Understanding Capitalism

An Introduction to Political Economy

Under contract with Polity Press (UK) / Wiley (US).

Draft contents

  1. Capitalism in crisis?
    1. The meaning of “capitalism”
    2. Inequality and other legitimacy problems
    3. The productivity slowdown
    4. The culture of capitalism
  2. Origins of capitalism
    1. The Industrial Revolution
    2. Mercantilism and colonialism
    3. The birth of modern finance
  3. Markets as exchange
    1. Adam Smith revisited
    2. The basic trade model
    3. General equilibrium
    4. Economic growth
    5. Is capitalism sustainable?
  4. Law and politics as exchange
    1. Externalities and property rights
    2. The calculus of consent
    3. Public reason
    4. Self-governance
  5. Conflict as exchange
    1. The transitional gains trap
    2. The bargaining model of war
    3. The paradox of power
    4. Inequality and social unrest
  6. Market power
    1. Labor-capital relations
    2. Creative destruction
    3. Corporate social responsibility
  7. Varieties of capitalism
    1. Mapping institutional diversity
    2. The equality-efficiency trade-off
    3. Is the Chinese model viable?
  8. Alternatives to capitalism?
    1. The socialist calculation debate
    2. Worker cooperatives
    3. The prospects for anarchism

The book starts with an overview of the contested definition of capitalism, and I discuss the main challenges the system faces in terms of income distribution, economic uncertainty, environmental protection, and growth stagnation, as well as its individualistic cultural norms.

Chapter two delves into the economic history literature. Why did the Industrial Revolution start in Britain, and what role did the institutions of capitalism play? What is the connection between colonialism and modern global inequalities? How did modern finance get started and why are financial markets are so much more powerful than old patronage systems?

Chapters 3 and 4 explore the idealized version of capitalism as a system based on voluntary exchange. Beyond the simple model of trade and the revisiting of Adam Smith’s model of economic development, I explain how property rights might be created by Coasean bargaining, how Posnerian judges are supposed to act, and introduce the social contract theory of politics to explain how we would ideally select different institutions for collective action for different tasks and circumstances.

Chapters 5 and 6 move from the idealized version of capitalism to the real world system, marked by conflict and disruption. I cover both the darker sides of real world capitalism, like rent-seeking and violence, and the more positive examples like the existence of corporate social responsibility.

Chapter 7 overviews the varieties of capitalism literature, which details the various social-economic trade-offs that different societies might make, and, also that different individuals within those societies might support. This part also discusses the development of China and its role in the global economy. The book concludes with a chapter on possible alternatives to capitalism, such as socialism, worker-managed cooperatives, and anarchism.

Description

This book provides an introduction to the study of capitalism. To understand capitalism we need to understand both its history and its alternatives. The economic and political institutions that underpin modern capitalism have a long and difficult history, and some of them have faced and continue to face fierce contestation. This book explains the role these institutions play in enabling economic progress and continued prosperity, and identifying the nature of the challenges that one must face when thinking about alternatives to capitalism or, more modestly, about reforms to capitalism.

Almost since its inception, capitalism has experienced periodic crises of legitimacy. Each time the concerns about the basic justice and equity of the system have reached their peaks, a re-evaluation of the system has followed, usually accompanied by various policy and institutional changes. We are once again in a period of low legitimacy and high doubt, partly as a consequence of the long shadow left by the 2008 financial crisis, partly due to longer term problems, such as the decline in productivity and low growth in real wages since mid-1970s, and partly due to broader changes in culture, such as the increased attention paid to gender and race issues. It is thus time for another re-evaluation of the system, but what I propose in this book is a broader re-evaluation, taking into account the entire history of capitalism and its challenges. Rather than focusing too narrowly on the present crisis of legitimacy, which risks over-emphasizing transient issues, we should consider the bigger questions: Why is capitalism suffering from such periodic crises of legitimacy? Is there a viable alternative to the system? What have we learned from the failure of socialism? Is China’s “state capitalism” a genuine threat to democratic capitalism? Can the system be reformed such that it becomes more robustly stable while maintaining its capacity for growth, or is a life of perpetual disruption and uncertainty the best we can hope for? Are certain varieties of capitalism inherently more desirable than others or are we stuck forever arguing about difficult trade-offs? Are the capitalist systems moving in some predictable direction or is the future entirely open-ended?

How markets function and the outcomes they deliver, in terms of growth, equality, stability and other indicators, depends on the overarching institutional framework within which economic activities happen. This institutional framework includes basic “rules of the game” such as the definition and enforcement of property rights, as well as a variety of goods and services provided by government, and the regulatory constraints upon private actors. These economic institutions, in turn, depend on existing political institutions and the cultural milieu within which politics operates. The extent to which economic activities lead to inclusive benefits in society or, on the contrary, benefit only a small privileged sub-set of the population, depends on the interactions between politics and economics.

Introductory economics textbooks all too often ignore this institutional background and the political processes that ultimately determine economic and social outcomes. This is where political economy enters the picture. Political economy, on one hand, uses basic economic models to make sense of the otherwise bewildering complexity of the economic, social, and political world. But, on the other hand, it takes psychology, sociology and politics seriously. Rather than assuming a world of perfectly competitive markets, structured by exhaustive contracts that are always credibly enforced at zero costs, and rather than assuming a world of perfectly gentle people who never steal or kill each other, political economy takes the world, and its people, at face value.

Starting around 1960s, the economics profession rediscovered political economy and the importance of institutions, but it did so with the advantage of the rigor of newly developed tools, from game theory to econometrics. Three new sub-fields of economics have since emerged exploring political economy questions with these modern tools: Public Choice, Economic History, and New Institutional Economics. In parallel to these developments, and partially overlapping with the normative side of Public Choice theory, a revolution in political philosophy occurred in the 1970s, spurred by the works of Rawls and Sen, and eventually giving rise to what we now call non-ideal theory and public reason liberalism. These works recreated social contract theory using modern tools, and borrowed the exchange paradigm from economics to analyze the problem of justice.

We are now at a stage in which a remarkable wealth of knowledge, both empirical and theoretical, has accumulated out of these fields, but it is still largely confined to narrow expertise. This knowledge is highly relevant to understanding capitalism and its crises of legitimacy. This book summarizes this knowledge for a broader audience, such that it is accessible both to the interested general public, and to undergrads taking classes in Politics, Philosophy and Economics (PPE) programs, as well as classes in institutional economics, public choice, economic history, and varieties of capitalism taught in many economics and political science departments.