Does free-market capitalism buttress democracy, or does it unleash anti-democratic forces? This question first emerged in the Age of Enlightenment, when capitalism was viewed optimistically and welcomed as a vehicle of liberation from the rigid feudal order. Many envisioned an equal-opportunity society of small producers and consumers, where no one would have undue market power, and where prices would be determined by the “invisible hand.” Under such conditions, democracy and capitalism are two sides of the same coin.

Domestic propaganda in the United States has pushed the same optimistic vision over the past century, aiming to convince voters that free-market capitalism is essential to the “American Way,” and that their liberty depends on supporting unfettered free enterprise and distrusting government. But economic developments in recent decades suggest that we should re-examine such beliefs.

To see why, allow me first to clarify some background ideas about what I call technological competition among innovating companies seeking to amass market power. Such competition differs from conventional price competition by producing only one or a few winners, rather than permitting all firms to survive with lower profits.

The winners of technology races are uniquely positioned to consolidate their market power through diverse strategies – including issuing periodic technology updates, acquiring competitors, or erecting barriers to entry with patents (often attaining far greater market power than intended by patent legislation). Technological domination thus is the basis for achieving market power over products sold to consumers, which in turn allows a company to extract monopoly profits.

In such situations market power becomes so entrenched that potential rivals prefer to cooperate with the top firm rather than compete with it. Laissez-faire policies that permit the growth of monopolies only enhance such power. As a result, market power becomes a permanent feature of a capitalist economy. Technological competition is ineffective, and creative destruction does not restore economic efficiency.

Permanent market power alters capitalism by ushering in a winner-takes-all economy in which one or a few technologically dominant firms monopolize each sector. Such an economy not only deploys resources inefficiently; it also produces a concentration of economic and political power that threatens democracy, whose survival then becomes dependent on the creation of new policy tools to protect it.

The Second Gilded Age

The First Gilded Age (1870-1914) is an essential reference point for comprehending the current moment, because its anti-democratic worship of business power undermined the optimistic Enlightenment view of markets. True, it was a period of extraordinary technological and economic progress, delivering most of the major twentieth-century innovations. Between 1895 and 1904, however, more than 2,000 firms were merged into 157 large conglomerates, leaving virtually every sector of the US economy dominated by a powerful monopolist.

Those who created these trusts believed they were doing God’s work of strengthening the economy by saving it from “ruinous” competition. Supported by the ideas of the eugenicist Francis Galton and Herbert Spencer’s theory of social Darwinism, business leaders saw themselves as the superior, intelligent men who had prevailed in the process of natural selection.

This selection process also applied to their firms, through which they were building a new society in which a few strong men would lead. It followed that small and weak firms must be eliminated or swallowed up within strong monopolies. The latter were seen as superior to all the unfit firms that were going bankrupt in frequent depressions. The big monopolies were also considered progressive organizations. As John D. Rockefeller put it, monopolization was unstoppable because it was “the law of God.”

These ideas were rejected by Progressive reformers and those pursuing antitrust enforcement under President Theodore Roosevelt after 1901, and under President Franklin Roosevelt in the New Deal era. Americans in these periods chose democracy and rejected the power-worshiping oligarchy, resulting in a long era of economic growth with shared prosperity.

But that story ended in 1981, when renewed laissez-faire economic policy led to the contemporary techno-winner-takes-all economy. In this Second Gilded Age, the worship of power and wealth has returned with a vengeance. Capitalism’s strong incentives for innovation and growth remain, but the survival of democracy hinges on whether the system’s most destructive effects can be contained.

In a techno-winner-takes-all economy, the market power conferred by innovation leads to one or a few firms monopolizing each industry. One firm might offer costly products of high quality, while a second may offer low-cost products of adequate quality. All these products are trademarked, and all monopoly profits are considered “innocent” by law, because they result from “spontaneous” innovations and are not subject to antitrust enforcement.

In this environment, small firms on the margin are vulnerable to either hostile acts or acquisition by larger firms. Dominant firms find it easy to snatch up competing innovative technologies, because small firms are reluctant to risk losing an economic war against powerful incumbents.

When a firm increases its price and earns monopoly profits, that leads to inefficient use of its economic resources, ultimately resulting in significantly lower output and lower demand for labor and capital inputs. As an approximation, a monopoly firm’s output and inputs might be reduced by as much as half. When market power is widespread, this results in lower investment, lower wages, and a lower rate of wage growth. The aggregate outcome is lower levels of income, consumption, and capital stock.

Moreover, when prices are too high, too few consumers will benefit from new innovations – as one often sees with costly drugs. There is substantial evidence that market power leads to extensive abuses of power more broadly. These might include the erection of high entry barriers to would-be competitors, suppression of competing innovations, efforts to compel acquisition of competitors, and so forth. The result is a gross national product that grows more slowly than is technologically feasible.

Capital Income and Monopoly Profits

The existence of monopoly profits changes business accounting. Under competitive conditions, the income created by a firm is divided into a labor share and a capital share. But with permanent market power, a firm’s income is divided into three shares: labor, capital, and monopoly profits.

This distinction between capital income and monopoly profits is central to techno-winner-takes-all capitalism. Net income paid to capital consists of interest payments at the prevailing market rates, whereas monopoly profits extracted by pricing higher than incremental costs are paid to the source of market power: mostly privately owned technology and other intellectual-property rights.

The fact that firms led by technologists “exploit” both labor and capital is the heart of the story, setting techno-winner-takes-all capitalism apart from the socialist view, in which capital always exploits labor.

Rising market power has caused most Americans to experience declining or, at best, slowly rising real (inflation-adjusted) incomes. Most monopoly profits originate in innovations, but the proportion of people who invest in risky startups or in companies engaged in risky innovations is small. Those profiting most from an innovation are the innovator and a small circle of financial advisers and early investors who buy the firm’s initial shares at low prices.

When an innovation succeeds, the firm’s stock becomes publicly traded, and its value rises sharply, making the owners wealthy within a short time. This explains why most monopoly profits and executive incomes earned today – and the wealth created by those profits since the 1980s – have benefited only a small minority of Americans. Income and wealth inequality have duly risen ever since.

The rapid rate of wealth accumulation caused by innovations contrasts sharply with the slow pace of growth attained by the accumulation of capital through savings. An extremely high rate of monopoly profits is the only way one can accumulate unimaginable wealth within one’s lifetime, and it explains why the US has 756 billionaires.

In a techno-winner-takes-all economy, conventionally measured profits are divided between capital and market power. Economic theory explains that interest payments compensate owners of capital for their past savings, whereas a patent pays royalties for a monopoly over a technology. These are two different economic functions. Equally, capital income and monopoly profits are different: a retiree with saved wealth is a capitalist who earns capital income, whereas an entrepreneur-inventor who owns a successful Silicon Valley startup makes mostly monopoly profits.

The same distinction between capital income and monopoly profits requires markets to differentiate between a firm’s associated assets, capital, and monopoly wealth. While a firm’s capital is the value of the tangible assets it owns (such as equipment, structures, and inventories), monopoly wealth is the current market valuation of future monopoly profits it is expected to earn.

In 2019, most capital owned by US corporations was financed by bonds, implying that the value of companies’ capital was expressed mainly in the bond market, leaving the stock market to reflect mostly monopoly wealth. In the same year, monopoly wealth accounted for 75% of the total value of stocks on US exchanges. The stock market has become primarily an arena for trading monopoly wealth, and the main risk of owning a firm’s common stock is the risk to its future earnings of monopoly profits.

Political Fallout

These economic and market dynamics have far-reaching political implications. One is high inequality, which is a direct result of a high degree of market power. It is well known that economic inequality creates political inequality, by giving the wealthy a stronger voice.

In thinking about this issue, I measure market power by the share of monopoly profits in income, and consider data about the domestic corporate sector where market power can be exercised. As the chart below shows, the degree of market power fluctuates with high long-run persistence. In the First Gilded Age, monopoly profits reached 31% of corporate income; in the Second Gilded Age, which began in 1981, their share has reached about 25%. These figures are compatible with other researchresults, showing a sharp corresponding rise in personal inequality.

Rising market power will always cause rising inequality, benefiting some and harming others. But a passive free-market policy aggravates such outcomes, because individuals are left to fend for themselves, and public policy neither compensates those harmed nor mitigates what causes it. Innocent citizens’ livelihoods then become society’s price for the collective gains from economic growth – an injustice that has severe political consequences.

The main winners from free-market policy and rising market power since the 1980s have been the few in the top income stratum and the technically skilled with a college education, while unskilled workers without a college education have been the most harmed. The result is social polarization, with the poor pitted against the rich, and the less educated against the college educated.

The critical point to remember is that this deeply divisive inequality results from technology and a specific free-market public policy. Those who lost their livelihoods recognize that they are the victims of a policy choice. They paid the price for others to benefit, and for some to grow immensely wealthy, and American democracy has been weakened as a result. The evidence shows that most of the participants in the January 6, 2021, attack on the Capitol were former thriving workers who had been left behind.

A Dangerous Trifecta

These outcomes reflect the impact of three factors: rising market power, automation, and globalization. Rising market power, as we have seen, has caused the decline or slow growth of all labor compensation. Meanwhile, automation has contributed to rising inequality among labor skills, by replacing some workers while benefiting others (an effect known as “skill-biased technological change”).

Consider the assembly line, which was introduced in 1913 to lower the cost of labor. Production was reduced to simple steps that made most of the skilled workers who produced automobiles at that time redundant. To work on the assembly line, one needed only the discipline and mental ability to perform a repetitive task, meaning no long apprenticeship, much less a college degree, was required.

The assembly line thus increased the productivity of unskilled workers and raised their wages. It created a class of highly productive, low-educated blue-collar workers whose work experience was their most valuable asset, one that allowed them to enjoy middle-class living standards.

Automation and robotics have had the opposite effect, replacing the unskilled workers who perform repetitive tasks, and causing them to lose their valuable work experience. Some found alternate well-paying jobs, but most workers without a college degree were forced to take dead-end, low-paying service jobs. This eviscerated the US middle class, previously populated by well-paid blue-collar workers.

Equally important, computers have complemented the work of college-educated skilled workers performing complex tasks that can now be executed more efficiently, increasing these workers’ own productivity and wages. Artificial intelligence, however, is likely to cause another upheaval in the skill composition of the US labor force.

The third factor is the wave of globalization that originated with the post-World War II US policy to help Japanese and German manufacturing recover. The same process then enabled China’s growth, much to the detriment of US manufacturing jobs. After the 1980s, information technology permitted more-educated workers to find satisfactory alternative employment, but this was not so for less-educated former blue-collar workers.

These three forces created large classes of winners and losers. Although those directly harmed were mainly low-skilled and less-educated workers in manufacturing and mining, the degradation of their lives also eroded the incomes of their immediate and extended families. Because most lived in specific geographic areas, such as the Midwest and Southeast, these regional economies experienced a slow economic death. Depression drove many to alcohol, substance abuse, and suicide, causing life expectancy to decline, while policymakers mostly ignored the problem.

Though we lack precise statistics, it is safe to say that these developments degraded the lives of tens of millions of Americans. Those harmed viewed their plight as profoundly unjust. They are angry and have lost faith in the system that betrayed them.

This is not surprising. It is essential for the viability of democracy that the public considers the distributive effects of public policy to be just. Without a just policy to tax the winners and help the losers recover their income and dignity, democracy will be weakened. Those harmed have turned against the educated elites who designed the policy, and against immigrants they perceive as taking their jobs and competing for scarce public goods and services. They have found a home in new anti-democratic movements such as Donald Trump’s MAGA, which has now taken control of the Republican Party.

Elephants in the Room

Over time, the techno-winner-takes-all economy has enabled the rise of a collection of interdependent economic and political power centers identified by the large firms, their top managers, and leading shareholders. Large firms – and a few ultra-wealthy individuals – exercise vast power through lobbying and campaign donations, but their power does not stop there. They also acquire vast amounts of information with which to manipulate our purchases and dominate our channels of communication. Armed with AI, their control over much of the information we receive will probably increase further.

All the ill effects noted up to now are exacerbated by social media. Firms like X (formerly Twitter) and Meta – each wholly controlled by a single billionaire – can have decisive effects on any election, which is hardly compatible with a healthy democracy. Much has been written about the destructive impact of social media on the functioning of democracy and civic engagement, so the point I would stress concerns their legal status.

Experience has shown that social-media platforms are conducive to mob behavior and the spread of fake news, conspiracy theories, hate speech, and much else. This content proliferates because the platforms are protected by Section 230 of the Communications Decency Act of 1996 (which was enacted not to improve public welfare but to aid President Bill Clinton’s re-election).

Making matters worse, the US Supreme Court has contributed to the formation of monopoly power and become a major obstacle to reform. In its 2010 Citizens United decision, it removed all restraints on using corporate wealth to influence elections, ignoring extensive literature showing that wealth substantially affects policy and carries extra weight in the political process.

Extreme wealth inequality also has significant anti-democratic culturaleffects that stem from wealthy individuals’ belief that they deserve to be rich by dint of their superiority. While the lifestyles and attitudes of the rich and famous are not central to my own work, I do think they can tell us something about the impact of wealth inequality on the vitality of democracy.

Consider two examples. The first is Andrew Carnegie, who came from humble beginnings but became one of the world’s wealthiest men by building a vast, vertically integrated American steel empire. Intending to promote the idea that rich people should devote their wealth to helping others, he wrote an article in 1889 that was turned into a book entitled The Gospel of Wealth.

In reflecting on what had made him wealthy, Carnegie seized on the prevailing ideas of his era. He saw himself as among the strong, superior human specimens naturally selected to be rich. Though he set out to encourage the wealthy to contribute to worthy causes, his conclusions were deduced from an obviously anti-democratic worldview.

The false theory of eugenics was popular during the First Gilded Age because it offered the rich an explanation of why they felt superior to those less well-off, thus providing a justification for their opulent lifestyles. Nowadays, with our modern knowledge of genetics, the wealthy cannot openly claim to be more intelligent than others. Nevertheless, many still feel superior, and they have found other ways to express it.

In “The Techno-Optimist Manifesto,” published last fall, Netscape co-founder and venture capitalist Marc Andreessen envisages a future in which the march of technology will be led by technologists innovating at an ever-increasing rate, culminating in the creation of a “techno-capital machine” that produces all necessities at vanishing marginal costs. In this telling, technologists are not just wealthy businessmen but messiahs who will guide humanity with their innovations and maintain social order by fighting their “enemies.” The obstacles to be knocked away include social responsibility, risk management, trust and safety, and regulations.

Andreessen’s vision combines technologists’ role as civilizational leaders with that of free markets in allocating all resources. The implication is that government should serve no function in the future.

This is a decidedly anti-democratic vision – a Silicon Valley oligarchy superimposed on a libertarian society. According to Andreessen, everyone else’s roles and rewards will be determined by how unfettered markets value their skills and economic contributions. Never mind that, in his scheme, the world appears to be converging to an economic system where most people will have virtually no market value.

Although Carnegie and Andreessen offer different views, they espouse the same gospel of wealth and power, and thus represent the same kind of threat to democracy. Moreover, their attitude is shared by many in the business community and academia. PayPal co-founder Peter Thiel’s contention that “Competition Is for Losers,” and that monopoly drives progress, amounts to the same old worship of power. So, too, did Joseph Schumpeter’s argument that a strong monopoly firm is superior to a competitive firm.

Similar ideas have been invoked since the 1930s to support lower taxes for wealthy Americans, who are said to deserve their hard-earned income and wealth. This sense of entitlement enabled the rich to justify their tax noncompliance and use of foreign tax sheltersto hide their wealth, in turn fueling the growth of a sprawling tax-avoidance industry.

The Chicago Fallacy

But it is the Chicago School’s ideas about monopoly that have had the most impact in recent decades. In the late 1970s, the economist Aaron Director and the legal scholar Robert Bork argued successfully that the Sherman Antitrust Act was designed to protect consumers only by ensuring they pay the best current price, an interpretation that ignores the strategies noted earlier, used to build up monopolies over time, and the other adverse effects of market power.

An entire generation of jurists and lawyers then bought in to the fallacy that technological competition can create progressive monopolies that benefit consumers. This idea was laid bare in Supreme Court Justice Antonin Scalia’s statement in Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP (2004):

“The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. … the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.”

How could a distinguished jurist accept such flawed, simplistic reasoning? The theories of eugenics and social Darwinism had been discredited, but they were replaced by market efficiency as the new anti-democratic “law of God.” The market is held up as a natural-selection mechanism that enables the strong and efficient to survive. If a monopolist triumphs in the market, that means it is the best organization to offer consumers low current prices. With this flawed reasoning, we have come full circle: Thanks to their superior power, monopolists are the best promoters of consumer welfare!

Back to Democracy

The ill effects of techno-winner-takes-all capitalism call for numerous policy changes. I outline many in my book, The Market Power of Technology, but I can mention only a few here. They fall into three categories, starting with data: We need accurate national and sectoral data on monopoly profits and wealth in order to develop robust public policies.

The second category concerns restraints on the market power of technology. Among other things, we should place strict limits on firms’ ability to acquire technologies to expand their technological reach; require higher standards for patent issues; reduce interrelated patent pyramids (which are used as entry barriers) by shortening the duration of secondary patents (those whose description depends on another patent); revise labor laws to improve the balance of power in the marketplace by making it easier for workers to organize and bargain collectively; and impose corporate income tax on monopoly profits. 

Finally, we need economic policies that will strengthen democracy. These include reforms that make restraining technological market power an explicit goal of antitrust law; increase marginal income tax rates (closer to 50%) on higher earners; repeal Section 230 and consider proposals to turn social media into regulated utilities; and invest extensively in low-income families’ children’s early education and health (which research indicates is the most promising path to stabilizing the American middle class and democracy over the long run).

Last but not least, we should establish “recovery rights” for those harmed by policy-supported adverse events. Workers displaced by forces such as the market power of technology, automation, globalization, or even the Federal Reserve’s monetary policy would have legal rights to assistance for rehabilitation, the acquisition of new skills, or direct compensation. This would eliminate the neglect that pervades existing policy. A similar approach is already used in Scandinavia with positive effects on democratic stability. Such policies can be designed to be universal and with minimal bureaucratic discretion.

Some on the radical left believe that capitalism, as Marxists describe it, is dead and has been replaced by surveillance capitalism, technofeudalism, digitally controlled systems, or something else. And yet, the profound impact of technology and the existence of a third claimant on national income both show that capitalism is as creative and strong as ever.

What has happened is that capitalism has been changed drastically by technology. Milton Friedman’s vision of Capitalism and Freedomnow seems out of touch with economic reality. Yet because many still cling to it, the policy reforms we need are being blocked. Without greater public mobilization to support them, the threat to democracy will continue to grow, in America and around the globe.

Project Syndicate