After the Wall: Branko Milanovic's Capitalism, Alone

After the Wall: Branko Milanovic's Capitalism, Alone

To supporters of the market economy, the fall of the Berlin Wall nearly thirty years ago was supposed to mean the undisputed triumph of capitalism. But tensions today from increasing inequality, the rise of populism, and the remarkable growth of China have thrown this foregone conclusion into doubt. Did capitalism’s supporters take a premature victory lap? In his recent book Capitalism, Alone, Branko Milanovic argues that while we must resolve some of capitalism’s internal contradictions and countries like China show there is more than one recipe, capitalism is here to stay.

Marxists struggle, Milanovic points out, to reconcile Marx’s writings with the communist countries that in fact emerged. In Marxist thought, feudalism transitions into capitalism before eventually becoming communism. In historical experience, however, it was poor feudalistic or pseudo-feudalistic countries that became communist, skipping any stage of capitalism. Furthermore, if communism is the highest form of economic development, how are Marxists to explain the regression of countries like the Soviet Union that have passed from communism now into a less ideal system?

Of course, liberal theorists have their own explaining to do. If a richer and more globalized world is meant to create a self-sustaining peace whereby war is too costly, a peak of classical capitalism in 1914 should have never brought about the first World War. If the trajectory of economies really is, as predicted by liberal theorists, to gradually become more market-oriented, it’s hard to rectify countries that have transitioned into Marxism rather than liberal capitalism.

Milanovic believes Marxists got it partially right. Some shock was needed to shed the shell of feudalism that suffocated the productive potential of countries considered to be “third world” that were also often targets of foreign domination. Western countries had a bourgeois middle class that eventually developed enough political power to protect its interests—stop the rich from being entirely extractive and stop the poor from confiscating all the property. But for countries that had been dominated by foreign powers, communism—or some sort of radical revolution—presented an effective way to establish both economic and political independence.

Milanovic is quick to qualify his statement on the value of communism as a positive transitory force, however. He shows that poor countries like China and Vietnam experienced better growth rates from transitions to communism compared to more developed countries like East Germany and Czechoslovakia. Contrary to Marxist prophecies, “it is the very failure of socialism in rich countries that falsifies simple-minded Marxist teleology.”

The seeds of these revolutions grew into what Milanovic calls ‘political capitalism,’ a system with high levels of top-down control and corruption but capitalist nonetheless. Despite authoritarian tendencies, political capitalist countries fulfill Milanovic’s definition of capitalism as “the system where most production is carried out with privately owned means of production, capital hires legally free labor, and coordination is decentralized.”

This political capitalist system in countries like China, Vietnam, and Malaysia, relies on discretionary decisionmaking at all levels in order to overcome the red tape of democratic bureaucracies. Ample discretion is ripe for corruption, and citizens of political capitalist countries tolerate the corruption in exchange for fast economic growth. Even as these countries grow and become a part of the globalized economy, the roots of their entrance into capitalism linger in how their governments function.

It is against this prototype of the political capitalist countries that Milanovic describes the other path of capitalism: liberal meritocratic capitalism. These countries, with the United States as his prototypical case study, are characterized by rule of law, no formal obstacles to economic mobility, and democratic competition as the primary form of political accountability.

An increasingly globalized world has generated tensions aplenty for today’s liberal meritocratic capitalism. A widening gap in wealth and income inequality is weakening the faith many have in the current system. A feature of today’s liberal meritocratic system is that, unlike centuries ago, those with high wealth income also benefit from high labor income. Evidence shows that wealth is becoming more concentrated at the top, and notably the type of wealth held by the wealthiest produces higher returns. The middle 60% of Americans hold most of their wealth in housing—an exceptionally undiversified and volatile asset—whereas the wealthiest have their wealth in financial instruments that have much higher returns. According to Milanovic’s calculations, 12-15 percent of people in France “could live at the standard of living of a median worker without working for even a day.” All of this serves to perpetuate the difference between those at the very top and everyone else.

These tendencies towards increasing inequality are not unique to the US. Evidence shows wealth concentration is similarly high in Nordic countries. And the best data from China and other political capitalist countries suggest levels of inequality exceeding that in the US, and roughly on par with Latin American countries.

Some forces of inequality aren’t necessarily bad in their roots, and it’s not clear that we have the desire or tools needed to counter-act them. Although the association between spouses’ level of education was near zero as recently as 1970, college graduates are increasingly marrying others with college degrees. With high earners marrying other high earners, inequality at the household level—with downstream generational effects—has reached the point where 1/3 of the rise in inequality between 1967 and 2007 can be attributed to this “assortative mating.” Further, Milanovic believes that the ability to earn higher income from harder work is not entirely a bad thing, especially contrasted to previous eras of richness being almost completely derived from inheritance.

As long as there is inequality globally, Milanovic reasons, there will be forces pushing people to go where incomes are higher. The exact same person doing the exact same work can experience as high as a 700% wage premium in the United States compared to their home country. Those forces will meet a backlash from citizens who perceive a threat to their status quo and a strain to their social safety nets. Regardless of the reality of these perceptions, our Westphalian system of governance continues to give significant rights to citizenship and, as long as it does, those with special privileges will fight to maintain their power.

An under-appreciated trend in equality is the decrease in global inequality. Milanovic estimates that the Gini coefficient—a standard measurement of inequality where 100 is complete inequality and 0 complete equality—has dropped from 75 in the 1990s to around 65 now. In essence, some trends in the West that are credited for hollowing out the middle class have come in exchange for a global middle class. John Rawls’s egalitarian framework expresses the injustice we find at imbalances of endowments across a nation, but rarely is that framework applied to the world as a whole. The Rawlsian citizenship lottery is perhaps the single most important determinant of one’s lifetime material well-being, yet people’s sympathies too often stop at their national borders.

There seems to exist some realm of possible policies that acknowledge the gains to migration while not ignoring the fragile political forces that are hostile to newcomers. In essence, higher-income countries can put a wall around the welfare state rather than the country. Milanovic considers policies like guest worker programs that allow a freer flow of labor without putting strain on social safety nets. However, this creates a class of “subcitizenship” that often creates a self-fulfilling prophecy of a lower class not being fully integrated into society. Furthermore, citizens often perceive migrants as leaching off the safety net, despite massive evidence to the contrary and regardless of what the law says they are entitled to.

To understand the future of liberal meritocratic capitalism and how to resolve its most pressing tensions, it’s helpful to consider its past. Milanovic develops a taxonomy separating Western capitalism into three stages: classical capitalism (countries like the US and UK before 1914), social democratic capitalism (1945-1980), and the current liberal meritocratic capitalism (21st century). One defining feature of classical capitalism is that those with high income from wealth rarely had high income from labor. Contrast this with today where those with increasing wealth are also high-income.

The second phase—social-democratic capitalism—was characterized by high collective bargaining of workers, very progressive taxation, and increased universal access to education. All three of these phases have a relatively high concentration of capital ownership and high transmission of advantages to future generations. For those with the impulse to simply re-establish the social-democratic phase, Milanovic points to some difficulties with this era being totally revived. Collective bargaining is more difficult in a globalized labor market where physical proximity of workers is scattered and competition more intense. Also, the gains from increased education to those lower on the economic ladder reaches a point of diminishing returns: Making non-literate people able to read will converge an income gap better than giving a master’s degree to someone with a bachelor’s degree.

His taxonomy of capitalism is a useful way to consider the so-far evolution of the market economy, but his description of the road ahead for political capitalism is far from convincing. His prototypical political capitalist countries—China, Vietnam, and Malaysia—have indeed experienced phenomenal growth rates compared to the high-income liberal meritocratic capitalist countries of “the West.” Yet he goes as far to say, “we should expect that income levels will eventually be similar across the entire Eurasian continent and North America, thus helping reduce global inequality even further.”

This is a stretch. Lower-income countries have the benefits of adopting the technologies of those on the production frontier, realizing the gains from mass urbanization, and the gains from infrastructure improvements by means of brute force. Yet these low-hanging fruits can only last so long.

The history of economic growth at the very least suggests a deceleration at some point, and it’s up to Milanovic to convince the reader that this time is different and China can sustain its incredible growth rates to the point of income convergence. China’s per capita GDP is only about a sixth of what is in Western capitalist countries. Admittedly, China has continued to chug along for decades of high growth for much longer than many economists predicted. Because China didn’t follow the “Western Path of Development,” in Milanovic’s phrasing, many incorrectly assumed it would plateau much earlier. Nonetheless, it does not immediately follow that this growth will last forever or is anything to be desired. It’s hard to take his arguments seriously until a political capitalist country reaches per capita GDP levels within a stone’s throw of liberal capitalist countries.

Milanovic seems to have too high a level of confidence in the bureaucracy of the countries he deems political capitalist. He states that “political capitalism promises much more efficient management of the economy and higher growth rates.” This derives from an idea that authoritarian governments can push optimal policies through without the inefficiencies of red tape that come from democratic accountability. But this “benevolent dictator” fallacy has been proven incorrect: The correlation and causation of authoritarian leaders with higher growth rates is weak and more likely negative than positive.

And again, Milanovic is too closely conflating high growth with good governance. When a country’s starting point is Maoist China, the institutions and groundwork that are ideal for sustained economic growth are so far away that almost anything would be a big improvement. He is comparing rates of change in economic output to absolute levels of quality in governance. He should be comparing rates with rates or levels with levels, but not mixing the two. He goes as far to say that “this remarkable performance of political capitalist countries is something that puts them, at least if prosperity is a key criterion, in competition with liberal capitalism as the best way to organize society.” Would he really prefer China’s type of governance over Hong Kong’s, even if economic performance were the only desired metric? If political capitalistic countries do indeed tend to depend on growth for their legitimacy, an eventual slowdown of growth makes Milanovic’s prediction of political capitalism as a force far less certain, and perhaps even discounted.

With China’s Belt and Road Initiative, China is exercising more of its influence across the world. And perhaps it will in a sense ‘export’ its model of political capitalism to more countries. But is its path truly a prototype for others? Many of the countries other than China he deems political capitalist aren’t also post-communist, and very few post-communist states are particularly political capitalist. India and Indonesia provide glaring counter-examples of how a country can go from colonialism to what he calls “indigenous capitalism” without communist flirtations.

Milanovic considers two hypothetical paths for liberal democratic capitalism: “people’s capitalism” and “egalitarian capitalism.” In people’s capitalism, everyone’s incomes differ from capital and labor but checks are in place to stop a tendency for inequality to rise. In egalitarian capitalism, “everyone has approximately equal amounts of both capital and labor income.” He believes we can objectively evaluate our goals from any new system by looking at concentration of capital income and intergenerational income mobility.

Many of Milanovic’s solutions to the fragilities of the current system are promising. A higher inheritance tax could dampen the intergenerational transmission of advantages, even if not eliminating it entirely. Shifting the wealth profile of the middle class by increasing access to high-returning financial assets could level out wealth concentration. More unconvincing is his assertion that housing wealth itself—a lower-returning and highly volatile asset—should be encouraged. Additionally, exploring alternatives to nonbinary citizenship systems could achieve an ideal balance between increased migration and stronger welfare states.

But a couple of Milanovic’s solutions to the fragilities of the current system are left underdeveloped and with unclear efficacy. Mass investments in public education as a road to curbing inequality are no slam dunk: Government spending on public education in the US has dramatically increased over the last fifty years with shaky improvements in quality. Truly equalizing educational opportunities would involve decoupling funding from local property taxes and nailing down how to provide for the non-schooling aspects of education. At the very least, it is not as simple as finding the political will to turn a knob to “equality” from the spigot of spending.

In the end, Milanovic’s greatest contributions in Capitalism, Alone come from his fresh approach to the history of different capitalist countries. His taxonomy of Western countries evolving from classical, social-democratic, and now liberal-meritocratic capitalism helps us put the current state of affairs into better context and think about the ways policy can and cannot improve the system. While he is overconfident in political capitalism as a dominating force in global politics and a sustainable alternative to liberal capitalism, his analysis of the forces and magnitudes of different kinds of inequality give a more nuanced story than is often found in public discussions.

Featured image is Pin Maker, from Diderot’s Encyclopedia