Democracy and free markets thrive on competition. But whereas democracy treats individuals equally, free markets empowers them on their income
It is a truism that people everywhere want to live in a safe, prosperous country where they enjoy freedom of thought and action, and can exercise the democratic right to choose their government. But the world faces a disarming question in 2017 and the years ahead: how can we be sure that political freedom and economic prosperity go together?
The American political scientist Francis Fukuyama has argued that liberal democracies, with their political freedom and economic success, have three important pillars: a strong government, the rule of law, and democratic accountability. I would add a fourth: free markets.
Strong government doesn’t mean simply military power, or an efficient intelligence apparatus. Instead, it should mean effective, fair administration—in other words, “good governance".
The rule of law means that a government will be constrained by what Indians would term dharma—by a widely understood code of moral behaviour, enforced by religious, cultural, or judicial authority.
Democratic accountability means that governments must be popularly accepted, with citizens empowered to replace corrupt or incompetent rulers.
But what brings about a strong government? Libertarians preach that the best government is that which governs the least, a “night watchman" confining itself to ensuring the security of life, property, and contracts. Marxists believe that, as Friedrich Engels put it, once the victory of the proletariat ends class conflict, “the government of persons is replaced by the administration of things." Both are wrong: all economies need a strong government to develop and prosper.
Strong governments may not, however, move in the right direction. Hitler provided Germany with effective administration: the trains ran on time (as did India’s trains during our Emergency in 1975-77). But Hitler put Germany on a path to ruin, overriding the rule of law, without which democracy can lead to the tyranny of the majority (after all, Hitler was elected).
By contrast, when combined with the rule of law, democratic accountability ensures that government responds to citizens’ wishes. Of course, various social groups and organized interests will not always see their programmes translated into policy; but democratic institutions are nonetheless essential, as they enable the non-violent channelling of grievances.
We cannot ignore the influence of history. As Fukuyama points out, China has historically experienced long periods of chaos. Unbridled military competition meant groups organized themselves as hierarchical military units, with rulers exercising unlimited power. When a group eventually emerged victorious, it imposed centralized autocratic rule to ensure that chaos did not return. And controlling a huge geographic area required a well-developed elite bureaucracy—hence the mandarins. Whenever China was united, it had unconstrained, effective government. But, Fukuyama argues, it did not have alternative sources of power in religion or culture to shore up the rule of law.
In Western Europe, by contrast, the Christian church imposed limits on what the ruler could do. So, military competition, coupled with constraints imposed by canon law, led to the emergence of both strong government and the rule of law.
In India, the caste system ensured that entire populations could never be devoted totally to the war effort. So war in India was never as harsh as in China. At the same time, the codes of just behaviour emanating from ancient Indian scripture have historically constrained arbitrary exercise of power by rulers. As a result, India’s governments are rarely autocratic.
History is not destiny—but it is influential, and it is a perpetual puzzle why India has taken to democracy, while some of its neighbours with similar historical and cultural pasts have not. Rather than speculating, let me turn to the relationship between democracy and free markets.
Both democracy and free enterprise create and thrive on competition. But, whereas democracy treats individuals equally, the free-enterprise system empowers them on the basis of their income and assets. What, then, prevents the median elector in a democracy from voting to dispossess the rich?
One reason that the median voter agrees to protect the property of the rich and to tax them moderately may be that she sees the rich as creators of prosperity for all. The more idle or corrupt the rich are, the more the median voter will vote for tough regulations and punitive taxes.
In some emerging markets today, wealthy oligarchs grew rich because they managed the system well, not because they managed their businesses well. When the government goes after these rich tycoons, few voices are raised in protest —and the government may become more autocratic as a result.
A competitive free-enterprise system, with a level playing field for all, minimizes this risk, by allowing the most efficient to acquire wealth. The process of creative destruction replaces badly managed inherited wealth with new and dynamic wealth. Great inequality, arising over generations, does not become a source of popular resentment. Instead, everyone can dream that they, too, will become a Bill Gates or a Nandan Nilekani.
The difficulty in a number of Western democracies is that the playing field is being tilted. For many in the middle class, prosperity seems unattainable, because a good education —today’s passport to riches—is unaffordable. The growing perception of unfairness is eroding support for the free-enterprise system.
Let me turn finally to India. Of Fukuyama’s three pillars, the strongest in India is democratic accountability. We also adhere broadly to the rule of law. Where we have a long way to go is in the government’s capacity to deliver public services. While strong institutions—an independent judiciary, opposition parties, press freedom, and a vibrant civil society—prevent government excess, our “checks and balances" require what might be called a “balance of checks." For example, we must not have an appellate process so slow that it halts necessary government measures.
The most heartening development is that more people across India are becoming equipped to compete, and more of our young entrepreneurs are unwilling to kowtow to the government as a matter of course. If we are to have prosperity and political freedom, we must also have economic inclusion and a level playing field. Access to education, nutrition, healthcare, finance, and markets for all our citizens is a moral imperative, precisely because it is a precondition for sustainable—and democratic—economic growth.
Raghuram Rajan, former governor of the Reserve Bank of India, is professor of finance at the University of Chicago Booth School of Business.