Big Government and Capitalism

From Stumbling and Mumbling.

In the Economist’s rather good survey of the growth of government, there’s one thing missing – something right libertarians tend to understate. I refer to the possibility that the increasing size of the state over time has often served the interests of capitalism.
I don’t just mean that individual capitalists are quick to use the law to suppress basic freedoms, or that they got massive state handouts when governments bailed out banks. I’m thinking of six general mechanisms:
1. A solution to stagnation. Back in the 1960s, Baran and Sweezy argued that because capitalism was better at generating profits than it was at investing them, it contained a tendency towards stagnation. State spending, they said, was one way of boosting aggregate demand and offsetting this tendency.
Although this theory fell out of favour in the inflationary 70s, I suspect it has regained relevance recently, as a key feature of western economies has been a dearth of investment opportunities.
2. Stabilization. In theory, a small state could stabilize economic fluctuations through orthodox deficit spending. In practice because recessions are unforeseeable and because fiscal policy works only with lags, this is not possible. Instead, stabilization requires the existence of a largish state, which creates a big non-cyclical component of aggregate demand.
And let’s be clear here. Capitalists value stabilization; very few chief executives are fans of Robert Lucas’s view (pdf) that the welfare costs of business cycles are small.
3. Legitimation. Insofar as capitalism tends to generate inequality, it also produces social unrest which, in turn, can deter investment and growth; it is no accident that traditionally very unequal south American countries have had poor long-run growth. A welfare state which buys off discontent is thus in the interests of capital. Remember, arguably the first modern welfare state was established by Otto von Bismarck, a man not commonly regarded as a loony lefty.
A welfare state also sustains capitalism in another way. For aggregate profits to be maximized, capitalists must get workers’ wages back, in the form of consumer spending. However, if workers must save for old age or against the risk of unemployment, this will not happen – which is potentially detrimental for profits.
4. A solution to the paradox of wages. For any individual capitalist, the best possible outcome is for him to pay low wages and thus have low costs, whilst everyone else pays high wages, so he enjoys high demand. The existence of a big state helps resolve this paradox by increasing the demand for labour and hence wages. Of course, sometimes – in many countries in the 70s and 80s – the state can go too far in this regard, from the perspective of capital. But this doesn’t alter the fact that sometimes – in the 30s – it didn’t go far enough.
5. Regulation diminishes the principal-agent problem. Whether because of asymmetric information or the problem of collective action, shareholders have only imperfect control over bosses. In a free market, then, bosses might act in ways that maximize their own (short-term) advantage, to the detriment of shareholders and society – as, for example, when banks took too much risk. Sometimes, then, the state has to do what shareholders cannot, and regulate firms – though as we saw in the banking crisis, it does so only imperfectly.
6. Regulation and red tape are an overhead which bears more heavily upon smaller firms. As such, they can benefit larger firms, who enjoy less competition.
Now, I am not saying here that big government is always and everywhere in the interests of capitalism; in the 70s and 80s it often wasn’t. Nor am I saying it is the only cause of big government.
What I am saying is that the state grew in the 20th century in part because that is what capitalism required. It is no accident that heads of big business are rarely full-blooded libertarians – a fact which the latter should remember.

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