23 July 2015

Why a strong society can make us all richer


What is capitalism? A quick glance at its most inflammatory criticism and it is a ‘deadly cancer’, whose existence is a force ‘ravaging the earth’, securing the ‘reckless rule of wealth at the expense of the common good’.

For those who reject the system outright, its major crime is that it can account only for the material, leaving no space for humanity, society, or qualities like honesty or friendship. In the setting of the average American family, capitalism demands that old Grandpa Simpson be shipped off to a home, not for not making sense, but for not making cents.

Increasingly however, such criticism is not confined to the sphere of the radical. Softer criticism is often wrapped in the language of a ‘need for reform’. Mark Carney has spoken on how market fundamentalism can erode social capital: those qualities of honesty and friendship, our humanity, the strength of society. The delivery may be more subtle; it may ignore the fact that many of the examples from the financial crisis illustrate less the excesses of capitalism and more the results of catastrophic market failure, but the criticism is the same. Capitalism is too much about the greedy, and not enough about Granny.

Yet look around the world and we see the opposite. From every corner of the globe, every continent, among rich countries and poor, it holds that the stronger a nation’s social capital, the higher on average its GDP per capita. Moreover, data analysis from the Legatum Prosperity Index™ shows that this relationship is anything but weak, it is strong.[1] Far from capitalism undermining social capital, it is the wealthy capitalist economies whose social capital is most pronounced.

When we look specifically at humanity, honesty, and friendship – the attributes critics feel most threatened by capitalism – the relationship grows even stronger. Take our benevolent intent (in the form of the act of donating to charity), the extent to which we trust each other (generalised social trust), and the strength of our social support networks (family and close friends) and the link to wealth is even more conspicuous.[2]

Setting the data and its conclusions aside, the problem with the critics’ account of capitalism is that it treats social capital as some form of desirable good that is external to the system. It is not external. Capitalism without social capital is like democracy without the secret ballot: fatally undermined. Social capital, and in particular, its main ‘output’ or ‘proxy’ (generalised social trust), is not a phenomenon that can be separated from a successful capitalist free market system. Indeed, without it, such a system would fail to function effectively.

The economic importance of trust is well documented. For the free market system, the role of trust in reducing transaction costs is particularly important. Without trust, the cost of economic interaction through the constant need to resort to the legal system to enforce and implement contracts would be prohibitive. ‘Free’ markets would be shackled.

The implications of trust for capitalism are significant. Beyond the simple functioning of the market, studies have shown that more trusting countries have higher investment rates and economies better able to encourage innovation. For capitalism’s greatest attributes, trust is key.

Yet trust is not the only way that social capital can keep markets free. State intervention, particularly through taxation, can be incredibly distortionary, resulting in market failures that cost the economy and the wealth of the citizens it supports. Yet in an age where we centralise social responsibility at a state level, such intervention is necessary to deliver the help and care that vulnerable people need. If anything erodes social capital, it is the omniscient, omnipotent, omnipresent nanny state, not the market.

Strong society can help reduce the need for this costly intervention. Where social capital, and in particular the extent to which we look out for one another and help the vulnerable in our community, is strong, such deep state intervention should not be necessary. Market distortion is lessened, as is the threat of market failure.

Given its economic importance, it is easy to see why governments like the UK have been exploring policies to promote social capital. New Zealand were doing it through their ‘Stronger Communities Action Fund’ as early as 2001.

Yet such efforts to strengthen social capital in the UK have been received with suspicion by the very people who bemoan its supposed loss at the hands of the market. Cameron’s Big Society project was cynically received as a front for spending cuts. It was not. It was a recognition that a strong society and economic success go hand in hand.

Critics are right when they point to the importance of social capital. It is important, not because free markets overlook it, but because they need it. Economic success doesn’t have to come at the expense of honesty, humanity, and friendship. Indeed, if as a society we are honest, benevolent, and close to our friends and family, evidence suggests we are all the wealthier for it.

[1] Correlation coefficient = 0.681

[2] Correlation coefficient = 0.738

Harriet Maltby is the Government & Economic Policy Researcher at the Legatum Institute.