Capitalism, its ‘Alternative’, and the Wealth of Nations

In August 1991, facing an economic, military and moral bankruptcy, the Soviet Union ceased to exist. For almost seventy years it claimed to operate an ‘alternative’, better, economic model. Left on its own in the race, capitalism scored a technical victory. So dramatic were the events, so obvious the outcome, that many thought it was unnecessary to theorize on the basic question: why did the race end the way it did?

Thirty years on, things are less clear cut: now China claims to have an alternative model, which, at least for a while, has performed remarkably well. Many developing countries are taking interest. On the other side, some capitalist economies seem to be losing their self-confidence. It is time to go back to the basic question, this time attempting an answer based on first principles.

In fact, both models are about ‘capital’, that is productive assets in relation to the individuals who operate them. Capitalism and its alternative have different ‘theories’ about that relationship, though both start with some ‘original state’. For capitalism, originally assets were fully owned, privately, by individuals who had unlimited and exclusive rights to use, deploy, or alienate them at their own discretion, for their own benefit. Then, certain rights were carved out and granted to other individuals; for example, secured creditors got the right to take possession of the asset in case interest payments are in default; the original owner is left with a residual right. Needless to say, following many carve-out transactions, the allocation of rights gets remarkably complicated.

Under the alternative, productive assets were originally owned collectively. Then the collective ‘gifted’ some rights to certain individuals: some got the right to occupy residential accommodations, others to cultivate land, yet others to set up production lines. Again, the final allocation of rights could be remarkably complicated.

It is important to emphasize that the above theories are not a description of the actual historical process that created the current allocation. For capitalist societies, the original state may be so remote in time that very little is known about it. For societies claiming the alternative model, the original state is supposed to lie in a revolution that erased all earlier commitments in order to start afresh. But, then, revolutionaries had more urgent tasks than to document what assets were gifted to whom. Rather, these theories are just ‘stories’ about how current institutions were formed. They might also serve a useful didactic purpose of explaining how respective societies are supposed to operate.

Now, does it matter whether the rights of an individual in relation to an asset are described using one story or another? To be sure, the substance of that relationship matters a great deal. For example, a farmer who fears that the land that he cultivates is about to be taken away, has an incentive to over-exploit it, regardless of whether the termination is articulated as a repossession or because the original gift was fixed in time.

Still, stories matter. If the capitalist carve-out process is competitive, transactions are voluntary, and acquired rights enforceable at a low cost, then there is reason to hope that the outcome would promote the wealth and affluence of the entire nation. In contrast, the alternative story implies a political entity, be it a government, a party, or a citizens' committee, that controls the pool of assets on behalf of the collective. Which raises two problems. First, that the allocation of rights is likely to mix political and economic considerations. Second, since the political entity also holds the power to police the arrangement, it cannot commit to implementing it as promised. It might be tempted to exploit those right-holders that performed exceptionally well.

I find these considerations quite convincing in favour of the capitalist theory; only that, like any theoretical argument, it rests on many assumptions, many ‘if’ statements. Is it really the case that, in capitalist societies, most of the carve-outs are competitive and free of political interventions? And is it really the case that political entities, say Chinese regional governments, managed by bureaucrats whose career progression depends, among other things, on the economic performance of the province, cannot be incentivized to gift rights in a manner that is conducive to the nation's wealth? Isn't it the case that William I (The Conqueror) of England, though politically motivated while creating a register of assets, the famous Domesday Book, ultimately laid down the foundations for British capitalism?

The point of this analysis is that the important difference between capitalism and the alternative model is not in the story but rather in the operation of the political-economic process that governs the allocation of rights. It is safe to predict that the fortunes of nations would keep on surprising, as they have been for hundreds of years. Some nations will rise and become wealthy, others will fail and become poor. Outcomes will be driven by political-economic mechanics rather than stories that societies tell themselves. Needless to say, analyzing the actual process of rights allocation is a way more difficult task than, well, telling stories.

Oren Sussman is Emeritus Reader in Finance at the Saïd Business School of the University of Oxford.