The rise in prominence of China, and the ongoing economic strength of the cities of Singapore and Hong Kong, has caused a new question to be asked: does the kind of capitalism practiced by such countries constitute a real challenge to traditional capitalism? These countries are characterized by increasing economic freedom, but within a system that is largely politically and civilly not free. While the nature of the truncation of freedom varies, the question is rather deep: to what extent does political and civil freedom matter for economic development? My intention is to show logically the importance of full freedom and to illustrate that so-called authoritarian capitalism is not a viable alternative to the traditional Western liberal capitalism.
I begin by elaborating on some definitions of Western liberal capitalism and authoritarian capitalism. The former is defined as a system in which the individual is completely free to deploy his or her resources in whatever manner desired. The latter is a system in which individuals are free to deploy their resources in a limited way. For example, one may work at whatever job is desired, but the work available is limited by the overarching plan designed by the government. Generally, under authoritarian capitalism, any endeavor that does not fit into the grand plan of the state would be proscribed. Our definitions will focus on the ‘pure’ form of each type of capitalism, and it should be recognized that, in reality, no pure form of Western liberal capitalism currently exists.
After defining the two forms of capitalism, I will discuss the factors necessary for economic growth and development. Among these, I argue that the critical difference between the two types of capitalism is the human capital factor. The skill of entrepreneurship is required to arrange, and rearrange, economic resources into their most productive structure. My argument is that entrepreneurship will first be underdeveloped, and second may take a different form, in an authoritarian system than in a liberal capitalist system. This will result in a gap between the actual entrepreneurial ability in an authoritarian system than in a liberal system, and this gap will cause economic growth to lag in an authoritarian system.
I conclude with some empirical data on growth rates in the two types of countries discussed here. My findings indicate that GDP growth is highest in liberal capitalist countries, but second highest in authoritarian capitalist countries. Nevertheless, the gap in development has increased over time. Also, authoritarian capitalist countries tend to become less authoritarian and more politically free over time. Thus, the staying power of an authoritarian capitalist system is in doubt.
The authoritarian capitalist system is a poor version of the liberal form of capitalism. Because the former fails to fully use the human capital, and thus causes human capital to atrophy in some areas, the authoritarian system’s growth will always lag the growth of a free capitalist system. Thus, authoritarian capitalism is not a viable alternative to Western liberal capitalism.
2. Defining capitalism – the Western liberal version.
Capitalism, as defined by George Reisman in his economics text “Capitalism,” (Reisman 1998) is a system of societal organization that is based on property rights, especially the private ownership of “the means of production.” In a capitalistic society, people are free to pursue their own ends and to manage their own resources as they see fit. There is no coercion by any central authority. All trade is voluntary, and so mutually beneficial. Thus, the foundation of Western liberal capitalism is private property. The core of private property is the self, so that any labor that is deployed is an extension of one’s self.
Insofar as one is the owner of one’s labor, and trade must be voluntary, in a pure capitalistic system the only method of building up productive assets is through voluntary combinations of the labor and existing physical capital that exist and are owned by people. The essential problem faced by people engaged in production is the organization of labor and capital in such a way is to produce goods and services that are demanded by other people. This problem of organization can be solved by appeal to a system of prices that is sensitive to the relative demands of people. Thus prices reveal peoples’ relative subjective valuations of various goods and services, and production is adjusted accordingly. As long as a good or service is traded, it carries a price.
The system of free market capitalism demands the growth of a particular skill – entrepreneurship. For reasons that will become clear later, this type of entrepreneurship will be labeled economic entrepreneurship. Those individuals who are skilled in economic entrepreneurship will have the ability to arrange labor and capital in particular ways so as to produce those goods and services desired by people in the most efficient way possible, which will yield the largest profit. So profit is the entrepreneur’s guide, including expected future profit. Changes in profit will lead the skilled economic entrepreneur to continuously rearrange labor and capital to maximize profit. Failure to arrange the means of production effectively will lead the entrepreneur to try again until success or exhaustion, and so we have the process of continuous improvement.
While some will suggest no government is consistent with a pure capitalistic society and so advocate for anarcho-capitalism, others believe representative democracy is consistent with capitalism, as long as the role of government is limited. The view of government’s rightful role is diverse, even within the Austrian school of economics. (Callahan 2004)
3. Authoritarian capitalism
An authoritarian government is a government that exercises a great deal of control over the citizens of a particular nation, while some room for private choice may exist. One might call such a government “the state.” According to Ludwig von Mises (von Mises 1980), in an authoritarian system, all people must obey the plan of the state. The primary characteristic is obedience; subservience of the people and the primacy of the state. Prime examples of authoritarian governments are the former USSR and Nazi Germany. In an authoritarian government, people operate under the rule of man, whereas in a pure capitalistic society, people operate under the rule of law.
Initially, the idea of ‘authoritarian capitalism’ seems oxymoronic, since how can there be entrepreneurship in an authoritarian environment? However, if the term is understood as a hybrid model, then one can see this as an environment that has a strong government that often directs its people in certain ways, but that allows the people a certain measure of freedom in the deployment of their resources. In other words, an authoritarian capitalist environment would have economic control shared between government and the people, with the lion’s share of control held by government.
Key to understanding how the role of the state plays out in business is the level of interference by the state and its relationship to the size of the business. Based on discussions with entrepreneurs in China and other similar countries, one surmises that the freedom to conduct business on a small scale is complete, as is the freedom to advertise. Such freedoms are limited in the United States, for example, by the requirement for various vending licenses and limitations on advertising methods for certain products like alcohol and tobacco.
However, while interference by the state may be more or less equal in a country like the U.S., in a country like China interference really begins in earnest once a business becomes large enough to be ‘noticed’ by the state. Then, the interference becomes more direct and is not equally applied (McGregor 2010). Thus the key difference between authoritarian capitalism and liberal capitalism is the extent to which firms must align their behavior with the overall state plan for the economy.
At this point, it makes sense to point out that capitalism is a system of free markets. It assumes free men and women. A critical aspect of freedom is a person’s right to work at whatever he or she chooses (F. von Hayek 1978 Paperback Edition). In an authoritarian environment, these choices are likely strictly limited by the state. In a free society liberty does not mean the ability to whatever is desired. It does mean that your choices are not limited through threat of violence, and that is the case in an authoritarian environment. Thus, one cannot speak of “authoritarian capitalism” and assume capitalism to be meant literally. We are clearly dealing with a new concept in which people are not free in the classic (Hayekian) sense.
This is not to say that individual workers may not leave jobs in order to pursue other opportunities. In fact, it appears to be the case that workers are relatively free to work at whatever opportunity best suits them in these authoritarian capitalist countries. This makes it seem as though labor is free but this is a truncated freedom. The breadth of opportunities, and depth in a hierarchical sense, is limited by the state. Thus, while one may take any job available, the jobs available are a subset of what would be realized in a completely free capitalist system. The depth one may go, in a “climbing the corporate ladder” sense, is also limited due to political pressure. For example, in China, the leaders of the large firms are also typically high-ranking members of the Communist Party (McGregor 2010).
On seeing the above definition of authoritarian capitalism, one immediately thinks of China, the second largest country in the world by GDP. The first, of course, is the United States. While the US is far from a pure capitalistic environment, it is the symbol for free markets. China, of course, is an authoritarian regime that has slowly loosened the shackles on its people and has experienced enormous economic growth as a result. The Chinese experience, and other similar experiences, makes the concept of authoritarian capitalism intriguing. But is it a viable alternative to traditional Western capitalism?
First, economic growth must be defined. Is it an increase in national output? What about employment? What about household economic opportunity? In a pure capitalistic system, one may define economic growth as an increase in total wealth of the people of a nation. In the spirit of this essay, that definition will be maintained throughout.
Thus, the question is: how is total wealth increased? Studies of economic growth abound. A search of Google Scholar yields upwards of 900,000 hits. A highly influential article by Robert Barro (Barro 1991) contains the following insights. Political stability is, of course, an absolute necessity for economic growth. Also relative poor countries can demonstrate higher growth rates than relatively well-developed countries. This is attributed to the fact that there is considerable opportunity for the development of physical capital, which will allow productivity to increase more rapidly than countries whose physical capital is already well developed.
Human capital is a strong predictor of future growth, especially if the current level of economic development is below the potential implied by the human capital. This would occur if some restrictions on the use of human capital were in place, as was the case in the former USSR. As restrictions on human capital are reduced, it can find more productive allocations and thus growth and development will increase.
As already alluded to, there must be some physical capital to which the human capital may be applied. Thus, investment is a very important factor for economic growth. However, the more government consumption spending there is in proportion to the output of the entire economy, the less growth one can expect in the future. Note that government investment does not appear to have much impact (Barro 1991).
Barro’s work also includes two measures of the political environment. He categorizes economies into socialist, mixed, or primarily free enterprise. This is done in a subjective manner, but results indicate socialist countries experience negative growth, mixed countries no growth, and free enterprise positive growth, controlling for all other factors.
One factor not modeled by Barro but that is obviously critical to growth is openness to trade. This allows countries to specialize in production, but also facilitates the transmission of human capital and knowledge.
A key to understanding the issue discussed in this essay is the type of human capital being developed. Human capital is clearly not homogeneous. As such, a particular type of human capital must be defined in this context: entrepreneurship. Entrepreneurship is the skill set used in organizing productive forces to create goods and services, and the skill to rearrange productive forces continuously so as to keep finding the most efficient methods of production.
Entrepreneurship so defined is economic entrepreneurship. Such is the type of skill that, in a pure capitalistic environment, will determine the pace of development and growth. The alternative type of entrepreneurship, the type which is necessary for arranging productive forces in an authoritarian environment, may be labeled political entrepreneurship. (Henninger 2010)
The political entrepreneur specializes in navigating political circles and negotiating with the state in order to arrange productive forces. These productive forces are arranged in a circumscribed manner, being that options are limited to those allowed by government. In an authoritarian government, these options are necessarily constrained. So the political entrepreneur does not have the skill to organize productive forces to first create products desired by consumers, and second to continuously rearrange productive forces to maximize efficiency and meet changing tastes of consumers.
In an environment that was free and slowly becomes authoritarian human capital will still tend to be of the economic entrepreneur type. Thus, the portion of economic growth that is dependent on human capital will begin to suffer, but the changes may be slow or quick, depending on how quickly the freedom for economic decision-making is reduced. Furthermore, if the new authoritarian regime leaves open some few industries for “free markets” then economic entrepreneurs will specialize only in these markets.
In the opposite case, where the environment has been authoritarian and is becoming free, few citizens will possess the skills of economic entrepreneurship. As the markets become free, economic growth and development will be limited by the lack of economic entrepreneurship. The stock of this particular human capital can be slowly built up, but a freer environment also has the option to import human capital from other environments. A free flow of human capital will help the country to grow much more quickly by sharing knowledge and ability.
5. The Importance of Discretion
In the previous section we discussed various factors related to economic growth, human capital principal among them. Human capital is a very sensitive factor. After all, an engineer is no artist, and an economist no physician. Thus, a stock of human capital is extremely heterogeneous and its usefulness dependent on the current circumstances in the economy. Anything that limits the use of human capital, then, puts a brake on economic growth. In an authoritarian environment, the three broad ways human capital may be limited are: 1) limiting those who may contribute to the economy; 2) by the state limiting which industries are open to market activities; and 3) by forcing even so-called “free” industries to follow state-designed plans.
It is well known that many countries limit by gender those who may take part in the non-household economy. This puts a significant limit on the amount of human capital that can first be developed through education outside the home, and second on the deployment of human capital for the purpose of economic development. Typically commensurate with a limitation on participation is also a limitation on the type of household development that can occur. For example, a home-based business would likely not flourish in such a community. Cutting in half the amount of human capital that is developed clearly puts a low ceiling on potential economic growth.
Second, if only some industries are open, then entrepreneurs will develop their skills in those industries. Those industries will be developed and contribute greatly to the overall economic growth of the entire country, incidentally making aggregate measures of economic activity appear very strong. Since the industries cannot be grown at a high rate perpetually, the industries that are open will eventually reach a steady state of growth and economic development will stabilize. Because there are some industries that continue to be non-free, the economic development will be at a level lower than it could be in a completely free economy.
The final limitation of the use of human capital is the limitation of entrepreneurs, and even managers and workers, to work outside of a general plan. If peoples’ ability to respond to unforeseen circumstances is limited because of the state and its bureaucracy, then their ability to take advantage of opportunities that characterize business activities in a free market will be circumscribed. This argument is well developed by Hayek in “The Use of Knowledge in Society.” (Hayek 1945)
Hayek’s point in his 1945 essay is that information in society is not homogeneous, nor is it fully communicable in statistical terms. Those conditions that are dependent upon time and space thus can be known only to one or a few people. Insofar as said conditions offer an opportunity for profit, then in a free market those who are aware of the conditions will take advantage of them. To the extent individuals are prevented from taking advantage of those profitable conditions, the opportunities are lost and economic development is hindered.
Profitable conditions arise often because of imbalances in supply and demand of particular products. Arbitrageurs who would, in a free market, take advantage of these opportunities would perform the valuable action of equilibrating supply and demand. To the extent those actions are circumscribed, imbalances will become persistent and thus likely further hamper economic growth and development.
A critical part of economic growth and development is innovation. Innovation is clearly a function of human capital and the freedom to conduct basic research. The importance of human capital has been discussed above. In the context of innovation, a higher stock of human capital will allow faster and more prolific innovation. But research, if constrained to be conducted in a few select fields, will not yield as much new innovation and therefore stunt economic growth, as if research was free.
Researchers that are directed to focus on certain fields will likely become very efficient researchers. However, a key source of innovation comes from unintended discovery. A constrained researcher would not have the freedom to pursue such unintended discoveries and any innovations that would result from such pursuit will be foregone. A free researcher would pursue any discoveries according to his or her own discretion and resource limitations. This freedom, on balance, yields innovations that lead to economically important invention and technology that subsequently opens new vistas to an economy.
Freedom, or rather a lack of freedom, in the realm of education proceeds along the same lines as research. The danger here is that education will focus on a few fields of knowledge, like science and mathematics, to the exclusion of more creative fields. Such limitation, like limiting the fields of acceptable research, will ultimately reduce the number of “accidents” that occur that prove worthwhile, and it will limit the ability of citizens to apply their creative talents and gifts. Thus, potential avenues of development will be foregone.
7. Empirical Evidence
To this point, I have proceeded along logical grounds to discuss those limitations faced by an “authoritarian capitalist” system. It is instructive now to review available empirical evidence to shed some light on the veracity of our claims. Here, I follow along the lines laid down by Peter Leeson, in his article “Two Cheers for Capitalism?” (Leeson forthcoming). Specifically, we separate countries into four categories based on economic freedom and political/civil freedom and then examine economic growth over time.
We present two graphs that show economic development over time.1 The first graph shows the path of average annual per capita GDP for the countries in each category. Because data is released every 5 years, the content of each category is revised every 5th year. However, only category 1 (above average political freedom but below average economic freedom) has meaningful changes in its composition. The second graph shows the path of average annual GDP per worker.
The evidence is clear. Countries with both economic freedom and political freedom enjoy this highest GDP per capita and per worker. The next higher GDP is found among countries with more economic freedom but that are politically less free. There are so few countries in category 1 (economically less free but politically free) that they do not constitute a comparable sample.
The spread in per capita and per worker GDP is wide between the top two categories. The spread per capita is approximately $9,000 in 1975 and has widened to about $16,000 by 2007. The spread per worker is even larger: $18,000 in 1975 and $30,000 by 2007. This is about double the per capita spread. This tells us that the growth rate is faster in politically and economically free countries than in countries that are only economically free.
We can go further in our inquiry. Using various econometric methods2 we calculate the relative importance of economic freedom and political freedom in the growth of real GDP. Our estimates indicate that a one point increase in economic freedom yields a 0.84 point increase in the annual growth rate of GDP. A similar increase in political freedom yields a 0.18 point increase in the annual growth rate of GDP. Clearly, economic freedom is the more important of the two for GDP growth.
Next, we calculate the marginal impact of political freedom given a certain level of economic freedom. We find that there is no observable impact from the political freedom. This indicates that our logical discussion in previous sections may not have much impact on economic growth. However, political freedom tends to be connected to economic freedom. Indeed, a 1 point increase in economic freedom leads to a 1 point increase in political freedom. Increased political freedom only yields an increase of 0.3 points in economic freedom per 1 point increase in political freedom.
It is no doubt an ongoing argument as to which freedom leads which. It is quite likely that there is a feedback mechanism between the two. In other words, we do not have a sustained group of countries that have increased economic freedom while keeping political freedom stable. This is consistent with Peter Leeson’s results, mentioned earlier. He has shown that countries that become economically freer tend to become more democratic, which would increase political freedom on balance. These results indicate that an authoritarian capitalist system may not be sustainable except in some rare circumstances
The purpose of this essay was to determine the feasibility of authoritarian capitalism as an alternative to traditional Western capitalism as a system for maximizing economic growth. Capitalism is a system characterized by voluntary trade in which individuals make their own plans regarding deployment of their resources. An authoritarian capitalist system would be characterized by an economy in which individuals were allowed some discretion over the deployment of their own resources. Individuals’ discretion would be limited according to an overarching plan created by the government. Thus, people would have some freedom over their economic lives, but avenues of economic development would be limited by the government plan.
After discussing differences in the two regimes, the nature of economic growth was reviewed. This discussion highlighted the importance of human capital in determining economic growth. The importance of freedom and accidental discovery was highlighted, since this is a significant difference between traditional and authoritarian capitalism. The freedom to discover and develop new technologies is often the key to economic development, and this freedom is likely to be particularly reduced in an authoritarian setting.
Of particular importance is that entrepreneurial skill is not well-developed in an authoritarian system. This suggests that, if a system is becoming economically freer but is emerging from an authoritarian system, there will be a general lack of the necessary skill to develop the economy. Those skills must be learned over time or imported somehow. Further, to the extent the system remains authoritarian, political entrepreneurship will remain the dominant skill in acquiring the necessary resources to develop businesses and industries. Political skill is useful for redirecting resources, but it is economic entrepreneurship that drives economic growth. To the extent economic entrepreneurship is circumscribed and political entrepreneurship is dominant, economic growth will suffer.
Available empirical evidence regarding economic growth and economic and political freedom was reviewed next. The highest growth rate in GDP is to be found amongst countries that are both economically and politically free. The next highest growth rate is enjoyed by economically free countries that are not politically free. These are the authoritarian capitalist countries, following the definition laid out in this essay.
While authoritarian capitalist countries have the second highest growth rate, it is evident that their growth lags considerably behind economic growth in free countries. One must also keep in mind that we do not know if we are witnessing the peak of growth in certain authoritarian capitalist countries. Thus, empirical evidence can only offer some support for our position, and is by no means conclusive.
The purpose of this essay has been to refute the claim that an authoritarian capitalist system can rival a traditional capitalist system on the grounds of economic growth and development. By way of logic and empirical evidence, we have made our case that full economic freedom promises the highest rate of growth of an economy.
Barro, Robert. "Economic Growth in a Cross Section of Countries." The Quarterly Journal of Economics, 1991: 407-443.
Callahan, Gene. Economics for Real People. Auburn: Ludwig von Mises Institute, 2004.
Hayek, Friedrich A. von. "The Use of Knowledge in Society." American Economic Review, 1945: 519-530.
Henninger, Daniel. "Bring Back the Robber Barons." Wall Street Journal, March 3, 2010.
Leeson, Peter. "Two Cheers for Capitalism." Society, forthcoming.
McGregor, Richard. "China's Private Party." Wall Street Journal, May 15, 2010.
von Hayek, F.A. "The Use of Knowledge in Society." The American Economic Review, 1945: 519 - 530.
von Hayek, Friedrich. The Constitution of Liberty. Chicago: University of Chicago Press, 1978 Paperback Edition.
von Mises, Ludwig. Economic Freedom and Interventionism. Auburn: Ludwig von Mises Institute, 1980.
1 Economic freedom data comes from the Fraser Institute. Political freedom data comes from Freedom House. Freedom data is observed every 5 years, beginning in 1970. Economic freedom data is measured on a scale of 1 to 10, with a higher number associated with greater economic freedom. Political freedom data is measured on a scale of 1 to 7, with a lower number associated with greater political freedom. First, we convert the political freedom index so that a higher number indicates more freedom and is thus comparable to the economic freedom index. We then demean both freedom indices and create the four categories. Category 1 includes countries that have above average political freedom and below average economic freedom – this is the smallest category. Category 2 includes countries that have above average political and economic freedom. Category 3 includes countries that have above average economic freedom and below average political freedom – the authoritarian capitalists, according to our definition. Category 4 countries are below average on both freedom scales. Economic growth is measured as real GDP in U.S. dollars.
2 We use OLS and panel-data methods with two-way fixed effects to estimate our models.