The Roots of Modern Capitalism

Bruce Scott

Capitalism and democracy typically did not arise together in history, according to Bruce Scott. Whether they can continue to dominate the world’s systems of commerce and government raises a new question, he says. Scott is Paul Whiton Cherington professor of business administration at Harvard Business School and the author of a forthcoming book called Capitalism, Democracy and Development, to be published later this year by Springer Verlag.

At least since the 1835 publication of Alexis de Tocqueville’s remarkable Democracy in America, the United States has been known for its particular marriage of capitalism and democracy — decentralized decision making in both the economic and political realms.

Although there is no consensus definition of capitalism, since 1990 it has become the near-universal economic system, encompassing China and India, though not Cuba or North Korea.

Democracy is still more difficult to define, and the number of democracies varies depending upon the definition used. Yale University political scientist Robert Dahl calculates that more than half the 200 United Nations member countries, with perhaps two-thirds of the world’s population, could be characterized as democracies.

Thus capitalism, though imprecisely defined, has achieved near-total dominance in the global economy, and democracy has become the normative model if much less dominant in fact: China has built a hugely successful capitalist system but still maintains an authoritarian regime.

We need to define capitalism and democracy with more precision before we can predict whether they will continue to dominate as systems of commerce and government. First, there are varieties of capitalism; the U.S. variety differs from the European, for example, with Europe’s stricter market regulation and more egalitarian incomes.

Second, discussions of democracy tend to focus on processes for citizen participation while neglecting to consider whether that participation actually assures democratic outcomes. President Abraham Lincoln’s 1863 address at Gettysburg called the Civil War a test of whether “government of the people, by the people, for the people” would endure. As Lincoln implied, government by the people does not assure government for the people. As Lincoln was speaking, the United States had already enjoyed almost a century of government by the people yet had turned a blind eye to slavery, as though blacks were not people. It had turned an almost equally blind eye to the political rights of women.

Furthermore, the U.S. constitutional model divides sovereignty among three branches of government — legislative, executive, and judicial — while most other democratic regimes follow the British precedent, concentrating sovereignty in the popularly elected lower house of the legislature.

Defining Capitalism

Following is an attempt to provide an operational definition of capitalism, to show how it arose in history, and to suggest some conditions favorable to — and perhaps even essential for — democracy.

Many economists define capitalism more or less as a system of property rights coextensive with markets for production and consumption of goods and services, governed by the “invisible hand,” to use Adam Smith’s famous metaphor, which sets prices in line with demand and supply.

I prefer some political scientists’ definition of capitalism as a system of governance that originates with state permission for non-state actors to exercise economic power, subject to a set of rules and regulation. Under this definition, capitalism depends upon a delegation of power from the state to economic actors and upon the coercive power of the state to design, monitor, and ultimately enforce market regulation. The pricing mechanism coordinates supply and demand within a given market framework, while the visible hand of government enforces the framework and keeps it up to date.

While the state needs to be accountable for its legitimacy, that accountability need not be to a democratically elected government in order for capitalism to flourish. Venice, perhaps the earliest example of sustained capitalism (since at least before 1200), was no democracy; it was essentially a constitutional monarchy, its seven islands having formed a voluntary union governed by an elected duke.

Ending border controls, as here at the German-Polish border, signals freedom of movement, a requirement of capitalism.

Capitalism emerged well before large-scale democratic states, and political scientists see the existence of decentralized market-based decisions in the economy as a prerequisite for decentralized political power through democracy.

While democracy at the level of cities seems to date from ancient Greek and Roman times, no democratic states were clearly apparent before De Tocqueville’s observations on America, and his American example is the one case where some would argue that the two systems of democratic government and capitalism grew up together starting about 1630.

The historian Fernand Braudel, who dated the origins of capitalism to 1400-1800, admitted that he was unable to define capitalism, yet he recognized importantly that it was a system of economic relationships incompatible with feudalism, another system of economic relationships. Trade in goods and services did exist in many feudal contexts, such as those of the Aztecs, the Incas, Japan of the Shoguns, imperial China, India, and the Ottomans.

Ceding Power

Capitalism requires free movement and employment of labor and the right to buy and sell land, which were not compatible with feudalism. It recognizes that interest payments are a legitimate return on capital, and it provides the right for non-state actors to mobilize capital through legal vehicles such as partnerships, joint stock companies, and the modern corporation. All of these freedoms imply not only an end to feudalism, but also the willingness of the sovereign state to cede such power to non-state actors.

This concept makes clear that capitalism emerged in Europe long before elsewhere, with the exception of the United States, where European settlers brought many ideas and institutions with them.

Why did capitalism emerge in Europe? There is no single answer, but an important and distinctive element of the European experience was nearly continuous warfare in the 16th and 17th centuries. This political-military competition placed great strains on the existing political units in Europe, which have been estimated to be as many as 500 in 1500 and as few as 40 by the end of the Napoleonic wars in 1815 and 25 in 1940.

As with economic competition today, the chances for survival of a political entity then were much higher if it had an effective army, and the size of the guns and armies got dramatically larger over the centuries. Political entities that would survive needed money or at least borrowing power. Decentralization of power to would-be entrepreneurs and traders was a potential source of income for those rulers who would tolerate decentralized power. And constitutional monarchies, which borrowed money with the consent of parliaments, had much lower borrowing costs.

The historic preconditions for capitalism seem to have been competitive threats to sovereignty and autonomy on the one hand and accountable government on the other. Japan, China, India, and the Ottoman Empire had neither for centuries.

The preconditions for democracy seem to include control of the military and police by elected officials; a state with a monopoly of coercive power, including the coercive powers of the courts and the power to provide security for persons and property; the existence of markets for production and consumption; and acceptance of Enlightenment values, notably the notion that ultimate political authority is vested in human institutions that have been derived from human reasoning.

A number of conditions favor continuance of democracy, including rising incomes, avoidance of excessive inequalities in the distribution of wealth and power, a strong and well-mobilized middle class, and an accepted code of ethics, balancing individual self-interest against the responsibilities of citizenship.

Other conditions can threaten democracy. One of these is large sources of unearned income, such as so-called mining rents from oil. Nigeria and Venezuela are examples. The unearned income becomes a huge source of wealth and patronage for government leaders and thus a springboard to unaccountable power.

Building the underlying conditions to support democracy takes decades, and starting prematurely may not hasten the process, as evidenced in Bosnia, Kosovo, Iraq, Lebanon, and the West Bank. A number of European countries, such as Britain and the Netherlands, were well governed long before they became democracies.

Constitutions and elections do not alone necessarily signify democracy, as evidenced in contemporary Nigeria, Venezuela, and Zimbabwe. Constitutions and elections can be manipulated by elected leaders, and focusing on the establishment of these procedural aspects of government by the people may, in fact, delay its creation, let alone the creation of government for the people, which is more difficult still.

The opinions expressed in this article do not necessarily reflect the views or policies of the U.S. government.

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