Social Democracy and Capitalism: The Fraught Link

by Pranab Bardhan

In my earlier column, “Prospects of Social Democracy in a Post-Pandemic World” I did not have the time or space to discuss some systemic issues, like the fraught link of social democracy to the capitalist mode of production. Different people mean different things when they talk of social democracy and its somewhat close kin, democratic socialism. I usually associate the former with the mode of production remaining essentially capitalist, though with some important modifications, and the latter with the case where the ownership or control of the means of production is primarily with non-private entities (the state or cooperatives or worker-managed enterprises). In this sense Bernie Sanders and his followers wrongly describe themselves as democratic socialists, to me they are social democrats.

In social democracy those important modifications to the capitalist mode of production may involve some substantial reform in the governance of the firm and in the fiscal power of the democratic state to raise taxes to fund a significant expansion of redistributive and infrastructure programs. Yet these modifications will remain constrained by what used to be called the ‘structural dependence’ on private capital. How far that structural limit can be pushed will vary with a country’s institutional history, political culture, and social norms. Much will depend on how far the modifications of capitalism can leave unhampered the mechanism of productivity growth and innovation, which Schumpeter considered the engine of capitalist dynamics. Is there a magic balance achievable under social democracy? This will be central to my discussion in this article, as I often find that my social-democratic and democratic-socialist friends do not pay adequate attention to the question of innovations. I shall also comment on the need for significant reforms in the financial system, labor market policy and election funding for a social democracy to function properly,

Firm Governance and Innovations: Workers’ Voice     

Social democrats often insist on a larger voice of workers in the governance of the firm.(In the US presidential primary campaign Elizabeth Warren was a main proponent).  At a time of widespread job losses this can be particularly important in influencing the firm’s decision to outsource or relocate. Outside the firm they also demand anti-monopoly regulations not just because corporate concentration of power is bad for an efficient economy and democratic polity, but also because such concentration of buying power in the labor market (what economists call ‘monopsony’ power) weakens labor’s bargaining strength. They also ask for an active role of labor in the negotiations on international trade agreements, which are currently shaped by powerful corporate lobbies. Similarly, unregulated financial capital that often destabilizes capitalism and unregulated international capital mobility are vehemently opposed by social democrats as they weaken labor’s bargaining power and job security.

To all this one may raise the objection that with this kind of restrictions social democracy hurts the cause of technological innovations, and thus productivity growth and improvements in our standard of living. I am going to argue that this is not necessarily so. But before I go there, let me mention two issues relevant here which are not central to my argument. One is that some kinds of ‘innovations’ particularly in the financial sector (like the cleverly repackaged mortgages that were used in ‘subprime lending’ in the US), that became prominent before the financial crisis of 2008-9, are surely not worth the great devastation the crisis caused, or that their effects on productivity growth in the real economy are at best minimal. Secondly, on a more personal note, whenever I have visited Japan in the last two or three decades (the so-called ‘lost’ decades, of stagnation) I had come away with a sneaking feeling that for all the stagnation the Japanese standard of living is reasonably comfortable, and if it can be rendered environmentally and fiscally sustainable, maybe they, and other rich countries, do not need a frantic pursuit of more and more innovations. The story is, of course, different for developing countries, where productivities and living standards are still very low. But for these countries the challenge often is not that of really new innovations, but of catch-up and adaptive technical changes.

The question of technological innovations under systems that are alternatives to capitalism is important not just today, but it has played some role at least in Europe in the evolution of social democracy. There was a time in the immediate postwar period when the workers in some west European countries were sufficiently politically powerful to have the capacity to democratically upend much of the capitalist system if they really wanted to, and replace it with some form of democratic socialism. But astute consideration of the prospect of more innovation and productivity growth under capitalism persuaded many of their leaders that the workers’ share of a larger economic pie will in the long-run get them more, even at the expense of allowing a significant share of the pie to the capitalists.

But what about a larger role of labor in firm governance? Does it hurt innovations? Germany is one major country where some social democratic institution for voice of labor in the governance of the firm (in the form of works council or Betriebsrat, or more generally what is called codetermination or shared governance) has been active for some time and for which some empirical analysis is available. Although codetermination is there in some other countries of continental Europe (and recently spread to Canada and South Korea), it started earliest in Germany and worker representation in supervisory boards of large companies there has reached parity with shareholder representation. The worker representatives have a significant influence on investment and financial decisions and control of executives. Observational data on German works council suggest a generally positive effect on productivity, particularly if the firm has profit-sharing and collective bargaining arrangements. They also help in building trustful industrial relations, in improving information channels between managers and workers and in carrying out environmental goals, like emissions reduction. (Of course, trustful industrial relations are so scarce in the hierarchical workplaces, as in say much of US and India, that one may need more social and structural changes before codetermination can even begin to work.)

Recently a Berkeley colleague of mine, Ben Schoefer and co-authors have gone beyond observational data and used quasi-experimental evidence on German firms to come out with some interesting results on the effects of shared governance. They show that shared governance significantly raises firm productivity, without negative effects on profitability, on capital investment or on capacity to raise external finance. They also show that it reduces outsourcing by the firm, and improves women’s representation in the supervisory board.

Of course, not all productivity improvements are innovations, a great deal of it is catch-up and adaptation of technology. Not all innovations are fundamental breakthroughs, and often the real breakthroughs are products of basic research in public organizations (including the military, like that of internet and GPS in the US) and publicly subsidized institutions like universities and public laboratories. Commercial applications are usually made by enterprising private companies. Even in commercial innovations, one may distinguish between ‘disruptive’ innovations (which often upend incumbent firms and are close to the ‘creative destruction’ Schumpeter had in mind) and steady ‘incremental’ innovations (akin to what the Japanese call kaizen), which can be carried out even in large incumbent firms, but over time cumulate to quite a lot of productivity change. In Germany, Japan, South Korea, etc. the innovations are more often of this incremental kind. And there is no reason why, a social democracy committed to public and private investment in Research and Development cannot accomplish a steady stream of such incremental innovations.

Disruptive innovations funded by venture capital (taking a significant stake in start-ups) are more common in the US, but even there disruption in the form of exit of established firms is not that common now; more often established firms with deep pockets co-opt or buy up start-ups that are potential rivals–what Facebook did with Instagram and WhatsApp, and Alphabet with YouTube are well-known recent examples from the Big Tech sector. For Germany the quasi-experimental study cited above shows that shared governance did not have any differential effect in firm exit (or facing of bankruptcy) compared to other firms, which means labor representation did not significantly block firm exit or restructuring. But there is some indirect evidence that worker-elected representatives on the supervisory board of the firm can have longer horizons in matters like investment and more stake in the firm compared to the outside shareholder members of the board. This may make it easier for a firm to take up innovative projects with larger risk but higher return. One may also mention here that one important rationale for universal social protection systems (like universal basic income) is that by delinking the economic security issue from being tied to particular jobs such systems may make exit of inefficient firms or plants more acceptable to workers.

Firm Governance and Innovations: Mixed Ownership

There is also considerable evidence—cited in the work of the labor economist Richard Freeman and co-authors–of positive productivity effects of employee stock ownership and profit-sharing, as, for example, shown in a large 2007 study commissioned by the Treasury Department of the British Government. Studying the workers in US firms with meaningful programs of shared capitalism and a supportive culture of participation, and contrasting them with workers in firms that do not have such programs, Freeman finds the former to have more loyalty to the firm and pride in their work, and a willingness to think more innovatively and make creative suggestions.

Apart from more worker voice in firm governance and stock-ownership, social democracies may also try to experiment with some mixed (public-private) ownership and see if that helps or hinders innovations. We do not have much hard evidence on this but there are useful anecdotes. Most recent such anecdotes are from China (even though China is definitely not a democracy, the results about mixed ownership on innovations need not depend on its authoritarianism per se). In the desperate technology race that China has launched vis-à-vis the US there are now stories about some mixed-ownership firms doing reasonably well, benefiting both from long-term finance provided by the state and equity capital and risk initiatives from the private owner-partners. In the integrated circuits sector, for example, a recent mixed-ownership semiconductor company, YMTC, established in 2016 is already reported to be making memory chips almost as advanced as the world’s best (like those by Samsung from South Korea). There are similar stories from state-aided and –guided Chinese private firms in Artificial Intelligence (AI), where in some types of AI application the US is no longer the leader. Of course, with mixed-ownership and state-aided private firms there is always the danger that too-big-to-fail (or too much of a state favorite to fail) ventures after some time may turn into cozy rental havens, prone to ‘socializing’ losses and ‘privatizing’ profits. Keeping international competition open can, however, act here as a healthy disciplining factor, as the recent history of Japan, South Korea and Taiwan suggests.

Apart from aid and mixed ownership in firms the state can sometimes play a catalytic role in the innovation process through coordination and directional guidance, shaping the market expectations, creating demand through public procurement practices, and underwriting risks and making strategic initial investments. There are many examples of all this cited in the book by Mariana Mazzucato, The Entrepreneurial State. As she illustratively points out, every bit of technology that makes the iPhone so ‘smart’ was government-funded—the Internet, GPS, its touch-screen display and the voice-activated virtual assistant Siri.

In discussing the role of the social democratic state or the firm in the innovation process it is also important to stress that the pattern of innovations may be just as, if not more, important as the rate of innovations. If workers have a strong voice in the running of a firm and also in the general polity outside, it may be possible to redirect investment in new technology by a firm and by public authorities that conform more to social priorities—labor-absorbing and labor-empowering rather than labor-replacing technology, environmental and other long-run goals instead of short-run profits and monopoly rights –even with private patents the state may buy them and put in the public domain to accelerate future research and innovations, as, to take an early example, the French state did for the patented photographic invention of Louis Daguerre in 1839, which led to a rapid development of photographic technology.

Nordic Social Democracy and Innovations

It is worth stressing that Nordic social democracy has been quite conducive to innovations. Taking the rough country ranking estimates of the Global Innovation Index (reported by WIPO, the World Intellectual Property Organization), the ranking score for 2019 was slightly higher for Sweden than for US, and slightly lower for Finland and Denmark. The two most conspicuous features of the wage determination process in Scandinavian countries are compression of wages between high- and low-productivity firms and industries, and the confederate, rather than local, collective setting of such wage patterns. The relatively low wages in high-productivity firms/industries and hence higher profitability stimulate innovations as capitalists get to keep much of the surplus, when they invest in new technology. Contrary to popular impression the Scandinavian economic model is thus as much about dynamic capitalist efficiency as about equality—this was clearly stated in the original exposition of the model by two Swedish trade union economists Gosta Rehn and Rudolf Meidner in 1951, and subsequently developed by Scandinavian academic economists like Karl Ove Moene. Of course, these distinctive features of the Scandinavian model may be difficult to reproduce in countries with different labor institutions and cultural mores. In US and India, for example, labor bargaining, where it exists, is much too decentralized; a confederate mode of wage bargaining will require a major restructuring of labor institutions. Similarly, in both countries a repression of salaries of high-skilled workers and managers may induce large-scale emigration, to an extent that is not common in Scandinavian socio-cultural context, in spite of the fact that post-tax post-transfer household income in the top decile is much higher in US and Canada than in Sweden or Denmark. (These problems of social democracy in one country, when the surrounding world is different, may be akin to the problems of ‘socialism in one country’ that Trotskyists used to worry about in the now long-gone past).

Democratizing the Sphere of Capital, Both Tangible and Intangible

The ‘democracy’ part of social democracy should apply as much to economic democracy as to political. Our preceding discussion on the voice of labor in the governance of the firm and outside has already involved a major part of that economic democracy. Similarly, the call for anti-monopoly legislation is aimed at reducing concentration of economic power. In the US contrary to the prevailing view of anti-trust, influenced by the Chicago School, that looked primarily at the effect of monopoly on prices and consumer harm, there is a new generation of legal scholars (sometimes described as followers of the neo-Brandeis movement, following Justice Brandeis who had pointed to broader effects of concentration) who look at the impact of concentration on all stakeholders in the economy, including workers, producers and citizens, not just the consumers. This allows them, for example, to look at the adverse impact of the giant Tech companies, even when they are reducing prices for consumers (like Amazon), or providing services at what seems like zero price (like Google or Facebook). Not merely should social democrats embrace this wider view of anti-monopoly, they should also join in a growing demand for Big Tech to pay back for the ownership and control of massive amounts of private data that they are collecting from their billions of customers and using profitably (apart from aiming at installation of appropriate privacy protection systems and antidotes to ‘surveillance capitalism’). Andrew Yang, another contender in the US Presidential primary campaign, has launched a campaign for Tech firms to pay users a ‘digital dividend’ for their data. Since the state may be in a better position to bargain with Big Tech than the numerous, often unwitting, suppliers of the data, it may act on behalf of the users in return for a share in that dividend going into a public fund. (As it is, already the state in countries like China and India have got involved in making sure that the data from their citizens remain within the country). In general the aim of economic democracy should be to curb the growing power not just of tangible capital but of this kind of intangible capital as well.

Apart from Big Tech, one area of heavy concentration of largely intangible capital is that of Finance. Their concentrated power and excessive risk-taking allowed them to precipitate the Financial Crisis of 2008-9 and the attendant world-wide devastation, and then to come out of it with relative impunity. In the US even today just 3 private asset-managing firms, BlackRock, Vanguard, and State Street, together own about 20% of all firms on the S&P 500 index. In this context social democrats should seriously consider a public option in the financial system. The Roosevelt Institute, a think tank in New York has called for a Modern Reconstruction Finance Corporation (somewhat on the lines of a similar financial authority in the New Deal era) to help fund the proposed Green New Deal. Social democrats in all countries should try to redirect the pension funds of workers toward such public finance authorities that facilitate public investment in the service of social and environmental goals (projects like mass transit, affordable working-class housing, public broadband, public health and sanitation, and so on).

In doing this there is, however, a lot to learn from the mistakes in handling the public option in the financial system already in use for many years in countries like India, where public banks and insurance companies have been abused by politicians for dud loans to crony private companies and for parking Government debt to cover unproductive expenditure. The public development banks in East Asia (and Germany) have a somewhat better record. For countries with mainly private banking systems it has also been suggested that if the Central banks allow all citizens to open free bank accounts directly with the Central bank with all the usual facilities of a commercial bank account, then this public option can reduce the monopoly power of the big banks, apart from making it easier to run monetary policy and fiscal stimulus programs in a crisis. Morgan Ricks, John Crawford and Lev Menand have called for such a ‘FedAccount program’ for the American public.

In the US where the safety net is patchy and in developing countries where it is often non-existent, particularly for the vast masses of informal workers, social democrats supporting a generous welfare state (including a significant universal basic income) have to think about restructuring the whole public finance system, including streamlining the existing structure of subsidies (many of them mainly going to the rich and middle classes or taking the form of energy-inefficient fuel subsidies) and revamping the system of raising taxes from the rich (like more progressive income taxes, wealth, capital gains, and inheritance taxes, and a reformed system of local property taxes). This will be difficult if they do not simultaneously (and in coordination with other countries) put restrictions on international capital mobility and flight to offshore tax havens. It has been suggested by some that a tax on foreign financial transactions collected by individual countries may be contributed to a Global Environmental Fund, from which developing countries that usually suffer most from flight of financial capital, can borrow at a concessional rate for investment in mitigation of environmental degradation. (One, of course, has to keep in mind that in a world of digital super-connectivity there are some limits to restrictions on capital mobility and taxes on financial transactions).  In addition to raising the tax rates, for expanding the tax base (and, of course, for other labor-friendly objectives) social democrats should also keep the goal of high level of employment as a top priority. North European and other social democracies have often achieved this with active labor market policies for retraining and re-skilling, wage subsidies, and with public care-giving services which enable women to participate in large numbers.

Public Funding of Elections

The ‘democracy’ part of social democracy will remain essentially rigged as long as politicians mainly depend on large corporate donations for the increasingly expensive elections. It is now recognized that the Blair-Clinton-style social democracy wedded to High Finance is doomed to failure, both for the ‘social’ and the ‘democracy’ parts. But the most egregious recent case of a major social democratic party crashing under the burden of corruption is that of PT in Brazil. The corruption scandals clearly involved personal greed of some PT politicians, but much of the money illicitly procured was to feed the political machine of the party, that needed large sums to fund elections and to lubricate the post-election wooing of legislators of allied parties to rally behind particular policy programs. In the US the largely unregulated, and court-sanctioned, role of corporate money for campaign finance before elections and for lobbying of legislators between elections has made a mockery of democracy and rule of law, when these laws are essentially for sale. The situation is in some respects even worse in India, where the ruling party legally raises corporate money many times the total raised by all the other parties combined, not to speak of the undocumented illegal finance. Matters have been made murkier by the con game of what is called electoral bond (with very little disclosure requirement), introduced by the current regime under the guise of what was called electoral reform. In order to raise money some smaller parties at election time now sell their party ‘tickets’ for contesting elections to the largest contributors to the party fund.

Social democrats have to seriously consider the alternative of public financing of elections, with, of course, a system of strictly enforced limits on (and independent auditing of) expenditure by both parties and candidates. It is worth learning from cases of relatively successful reforms in public funding of election in some social democratic countries. In Canada there is substantial public funding with stringent regulations on ceilings of election spending; there are also tax incentives for small contributors. Germany uses public grants that match the funds from small contributors. Sweden, where corporate donations used to be a major source for political parties, public subsidies are now generous enough for the parties to voluntarily stop accepting corporate donations.

Social democracy to be viable and vigorous has to grapple with these systemic issues arising from the structural dependence on capital, by increasing the role of labor in firm governance, influencing the pace and pattern of innovations, democratizing the financial and fiscal space, and draining the current swamp of electoral funding.

Of course, the oligarchic interests of business and capital that now dominate most democratic polities will not easily give up on the powers they have acquired. Apart from the obvious uphill task of social movements and mass organizations in forcefully pushing an alternative political agenda and moral narrative, it may be possible to persuade some sections of the business world that social-democratic improvements in workers’ participation, welfare and morale within a modified framework of capitalism may not conflict with their long-term interests of productivity and profits, that capitalism can be saved from myopic capitalists.