Author Talks: Martin Wolf issues a wake-up call on the state of democratic capitalism

In this edition of Author Talks, McKinsey’s Nienke Beuwer chats with Martin Wolf, chief economics commentator at the Financial Times, about his new book, The Crisis of Democratic Capitalism (Penguin Random House, February 2023). Wolf examines the geopolitical challenges threatening market democracy and charts a course for overcoming the modern era’s instability. It starts with better welfare, economic dynamism, and hope—a “necessary condition.” An edited version of the conversation follows.

Why did you write this book?

My new book is called The Crisis of Democratic Capitalism. In essence, what it says is that our system, which is about the marriage of democracy with the market economy, is failing. It’s failing economically, and because it’s failing economically, it’s failing politically. That has left us open to profoundly antidemocratic forces, and we have to reverse this before it’s too late.

I wrote this book for two reasons that came together: the personal and the historical. Starting in the middle of the last decade, but really with the [2008] financial crisis, I began to become worried about the stability and effectiveness of our economic and political system. My first worries after the financial crisis were about the economic system, since the financial crisis was an economic event.

I wrote a book immediately afterward called The Shifts and the Shocks, which looked at the financial crisis, why it happened, why most of us failed to realize how serious it could be, and where it had left our societies rather damaged. I finished that in 2014, and it began to be clear that economically, at least, things were getting a bit better.

That was encouraging, but very soon afterward the political system seemed to be in disarray. We got the immensely surprising emergence of Donald Trump as presidential candidate for the Republicans and then his victory in the election. We got the Brexit referendum in the UK. Both of these occurred in the same year, in 2016. It was clear we were getting strong populist reactions—that was becoming the characteristic of politics.

It was also clear in other countries. We were seeing it in Italy and in France, in Spain, and even in Germany. It was clear this was happening, and it was happening at the same time as a reaction against democracy worldwide, what Larry Diamond of Stanford calls the “democratic recession.” That was the economic and political context.

The personal context is that my own parents were refugees from Europe during the interwar years—my mother in 1940 when Germany invaded Holland. That led to a cataclysm for their wider families who were mostly killed in the Holocaust. I always thought that a big reason why this happened was the Great Depression, which really is what brought the Nazis to power. So for me, there was a personal worry that was linked very closely to the economic worry.

What is the essence of this book’s argument?

It tries to answer the question: Why did this happen, and why now? My answer to the question of why this happened is that in the “consolidated democracies,” as they tend to be called, of the West—particularly Europe and North America—the deal, as I came to see it, between the people and the elites that inevitably play a dominant role in society, is that the elites are legitimate if they deliver a reasonably satisfactory economic future for the people. This deal came out of the Industrial Revolution, which transformed politics and, as I argue, was really why democracy became such a potent force.

We welcomed the emergence of a democratic universal suffrage in the early 20th century, and I think it was a consequence of the market economy and a reaction to it. This deal seems to be coming undone, and there are two big elements in the unraveling of this deal. There’s been a long period of de-industrialization, quite weak growth, and, in many countries, rising inequality—all of which were to the disadvantage of the old working class and lower middle class in many societies, which became very disaffected.

Then came the financial crisis, my trigger, as it were, which made it clear that the people in charge of the economic system—the politicians, the technocrats—didn’t know what they were doing. Worse than not knowing what they were doing, they were then bailed out with huge amounts of government support, while the people at large suffered big declines in disposable incomes over very long periods as a result of austerity and other such policy choices.

I think this created a profound disillusionment with elites, which left open the political field to populists of many different kinds, but the most important of them were populists of the right. This is what we are now living with almost everywhere.

Why do you call the relationship between liberal democracy and market capitalism a ‘difficult and fragile marriage’?

If you look at the history of humanity in postagrarian society, in settled, complex societies with complex divisions of labor—for example, pharaonic Egypt or the Roman Empire, or even the Middle Ages in Europe—political power concentrated among the wealthiest people was the standard political structure.

If they didn’t have the political power, they had a strong tendency to lose their wealth, so wealth and power were essentially one and the same. The standard form of political organization was monarchy, oligarchy, or plutocracy of some kind, so republics and democracies were very rare.

If you look at what we created, we created societies in which—at least in principle, and I think to some significant extent in reality—political power is diffused among the public, among the voters. The people they elect become prime ministers or presidents, and they have enormous political power. There’s no doubt about that.

At the same time, we have an economic system that generates immense wealth for some individuals and immense concentrations of economic power, and that looks like something of a contradiction. How does that happen? Why did that happen? What makes it last?

My answer to why it happened is that in some very important ways, despite these obvious tensions, when properly done, the market economy and democracy go along with one another. They both rest on the novel idea that people can’t be defined by ascribed inherited status. People are entitled, and this has become more and more radical over time as we have generalized it more. People are individuals who have a right to pursue the best lives they can for themselves and their families. If they turn out to be very successful, they can become very rich, and they can become very powerful.

Take a remarkable case: Abraham Lincoln, perhaps one of the greatest American presidents, came literally from a log cabin. That’s revolutionary, but it’s [not independent from] the political and the economic system. The market system and democracy rest on systems of restraint. You can’t do whatever you like. The systems are governed by law. They require legitimate competition for both political power and in the market.

I also argue that capitalism needs democracy because often democratic policies will want—and we saw this in the Americans’ case in the early 20th century—to stop predatory monopolies. They will want to ensure competition. That’s very, very important in securing capitalism. That’s a way that democracy helps, and it helps a great deal.

On the other hand, if you have an independent market economy, that gives everybody the security to say, “Well, we can afford to lose the election. We can still go back and do another job. There are independent institutions that will continue to support us. They will allow us to continue political life.” The marriage, then, is the fact that there is an autonomous economy independent, to a considerable degree, from democratic politics.

What makes it fragile are pretty obvious dangers. One danger is that the economy won’t deliver to the great majority of people the sort of life that they want and hope for, in which case they think this political system has failed. Therefore, they start thinking democracy has failed. There’s a lot of evidence that a lot of people think just that, and the financial crisis was part of that. Then, they look for saviors or demagogues, which could be populist leaders. People come along and say, “We hate the elites. You hate the elites. Let’s get together and dethrone them.”

The other great danger is that a plutocracy emerges, and it’s not just the very wealthy—and it increasingly seizes control of the political machinery in many different ways. It gets to provide the funding that elects the legislatures, which will do exactly what these plutocrats want. In the end, you end up with a plutocracy. You get a demagogic tendency of the democracy gone crazy and the plutocratic tendency of capitalism gone crazy, and then you’re in terrible trouble. I think that is where we are.

So it’s a marriage, but like many marriages, if they’re going to survive a long time, you need a lot of compromise and adjustment between the parties. That is the theme of the book.

What is the role of economic growth in democratic capitalism?

Economic growth is the core of it all in a number of ways. First, at the beginning, when economic growth began to get going, it did a number of very profound things for social and political life.

Our societies became urbanized, and that’s a very different background for politics than an agrarian society. Huge concentrations of human beings were in factories and mines, all working together and wanting to cooperate with one another to defend themselves. That created ideal conditions for the emergence of political institutions and parties representing the interest of the lower and working classes for the first time in politics. It didn’t really exist like that before.

Then, importantly, as the economy developed, employers began to realize that they needed educated workers. The move toward mass education, which began to emerge in the 19th century, was not just a demand from below, it was also increasingly a demand from above. Now, not all employers were so enlightened, but by and large, the more successful ones were the ones that increasingly employed the more educated people.

People wanted mass education, higher education, technocrats who could do science and engineering. All this became part of the system, and these then became political demands. It started to become a highly educated population by historical standards, revolutionarily so. Then, the world wars caused a mass conscription. In most societies, that was the first extension of the vote to women.

Women became indispensable to the war economies. They became part of the labor force. Capitalism itself created the demand and the need for a far more educated and far more engaged population that demanded rights.

Finally, because capitalism was developing greater prosperity, it was possible to give these new demandeurs in the political system the things they wanted while everybody was still getting better off. It was a positive sum politics, unlike the politics of stagnant economies, which had been the universal norm until about 1800.

The politics of growing economies are much more benign. You can actually manage politics so everybody becomes better off. Of course, all this ceases to work very well if growth slows dramatically or if inequality rises dramatically, as has been happening in recent decades, particularly in the last 15 years, which have been really dreadful for most Western economies. That’s a different story.

If you want a peaceful democracy, one in which people accept the outcomes of elections and regard them as legitimate, it is a necessary condition—I’m not saying sufficient, but necessary—that people have some real hope. The great majority of people have to have some real hope that their lives will get better. They have to see politics as positive sum. If they see it as a zero or negative sum, then there’s a great danger that you’re going to get the politics of rage and anger.

What are some of the most urgent and fundamental things that need to happen in order to safeguard democratic capitalism?

If you think about what we need to do to make democratic capitalism work better, I think the aims are reasonably clear. The really big questions concern how you do it. The aims are to restore growth as best as we can, and for that growth to be reasonably broad in terms of its impact. It needs to generate opportunities for most people. It needs to protect people through the most extreme vicissitudes of life.

The gaps in welfare systems that exist, above all I think, in the US, really need to be closed. This is less of a European problem. In the European case, the bigger problem is reengineering economic dynamism. That’s the biggest problem. We need to do this while managing our global environmental challenges, particularly climate.

I think that looks increasingly possible, though very difficult, because technology has moved in favor, at least to some degree, of a low-emissions or even zero-emissions economy. It might offer wonderful new energy possibilities, but that’s going to be a costly and often politically unpopular transition, and we’ve got to manage that. We have to do this, and to achieve equality of opportunity.

We need to invest very heavily in education, particularly education of young children, because that’s seminal in determining how well they do. Otherwise, we risk creating—and increasingly we are creating—a hereditary underclass and a hereditary superclass as we become more oligarchic as societies. That has to be prevented.

These things involve lots of policy choices, many of which are specific to particular countries because different countries have different problems. I mostly focus on the US and UK because they have so many other issues.

It’s also pretty clear that our political systems are not working very well. We have to think about how we select political leaders. How do parties work? How should parties choose their leaders in a way that produces people who are both responsible and accountable to the people?

We need to look very carefully at whether our media are helping the health of our democracy or undermining it radically by disseminating untruths and promoting violent anger and hostility, rather than some sort of civilized discourse among citizens. I think there’s a big set of issues there.

At the same time, we have to restore the credibility of experts. The paradox is that experts sometimes fail, and they will always fail, but we can’t run a complex modern society without experts who are also democratically legitimate. That’s also a great difficulty.

Finally, to bring this together, we have learned a lot in the last 15 or 20 years about the fragility of our societies and economies regarding financial-sector resilience, economic resilience, robustness more broadly, and the ability to cope with shocks we haven’t expected. In some ways we’ve done quite well, but I don’t think we’ve begun to learn all the lessons. We didn’t learn all the lessons we could have learned from the 2008 financial crisis, and we haven’t yet learned all the lessons of the recent crises. We need a forward-looking agenda that will be country specific.

There is one other that adds to the difficulties, and I discuss this at length: many of the things that helped us grow between, let’s say, 1870 and 1990, are weakening or have weakened dramatically. Our societies are aging. That’s an important drag on us. That is expensive. It demands higher taxes. The welfare state is maturing. We already have a very high burden of debt in our economies, and it’s difficult to expand that. There is strong evidence that innovation and underlying productivity growth is weakening across the economy as a whole. All this is occurring in the context of a huge economic revolution globally.

The emerging developing countries are increasingly the biggest parts of the world economy and the most dynamic parts of the world economy, without a doubt. With that is the shift of a vast amount of know-how, from the West to the rest, and the development of new know-how in the rest—not only in China but also in India.

These are changes that make what we had in the past much more difficult to sustain. There is a famous sixth-century Greek philosopher called Heraclitus whose most famous slogan was, “You can’t step into the same river twice.” I think that’s incredibly important in thinking about policy. The way I frame it is, our aims should be the same as they were in the middle of the 20th century—aligning with Franklin Delano Roosevelt, for example—but we can’t use the same means, and they won’t work in the same way.

That’s what I’ve tried to discuss. I’m sure there are many more ideas, but we do have to be realistic. The challenges we now face are big, and they won’t solve themselves naturally. If we leave the story to the populists, the challenges won’t solve themselves at all.

What are some reasons for optimism?

There’s a famous line from [Marxist philosopher] Gramsci, which is, “pessimism of the intellect, optimism of the will.” In other words, as long as we’re alive and we care for the world, for our children, our grandchildren, and for other people’s children and grandchildren, we have to be optimistic in the sense that we have to believe we can make things better if we try.

If we don’t have that, we will be paralyzed, and it certainly won’t get better. It won’t get better on its own. All the progress we have achieved has required the efforts of people in all dimensions, of our forebears, and we have an obligation to continue this. My decision is to act as if I’m optimistic even if I’m not.

The second reason is that over time, and we’re seeing it even in the last year or two, market-based democracies have turned out, amid many difficulties and tragedies, to be the most flexible, most legitimate, and most peaceful societies we have known. They look after their people—not well by any means, but better than anyone else—and they have shown remarkable flexibility. When they make big mistakes, they tend to learn from them.

We saw that again in the interwar period and after the Second World War. Market-based democracies learned so much from the mistakes they made after the First World War and in the ‘30s. For many decades we did much better as a result, so we can learn.

I do believe that free societies and free people can and will find ways to solve their problems. They have in the past, and I believe very strongly that they can and will do so again. I wouldn’t have spent four or five years writing this book—which was quite difficult and involved a lot of thinking in areas not familiar to me—if I hadn’t believed it might just influence where we’re going.

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