Feb 20th 2009

Shaky Social Contracts

by Robert Skidelsky

Robert Skidelsky, a member of the British House of Lords, is Professor emeritus of political economy at Warwick University, author of a prize-winning biography of the economist John Maynard Keynes, and a board member of the Moscow School of Political Studies.

LONDON - "Enrich yourselves," China's Deng Xiaoping told his fellow countrymen when he started dismantling Mao Zedong's failed socialist model. In fact, elites everywhere have always lived by this injunction, and ordinary people have not minded very much, provided that the elites fulfill their part of the bargain: protect the country against its enemies and improve living conditions. It is this implied social contract that is now endangered by economic collapse.

Of course, the terms of the contract vary with place and time. In nineteenth-century Europe, the rich were expected to be frugal. Conspicuous consumption was eschewed. The rich were supposed to save much of their income, as saving was both a fund for investment and a moral virtue. And, in the days before the welfare state, the rich were also expected to be philanthropists.

In the opportunity culture of the United States, by contrast, conspicuous consumption was more tolerated. High spending was a mark of success: what Americans demanded of their rich was conspicuous enterprise.

Societies have also differed in how wealthy they allow their elites to become, and in their tolerance of the means by which wealth is acquired and used. One dividing line is between societies that tolerate self-enrichment through politics, and those that demand that the two spheres be kept separate.

In Western countries, politicians and civil servants are expected to be relatively poor. In most of the rest of the world, a political career is regarded as a quasi-legitimate road to wealth. But the broad conclusion remains: wealth is conditional on services. When the services fail, the position of the wealthy is threatened.

In the current crisis, popular anger is - no surprise - directed against bankers. Their speculative frenzies ruined shareholders, customers, and the economy. Anger has come to focus on banking executives' huge compensation packages, composed largely of bonuses. Rewarding success is acceptable; rewarding failure is not.

Governments face a dilemma. Big banks cannot be allowed to fail; but the public expects bankers to be punished. Few will be ruined or imprisoned. But the banking system is sure to be re-regulated, as it was after the Great Crash of 1929-1932, when President Franklin Roosevelt promised to drive the money changers from the temple.

The global economy's downturn increases countries' political risk to varying degrees, depending on the severity of the shock and the nature of the implied social contract. Political systems in which power is least controlled, and the abuse of wealth greatest, are most at risk. The more corrupt the system of capitalism, the more vulnerable it is to attack. The general problem is that all of today's versions of capitalism are more or less corrupt. "Enrich yourselves" is the clarion call of our era; and in that moral blind spot lies a great danger.

Despite efforts to give it precision, estimating political risk is not an exact science. It requires political theory, not econometrics. Forecasting models, based on "normal distributions" of risk over short slices of recent time, are notoriously incapable of capturing the real amount of risk in a political system.

One of the "safest" political systems of recent times was President Suharto's regime in Indonesia. Suharto came to power in 1966, establishing a quasi-military dictatorship and encouraging Indonesians to "enrich themselves." Despite the depredations of his family, enough Indonesians did so over the next 30 years to make his rule seem exceptionally stable - until the East Asian financial crisis of 1997-1998 sent the Indonesian economy into a tailspin, triggering violent riots that forced Suharto out.

Similarly, few regimes seemed more stable than that of the Shah of Iran, another long-term ruler, who, having bankrupted his country, was forced to flee the fury of a mob in 1979.

The lesson is clear. Autocracies, which are much praised for their decisiveness, and for guaranteeing "law and order," are paper tigers. They appear immovable until the moment they are evicted by popular anger. In face of economic failure or military defeat, their emperors turn out to be naked.

In such situations, the great advantage of democracies is that they allow a change of rulers without a change of regime. Failure discredits only the party or coalition in power, not the entire political system. Popular anger is channeled to the ballot box. In such countries, there may be "New Deals," but no revolutions.

In estimating political risk today, analysts must pay particular attention to the character of the political system. Does it allow for an orderly transition? Is it competitive enough to prevent discredited leaders from clinging to power? Analysts also must pay attention to the nature of the implied social contract. Broadly speaking, the weakest contracts are those that allow wealth and power to be concentrated in the same few hands, while the strongest are built on significant dispersal of both.

Deepening economic recession is bound to catalyze political change. The Western democracies will survive with only modest changes. But strongmen who rely on the secret police and a controlled media to maintain their rule will be quaking in their shoes. Even Venezuela's Hugo Chávez, who built his power on populist anti-Americanism, must be praying for the success of US President Barack Obama's stimulus package to lift his falling oil revenues.

The big countries with the highest political risk are Russia and China. The legitimacy of their autocratic systems is almost entirely dependent on their success in delivering rapid economic growth. When growth falters, or goes into reverse, there is no one to blame but "the system."

Igor Yurgens, one of Russia's most creative political analysts, has been quick to draw the moral: "the social contract consisted of limiting civil rights in exchange for economic well-being. At the current moment, economic well-being is shrinking. Correspondingly, civil rights should expand. It's just simple logic." The rulers in Moscow and Beijing would do well to heed this warning.


Copyright: Project Syndicate, 2009.

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