Categorized | Economics, Global Economy, US, World

Piketty’s Puzzle: Globalization, Inequality and Democracy

Image by Abode of Chaos

Image by Abode of Chaos

One of the most striking trends of modern times, the concentration of global wealth in hands of the very few, has been popularized by Thomas Piketty in his hugely influential Capital in the Twenty-First Century. Piketty argues that the rate of return on capital consistently exceeds the rate of economic growth. In the absence of more aggressive state intervention to redistribute wealth from rich to poor, Piketty’s economic law means that we will see an acceleration of inequality since the rich will always own a disproportionate share of capital. What does this increase in inequality mean for democracy? I sympathize with Piketty’s view that a significant increase in existing inequalities of wealth may be harmful to the quality of existing democracies. The legitimacy of democracy depends, at least in part, on producing outcomes that citizens think are fair. A rapid growth in inequality risks undermining this implicit contract between citizens. However, we also should consider the impact of inequality on the process of democratization. Our globalized world, with its high levels of financial integration and mobility of capital, may have the curious side effect of making transitions from autocracy to democracy more likely.  So while it is right to think consider how inequality will change established democracies, we should also think about what it means for the possibility of transitions to democratic government in autocratic states.

Political scientists often consider the transition from dictatorship to democracy in game theoretical terms. The elites undertake a kind of back of the envelope calculation about the costs and benefits controlling the apparatus of state. Maintaining an autocracy comes with certain costs, the costs, for instance, of controlling the population. These costs are weighed up against the risks of allowing the general population to set the rate of taxation. This might make one assume that increasing levels of equality will bolster the chances of democracy. Here’s an intuitive theory: as the distribution of income in a society becomes more equal the pressures to pursue redistributive policies from the disenfranchised in society will diminish which, in turn, reduces the costs of tolerating democracy for the elites. That’s a complicated way of saying that higher levels of equality make democratization a cheaper deal for elites. So far this all seems to support the commonsense thesis that a growth in inequality is bad for democratization. Large levels of inequality increase the risks associated with democratization for the ruling elite, so the elite are less likely to relinquish control of the state.  But this picture is incomplete.  We need to think about how easy it is for elites to move their money around in the modern world. Technological change and financial innovation have made assets more mobile, this has some pretty profound consequences for the risks and rewards associated with allowing a transition to democracy.

So how might this increased financial integration change the behavior of autocratic elites? A recent paper by John Freeman and Dennis Quinn presents some interesting conclusions about the implications of financial globalization for democratization. Unsurprisingly they suggest that a greater level financial integration makes it easier for elites to move their assets out of the country and that this is going to reduce the threat of democratization to a ruling elite, as any progressive change to the system of taxation will have less impact on their income and assets.  More controversially they argue that this is likely to happen even if the ruling elite is not feeling pressure to democratize. In a financially integrated world an investor naturally seeks an international portfolio of investments, one which diversifies into foreign equities. This kind of international portfolio will reduce risk and increase return because it is less dependent on the performance of the native economy. Innovation in financial products has changed the picture too. Many assets which would have previously be described as fixed – such as land – are now chopped up and traded on global markets. When it was not possible to sell these kind of fixed assets abroad, the wealth of a ruling group was yoked to a particular country but we now live in a world where these assets can be traded easily. In short, we are living in a world where elites are capable of spreading there wealth across the globe and are strongly incentivized to do so. A corollary of this is an increase in income inequality within the country in question; the domestic elites accrue large benefits from the asset sales and can accrue a high rate of return on their capital if they invest it abroad.

All of this might point to some interesting and surprising conclusions about the relationship between the level of inequality in autocratic states and the probability of democratization.  In many cases, an autocratic state with high levels of financial integration will produce a domestic elite with an international portfolio of capital investments and this is likely to result in increasing inequality within a society.  This international portfolio of investments also increases probability of a transition to democracy, as the domestic elite have less incentive to maintain the repressive apparatus required to maintain autocratic rule and less to fear from a system of taxation under the ownership of democratic governments.  It may be the case then, that the accelerating level of inequality Piketty has identified–facilitated in part by a globalized economy which allows a high rate of return on capital–may have the perverse effect of making the world a more democratic place by reducing the incentives of elites to maintain control of the apparatus of state in autocratic countries.

Image courtesy of Abode of Chaos

George Robinson

About George Robinson

George is currently a Thouron Scholar at the University of Pennsylvania. Before moving to the U.S, he worked as a policy adviser at HM Treasury. He has an MPhil in Politics from the University of Oxford.

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