January, 2019

Randall G. Holcombe: Political Capitalism

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Political capitalism: how economic and political power is made and maintained sets out to convince the reader that a new economic system has emerged in countries like the United States. This system, which Holcombe refers to as political capitalism, is defined by cooperation between the political and economic elite for their mutual benefit at the expense of the masses. While there is widespread agreement across the political spectrum about the symptoms of political capitalism—cronyism, clientelism, etc.—the underlying structure of the system is not well understood and thus there remains substantial disagreement surrounding what, if anything, can be done to reform it. Holcombe’s goal is to identify the causes of political capitalism in order to provide a framework for understanding which reforms can effectively limit its negative effects.

The book consists of three parts. In the first part Holcombe introduces the concept of political capitalism, arguing that it is a unique economic system and must be studied as such. In Holcombe’s opinion, one of the reasons that social scientists, and economists in particular, have not yet recognized political capitalism as a distinct economic system is that comparative systems analysis has fallen by the wayside in the wake of communism’s collapse. As a result, economists have failed to analyze interventions into the market economy systematically; instead, economists evaluate the effects of one-off interventions in isolation, not recognizing the systemic influence that these interventions have on broader economic, political, and social institutions.

In the second part of the book, Holcombe provides a detailed overview of the components of political capitalism. The first component is elite theory. This theory places people into one of two groups: the elites and the masses. Those in the former group have the power to establish the rules within which the government compels everyone to interact. For Holcombe, this distinction is at the core of political capitalism; it creates a discontinuity that influences the behavior of everyone in the polity. The source of this discontinuity, and the second component of political capitalism, is the transaction costs faced by the elites and the masses. Here Holcombe draws on the Coase Theorem to make his point. The elites are members of what he refers to as the low transaction cost group, while the masses are members of the high transaction cost group. These transaction costs prevent the two groups from bargaining with each other to adopt Pareto reforms. Instead, members of the low transaction cost group–the elite–bargain with one another for mutual benefit all while imposing the costs of their preferred policies on the masses, who are largely powerless.

The next component of political capitalism is rent seeking. Holcombe argues that the concept of political capitalism refines our understanding of this behavior by highlighting the institutional setting within which rent seeking takes place. Holcombe criticizes the standard approach to rent seeking that emphasizes full rent dissipation by noting that both the rent seekers—i.e. the economic elite—and rent creators—i.e., the political elite—can mutually benefit if they can devise mechanisms that limit access to politically-created rents. By separating people into high- and low-transaction cost groups, the elites can restrict access to the political system, preventing full rent dissipation.

The fourth component of political capitalism is the combination of transitional gains (and losses) and rent extraction. Holcombe argues that the transitional gains trap is not a mistake. Instead, the political elite intentionally create rents that are capitalized into the value of the affected assets in order to subsequently extract these rents from the recipients of the favorable legislation by threatening to deregulate. In so doing, the economic elite must participate in the system or risk going out of business. One of the reasons that regulations are written vaguely, Holcombe argues, is to facilitate this type of exchange. Vagueness provides a cover that allows the political elite to sell forbearance to the economic elite.

The final component of political capitalism is the regulatory state, which incorporates all the other components. In Holcombe’s view, political capitalism finds its origins in the regulatory state. The goal of regulation is to induce people to behave in a way they otherwise wouldn’t, and as a result creates an opportunity for exchange between the regulator and the regulated. Not everyone has access to this type of exchange, however; only those who are in the low transaction cost group—the elites—are able to influence the pattern of regulation. Not only do vaguely-written regulations create a space for political exchange, they also enable the regulators to limit who has access to beneficial regulations, preventing full rent dissipation from occurring.

The last part of the book begins with an examination of the link between democracy, Progressive ideology, and political capitalism. Holcombe distinguishes between two views of democracy. The first is a system wherein the voters choose representatives that are subject to constitutional constraints—i.e., they are essentially stewards that manage the constitutionally-authorized functions of government. The second view of democracy is a system wherein the voters decide what actions the government will undertake, irrespective of whether the constitution authorizes those actions. In Holcombe’s view, this latter notion of democracy, when combined with Progressive ideology, gave rise to idea that the government’s role is to ensure the economic well-being of its citizens, who express their general will through the voting process. This idea acts as a moral cover for the elite by legitimizing their actions and allows political capitalism to spread.

Next, Holcombe turns to the institutional evolution of political capitalism. In his view, as market economies become increasingly complex and the ownership structure becomes more sophisticated, so too must the regulatory environment that provides third-party enforcement. Thus, the regulatory state is an unavoidable by-product of capitalist development. As the size and scope of government expands, so too does the opportunity for the elites to shape the “rule of the game.” Thus, Holcombe argues that unless the constraints on the elite evolve alongside the market and the state, there will be an inherent tendency for market economies to evolve into political capitalism.

In the final two chapters of the book, Holcombe addresses the challenges that must be overcome if the system is to be reformed and whether political capitalism is inevitable. He sees three challenges with limiting the power of the elite. First, policymakers are part of the elite. Since they are currently benefiting from the status quo they are unlikely to be to keen on reforming it. Second, those who wish to reform the current system must agree on how it can be controlled, which requires an understanding of how the system operates. Holcombe sees the power of ideas as the solution to these two challenges. Reform will require widespread opposition to political capitalism and widespread agreement on how best to limit its influence. The final challenge is to devise institutional mechanisms that can limit the inherent tendency for market economists to evolve into political capitalism. Here, Holcombe sees a reinforced system of checks and balances as the institutional mechanism most likely to constrain the elites.

I do have a couple of minor criticisms of the book. First, Holcombe treats the masses as if they respond passively to the elites’ actions. This follows logically from the transaction cost framework that Holcombe employs to highlight the difference between the elite and the masses. Nonetheless, the masses have other options available to them—e.g., altering their production patterns to reduce the size of the extractable surplus that the elites can capture via changes to the institutional structure. In McChesney’s (1987) rent extraction framework, for example, private entrepreneurs respond to the possibility of rent extraction by making investments that are less easily expropriated. Second, given the importance of both ideas and policymaking in Holcombe’s account of the emergence of political capitalism, I was surprised that he didn’t discuss the role of academics in this system. Surely the academic elite play a part in shaping economic policy and influencing ideology. For instance, early influential progressives, like Richard Ely, were academics who shaped both public opinion and policy. Moreover, it would seem like the same “gains from trade” that exist between the economic and political elite also exist between the political and academic elite.

Nonetheless, Holcombe has made an important contribution to our understanding of the current political economy of the United States and other advanced capitalist economies by laying the groundwork for a fruitful research program. Accordingly, while I would recommend this book to anyone interested in the relationship between the state and the economy, scholars interested in working on this type of research will especially benefit from engaging with the ideas presented in Political capitalism.