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Capitalism and the Future of Nation States

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Capitalism and the Future of Nation States

Today, I’m pursuing a conversation initiated on Twitter about the future of nation states—and why ambitious capitalists need them more than ever.

Stefano Bernardi, an angel investor and scout for Atomico, recently tweeted about the idea that nation states could disappear. He asked which books were worth reading to get an idea of what’s next. My first answer was that maybe nation states would be replaced by city states, and so these are the books I suggested:

Then I had another idea, which was that maybe nation states would be circumvented by networked communities connected by trade, finance, religion, or a given mission rather than citizenship. On this hypothesis, I find these precedents worth studying:

Ultimately, I realized that one thinker in particular could help us find answers to Stefano’s question, notwithstanding the fact that he died in 1985: I’m thinking about Fernand Braudel, a well-known French historian, social scientist, and author of one notably thorough work on the history of capitalism, Civilization and Capitalism, 15th-18th Century. Read along!

1. Even though I’m French, I must admit I had never really read Braudel until now. I knew of his ideas and concepts, of course (we Sciences Postudents are trained in the art of quoting authors we haven’t read). But Braudel burst into my intellectual universe recently in no small part thanks to venture capitalist and economist William H. Janeway. Bill quotes Braudel extensively in his book Doing Capitalism in the Innovation Economy, and he has (rightfully) declared Braudel one of the most enlightening thinkers when it comes to understanding venture capital:

I found an unlikely guide in the great French historian Fernand Braudel… [His] meditations on what capitalists do generated a shock of recognition that I can still feel. Although the domain and context in which Braudel’s financiers operated is vastly different from the world of today’s working venture capitalist, the activity remains recognizable: putting surplus cash to work, again and again, wherever the potential return is unlimited by either institutional structures or competition.

2. For Braudel, the economy can be subdivided into three categories.The first, which he calls “material life”, is made up of the infinite, informal transactions that form our daily lives. The second, the “market economy”, is where individuals conduct business, establishing a link between production and consumption. The third, finally, is “capitalism”. As Bill explains above, Braudel sees within capitalism an ensemble of processes that allow one to extricate oneself from the trivialities of commerce and pursue increasing returns to scale. The market economy is the world of merchants, those who buy and sell while taking a small margin as items pass through their hands. Capitalism, on the other hand, is the world of the traders, financiers, and entrepreneurs who have understood that they can attenuate the rigorous competition in the market economy by “inserting” capital into the production process.

3. For a long time, capitalism was at the margins of the economy. Its first iterations were what Braudel called the “faraway trade” (after the German word Fernhandel), for example that involving spices, silk, precious metals. In these sectors, where the goal was trading rare, non-perishable goods, lengthening the routes of commerce weakened the competitive dynamics between various economic agents. Few organizations were effectively able to trade from one end of these long routes to the other. The reward thus wouldn’t go to the best merchants, those who were most skilled in the art of buying and selling. Rather it went to those organizations which could invest in a financial, informational, and logistical infrastructure that could operate at the largest scale and secure a long-term competitive advantage.

4. Capitalism then started to spread throughout the economy.Technological progress allowed capitalists to arrive in all sectors, setting off a race for scale. Today, there are few markets where businesses are simply content to buy and sell. Almost all sectors, even those that do not require large amounts of capital, are dominated by capitalistic businesses that utilize assets to avoid the difficulties caused by perfect competition. And so the history of capitalism is that of capitalists evicting merchants from a growing number of sectors of the economy. As I wrote in a previous issue more than two years ago, “Capitalists mostly care about return on assets (RoA) and return on equity (RoE), which enables them to take the larger view. As they’re focused on capital asset velocity, they tend to beat…the ‘merchants’, who obsess primarily about net operating margin.”

5. Capitalism played an extraordinary role in progress. The increasing returns it generated through scale created an economic surplus that allowed, depending on the context, for lower prices for consumers, higher salaries for workers, and/or better returns for investors. It’s for this reason that both the right and the left have always encouraged capitalism in the West. It was necessary, of course, to curb its excesses, but it was always counted on to develop the economy. Case in point: Mariana Mazzucato doesn’t like when “leftist economists” like her are depicted as anti-capitalists. As she’s argued on Twitter, you can be both for capitalism and for more state intervention. Indeed, the most prosperous countries were always those where capitalists benefited, according to Braudel, from a certain “goodwill” on the part of the state. Or, as Dani Rodrik puts it, “capitalists need the state more than the state needs them”.

6. How, exactly, does capitalism contribute to economic development? The process happens in two stages. First, you need to create and capture more value, and this is where capitalism makes a difference. Then you need to realize that value (that is, turning it into wealth) and it really matters wherethat happens. The whole point of having local capitalists is that value is realized locally and the resulting wealth spills out locally, enriching everyone around in the process (which might require some redistribution through taxes, benefits, and public services, but that’s another story). This two-stage process is why every state has an interest in supporting local capitalists with access to a supportive domestic market and various forms of industrial policy. The goal is to have capitalists create and capture even more value that will then be realized locally. In exchange for this support and “protection”, capitalists have to contribute to local development through consumption, investment, and redistribution. The state contributes to capitalists succeeding; capitalists, in turn, contribute to lifting up the local “material life” and “market economy”, thus strengthening the state.

7. Like all technological revolutions, that of computers and networks allowed capitalism to escape even further from the market economy by intensifying the race for increasing returns to scale. In the 20th century economy, numerous countries succeeded in positioning themselves well on the chessboard of the world economy, turning industrial capitalism and the resulting increasing returns to scale into the motor for their local development. But now that capitalism is driven by computing and networks and thus plays at an even larger scale, the resulting economic surplus is becoming more and more concentrated within just a few “economic worlds”, to use Braudel’s term (économie-monde). One economic world is centered on Silicon Valley; another one is centered on China. Today’s version of capitalism gives birth to even larger organizations and a greater geographic concentration of wealth.

8. What about the future of nation states? Braudel reminds us that the center of our Western economic world has changed several times since the Middle Ages. Venice, Antwerp, Genoa, and Amsterdam were effectively city states. But then London and New York came along, and they were more accurately large cities within nation states. There were two reasons for the rise of a nation state (Great Britain) as the dominant economic center of the day, as opposed to a mere city as was the case before. One was the end of the Napoleonic Wars and the aftermath of the Congress of Vienna. The other was the Industrial Revolution. The growth of textile manufacturing meant that there were less domestic land and labor to grow crops. Only a nation state could compensate for that fact with a navy able to master the sea, a vast colonial empire to grow cotton and tea, and the strength to negotiate favorable trade agreements with other nation states. You needed a nation state to support capitalist enterprises at the scale enabled by the Industrial Revolution. Sovereign entities had to scale up at the same pace as capitalist ones so that their mutually beneficial alliance could bear fruit.

9. This doesn’t mean that cities couldn’t prosper. The remaining city states (like Singapore, Vatican City, Monaco, and, to a certain extent, Luxembourg), all found a niche which permitted them to thrive. But cities that were on their own in the 20th century also had difficulties securing critical resources such as oil, gas, food, even water. If you’re surrounded by friendly neighbors in a stable part of the world, like Luxembourg or Vatican City, everything is fine. But if you depend on hostile or hegemonic neighbors for access to resources, you need to be careful. Hong Kong was retroceded in 1997 not because China asked, but because the 99-year British lease on what is known as the New Territories (and Kowloon) was about to expire, and Hong Kong itself (that is, the island) simply cannot survive without its hinterland. Singapore, on the other hand, is sovereign indeed, but it has to overcome perpetual uncertainty when it comes to securing its water supply from neighboring Malaysia.

10. What about today? You don’t need land and labor to run today’s businesses with increasing returns to scale (that is, tech businesses rather than manufacturing businesses). This is probably why some large cities in the West are feeling tempted to recover their independence. Yet just like my friends David Galbraith and James Crabtree, I don’t think we should conclude that nation states will disappear:

  • Today’s capitalist organizations still need states to support their expansion—and since they’re larger than in the past thanks to computing and networks, the corresponding states need to be able to match that scale with more resources and superior strategic power. This is why we’re seeing wealth concentrating within very large and populated countries such as China and the US, with mid-size countries bound to become mere “intermediate” regions (Braudel’s word).
  • There is still an opportunity for smaller sovereign entities to prosper, but just like in the 20th century you need to be creative when it comes to positioning and absolutely ruthless when it comes to implementation. Singapore’s Lee Kuan Yew is the definite model here. (And I don’t think that current leaders in countries such as France, Germany, and the UK rise to that bar.)
  • Finally, it’s true that the rise of computing and networks makes it easier for communities of networked individuals to circumvent nation states. But I don’t think it’s the case for every nation state. Sure, a sovereign collective can escape nation states if they’re mid-size countries deprived of thriving capitalist entities. However, whenever that solid alliance between local capitalists and the state exists, like in the US or China (but not Europe!), it will always prevail over any contemporary version of the Knights Templar or the Hanseatic League.

In conclusion, Europe’s position within this new phase of capitalism isn’t yet clear. The Old Continent could remain an “intermediate” region supplying ancillary services to an economic world dominated by Silicon Valley and the US. But perhaps it could also become an economic world in its own right. I think the latter scenario can only happen if sovereignty is enforced at the continental level rather than at the national one, and if the EU finally gets serious about supporting local tech-driven capitalists.

Related: 10 Tech Giants That Are (Almost All) in Bad Shape

 

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