The Rising Democratic Deficit of Capitalism
Hi all,
I published an essay in Vrij Nederland (in Dutch) last month, just before Christmas. This version has references and links that can’t be added to an old-fashioned paper version. The main message is that politicians should not leave finance to central bankers and/or asset managers. Yes, finance and the financial system are complex and complicated, but addressing the issues only when things go wrong is too little and too late. Have a nice read.
Merry Christmas
Hans
How Big Money is Steering the World Economy: The Rising Democratic Deficit of Capitalism
In today’s economic landscape, unelected technocrats and global financial giants wield ever-increasing influence. Central bankers, detached from democratic accountability, execute policies that shape economies and societies. Meanwhile, massive global capital flows, driven by opaque asset managers, determine what thrives or falters in the real economy. The question is no longer whether capitalism can serve the public good but how we can reclaim it for that purpose.
Activist Central Bankers: When Policy Takes Centre Stage
The Eurozone crisis of 2012 remains a defining moment in the evolution of modern central banking. Following Greece’s example, Southern European countries found themselves grappling with soaring borrowing costs. Financial markets were in turmoil, and political leaders struggled to restore confidence. Amid this uncertainty, Mario Draghi, the then-unelected President of the European Central Bank (ECB), delivered a single line that would become legendary: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Markets responded decisively. Draghi’s promise stabilized bond yields and calmed financial speculation, but it also marked a seismic shift in the role of central banks. No longer merely guardians of price stability, they became active players in responding to crises. Draghi’s intervention ensured that central banks increasingly became the architects of financial markets, wielding influence far beyond their original remit.
The years following the crisis saw an era of low inflation that ushered in unprecedented monetary experiments. Central banks employed negative interest rates and launched massive asset-purchasing programmes, buying government and corporate debt to nudge inflation towards the 2% target. The results were underwhelming, but the precedent was set: central banks could and would do more.
When the pandemic struck in 2020, central banks again took centre stage, acting swiftly to stabilize economies. However, the same central banks pivoted sharply when inflation surged due to energy shortages. They implemented the steepest rate hikes in decades, an abrupt reversal reverberating across global markets. It was entirely normal for central bankers that in 2022, Isabel Schnabel, one of the ECB’s board members, could openly discuss the sacrifice ratio—the potential higher costs this time of bringing inflation down. In other words, how many people would need to lose their jobs or accept a real wage decline to achieve lower inflation. The consequences extended beyond immediate economic disruptions: higher borrowing costs made investments in renewable energy less viable, effectively stalling the much-needed energy transition. This unintended consequence highlighted the limits of central bank mandates, which focus narrowly on price and financial stability without broader societal considerations.
This centralisation of power raises fundamental questions. While operating within their mandates, central banks have increasingly taken on roles that intersect with democratic governance. Should unelected technocrats dictate policies that reshape societies? And why do elected leaders allow such a profound transfer of responsibility?
The Rise of Asset Managers and Capitalism Without Accountability
As central banks expanded their influence, another transformation quietly reshaped the financial landscape. Over the past decade, global asset managers operating within the shadow banking system have emerged as dominant players. Firms such as BlackRock, Vanguard, and State Street now manage trillions of dollars in assets, dwarfing the GDP of most nations. This shift represents a fundamental change in capitalism, as ownership and influence consolidate in the hands of a few.
These asset managers owe their rise to several factors. Pension funds and other savings pools seeking professional management have entrusted their wealth to these firms. Simultaneously, regulatory constraints on banks made asset management more lucrative, further boosting its appeal. Asset managers increasingly served private banking clients through banking channels. Technological advancements amplified the trend as scale became a key determinant of efficiency and cost-effectiveness. As a result, the largest asset managers now dominate global markets.
This concentration of power has ushered in what German researcher Benjamin Braun calls “asset management capitalism.” Unlike traditional shareholder capitalism, where investors actively engage with companies to drive performance, asset management capitalism is mainly passive. These firms invest broadly in markets rather than individual companies, relying on algorithms to manage portfolios. The result is a system where accountability diminishes. Asset managers own stakes in up to 80% of companies in the US stock market and significant portions elsewhere, yet they remain detached from the specific outcomes of those companies.
This passivity has profound implications. First, asset managers lack the incentive to push for sustainable or ethical practices, focusing instead on aggregate portfolio returns. Second, their business model prioritises short-term gains, often at the expense of long-term societal or environmental considerations. Third, their systemic dominance limits competition, creating a financial ecosystem where many firms wield disproportionate influence.
The paradox of asset management capitalism is stark. These firms could theoretically champion change due to their vast influence, but their structure and incentives make them indifferent to individual outcomes. They are universal owners and don’t look for winners, even those not winning sectors. This indifference explains why large investors often resist sustainability initiatives, even when acknowledging long-term risks. Short-term profits, after all, take precedence. It is even more cynical: they bet on the fact that systemic risks are soo huge that they will be socialised — and even lobby for that.
BlackRock exemplifies this dynamic. As the world’s largest asset manager, overseeing $11.5 trillion in assets, its decisions shape global markets. CEO Larry Fink’s annual letters to shareholders reveal a carefully curated narrative. When sustainability gains public favour, BlackRock champions it; when sentiment shifts, it retreats. This selective advocacy highlights the industry’s priority: preserving returns while deflecting responsibility for broader societal challenges.
The Erosion of Democratic Leadership
In the face of these transformations, democratic governments have faltered mainly. One might expect elected leaders to counterbalance the power of unelected technocrats and global capital, but their efforts have been limited and inconsistent. In countries like the Netherlands, calls to redirect pension investments towards national interests have yielded little success. The globalised nature of capital markets makes such initiatives impractical. In finance terms, it limits the diversification of the portfolio, leads to concentrated risks and might lead to sacrificing some returns. So, not in the interests of the client. So, finance is globalised, while politics is foremost national.
Following the financial crisis, governments implemented stricter bank regulations, curtailing risk-taking. However, these measures inadvertently shifted power to less-regulated asset managers, creating a new centre of financial dominance. Meanwhile, central banks have continued to act where politicians fail, justifying their interventions as necessary for economic stability. Yet, these interventions often come with societal costs, including job losses, wage stagnation, and delayed climate action.
Politicians cannot often address these more profound systemic challenges due to short-term electoral cycles and limited expertise. Asset managers' opaque lobbying efforts further complicate regulation, creating a landscape where democratic oversight is increasingly marginalised.
The relationship between central bankers and democratic politicians is no less fraught. There is a historical rationale for central bank independence: insulating monetary policy from political opportunism has helped prevent runaway inflation. However, this independence has become a power transfer many politicians are reluctant to challenge. Central banks are often left to address economic issues that governments fail to resolve through legislation, from financial crises to income inequality.
Centrally managed monetary policy is not value-neutral. It prioritises financial stability, sometimes at the expense of broader societal concerns such as employment, equality, or sustainable development. For example, central bank policies to curb inflation often result in job losses or wage stagnation, disproportionately affecting lower-income groups. As we have seen in the last few years, asset price inflation also leads to rising wealth inequality. While stabilising economies is crucial, the implicit trade-offs usually align with a political agenda favouring conservative economic principles over progressive social policies.
Breaking the Trilemma: A Path Forward
The current system presents a trilemma. Central banks wield outsized influence, governments remain passive, and markets prioritize profits over public welfare. Yet, solutions are within reach. Breaking up the most significant asset managers would restore competition and accountability. Introducing a financial transactions tax could slow capital flows, reduce market volatility, and encourage long-term investments. Pension funds could be incentivised to invest more directly, bypassing asset managers altogether.
These measures require global coordination, a daunting challenge in today’s fragmented geopolitical environment. However, without such reforms, the cycle of concentrated wealth and weakened democracy will persist.
Central banks present a more complex challenge. Politicising monetary policy is widely regarded as unwise, yet greater democratic oversight is necessary. Governments must reclaim their role, setting clear expectations for the financial sector and ensuring that monetary policy aligns with broader societal goals. Ultimately, politicians must rise to the challenge, even if it means confronting the uncomfortable realities of modern capitalism.
Conclusion: Who Holds the Reins?
The disproportionate influence of unelected technocrats and financial giants defines the current economic order. Central banks, driven by narrow mandates, implement policies with far-reaching societal consequences. Detached from accountability, asset managers dominate global markets while prioritising short-term profits. Meanwhile, democratic governments stand on the sidelines, unable or unwilling to reclaim control.
The stakes are higher than ever. Without decisive action, capitalism's democratic deficit will continue to grow, leaving the global economy at the mercy of a select few. It is time for elected leaders to confront this imbalance, ensuring that capitalism serves the many rather than the few. Only then can we restore the promise of a system that works for society.
Great insights! Why concentrate on saving capitalism? In any way or form it can only function in a growth economy and that is not compatible with our planetary boundaries.
Capitalism most definitely needs to go :)