes as well as classes in an environment of widespread poverty but high expectations, the tensions between democracy and the market economy are even more acute.

Manas Chakravarty looks at trends and issues in the financial markets. Comment at capitalaccount@livemint.com

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