What is the relationship between democracy and the free enterprise system?

Updated on: Apr 01, 2013

Ponder on ‘Democracy and Free Enterprise’ before you enter the world, — that was Dr Raghuram G. Rajan’s advice to the graduating students of IIM-Bangalore.

Delivering IIM-Bangalore’s 38th annual convocation address, Dr Rajan said ‘Democracy and Free Enterprise’ are usually found together — it is hard to think of a flourishing democracy that is not a market economy. Moreover, while a number of autocratic economies have embraced some semblance of free enterprise (or Socialism with Chinese characteristics, as the Chinese Communist Party would say), it seems to be only a matter of time before they are forced to become more democratic.”

There is indeed a fundamental commonality between democracy and free enterprise. Both guarantee participation to all but neither guarantees power or success. Instead, political and economic entrepreneurs try to persuade the public that their product is the best, and it is collective choice, whether by the electorate or the marketplace, which determines success.

Dr Rajan said “These similarities are, of course, accompanied by considerable differences. After all, in aggregating choices, democracy treats individuals as equal, with every adult getting an equal vote, whereas free enterprise empowers individuals based on how much income they generate and how much property they own.”

“There is, therefore, an inherent tension between systems: the less well-off majority could vote to dispossess the rich and successful. And the rich, through their money power, could try to erode the political rights of the voter. Indeed, there is a delicate balance between democracy and free enterprise, which if upset, could destroy both,” he added.

“And as I argue, the Government plays a critical role in maintaining the balance. The implications for India are considerable,” he added.

Dr Rajan, explaining the reasons said, “One reason that the median voter rationally agrees to protect the property of the rich may be that she sees the rich as more efficient managers of that property.”

“So, to the extent that the rich are self-made and have come out winners in a competitive, fair and transparent market, society may be better off allowing them to own and manage their wealth, while taking a reasonable share as taxes. The more, however, that the rich are seen as idle incompetent, or crooked, the more the median voter should be willing to vote for tough regulations and punitive taxes on them,” he added.