Editor’s Note: This is an excerpt from a longer essay by Niall Ferguson, titled 'Capitalism, Socialism and Democracy Revisited,' published by the Hoover Institution as part of a new initiative "Socialism and Free-Market Capitalism: The Human Prosperity Project."

The terms ‘capitalism’ and ‘socialism’ had their origins in the British Industrial Revolution. As the Chicago economist Thorstein Veblen argued, nineteenth-century capitalism was an authentically Darwinian system, characterized by seemingly random mutation, occasional speciation and differential survival. Yet precisely the volatility of the more or less unregulated markets created by the Industrial Revolution caused consternation amongst many contemporaries. Until there were significant breakthroughs in public health, mortality rates in industrial cities were markedly worse than in the countryside. Moreover, the advent of a new and far from regular ‘business cycle,’ marked by periodic crises of industrial over-investment and financial panic, generally made a stronger impression on people than the gradual increase in the economy’s average growth rate. Though the Industrial Revolution manifestly improved life over the long run, in the short run it seemed to make things worse.

Intellectuals, as Schumpeter observed, were not slow to draw attention to this shadow side. One of William Blake’s illustrations for his preface to Milton featured, amongst other somber images, a dark-skinned figure holding up a blood-soaked length of cotton yarn. For the composer Richard Wagner, London was ‘Alberich’s dream come true—Nibelheim, world dominion, activity, work, everywhere the oppressive feeling of steam and fog.’ Hellish images of the British factory inspired his depiction of the dwarf’s underground realm in Das Rheingold, as well as one of the great leitmotifs of the entire Ring cycle, the insistent, staccato rhythm of multiple hammers.

Steeped in German literature and philosophy, the Scottish philosopher Thomas Carlyle was the first to identify what seemed the fatal flaw of the industrial economy: that it reduced all social relations to what he called, in his great essay Past and Present, ‘the cash nexus’:

the world has been rushing on with such fiery animation to get work and ever more work done, it has had no time to think of dividing the wages; and has merely left them to be scrambled for by the Law of the Stronger, law of Supply-and-demand, law of Laissez-faire, and other idle Laws and Un-laws. We call it a Society; and go about professing openly the totalest separation, isolation. Our life is not a mutual helpfulness; but rather, cloaked under due laws-of-war, named ‘fair competition’ and so forth, it is a mutual hostility. We have profoundly forgotten everywhere that Cash-payment is not the sole relation of human beings … [It] is not the sole nexus of man with man,—how far from it!  Deep, far deeper than Supply-and-demand, are Laws, Obligations sacred as Man’s Life itself.

That phrase—the ‘cash nexus’—so much pleased the son of an apostate Jewish lawyer from the Rhineland that he and his co-author, the heir of a Wuppertal cotton mill-owner, purloined it for the outrageous ‘manifesto’ they published on the eve of the 1848 Revolutions.

The founders of communism, Karl Marx and Friedrich Engels, were just two of many radical critics of the industrial society, but it was their achievement to devise the first internally consistent blueprint for an alternative social order. A mixture of Georg Wilhelm Friedrich Hegel’s philosophy, which represented the historical process as dialectical, and the political economy of David Ricardo, which posited diminishing returns for capital and an ‘iron’ law of wages, Marxism took Carlyle’s revulsion against the industrial economy and substituted a utopia for nostalgia.

Marx himself was an odious individual. An unkempt scrounger and a savage polemicist, he liked to boast that his wife was ‘née Baroness von Westphalen’ but was not above siring an illegitimate son by their maidservant. On the sole occasion when he applied for a job (as a railway clerk) he was rejected because his handwriting was so atrocious. He sought to play the stock market but was hopeless at it. For most of his life he therefore depended on handouts from Engels, for whom socialism was an evening hobby, along with fox-hunting and womanizing; his day job was running one of his father’s cotton factories in Manchester (the patent product of which was known as ‘Diamond Thread’). No man in history has bitten the hand that fed him with greater gusto than Marx bit the hand of King Cotton.

The essence of Marxism was the belief that the industrial economy was doomed to produce an intolerably unequal society divided between the bourgeoisie, the owners of capital, and a property-less proletariat. Capitalism inexorably demanded the concentration of capital in ever fewer hands and the reduction of everyone else to wage slavery, which meant being paid only ‘that quantum of the means of subsistence which is absolutely requisite to keep the laborer in bare existence as a laborer.’ In chapter 32 of the first tome of Capital (1867), Marx prophesied the inevitable denouement:

Along with the constant decrease of the number of capitalist magnates, who usurp and monopolize all the advantages of this process of transformation, the mass of misery, oppression, slavery, degradation and exploitation grows; but with this there also grows the revolt of the working class …

The centralization of the means of production and the socialization of labor reach a point at which they become incompatible with their capitalist integument. This integument is burst asunder. The knell of capitalist private property sounds. The expropriators are expropriated.

It is no coincidence that this passage has a Wagnerian quality, part Götterdämmerung, part Parsifal. But by the time the book was published the great composer had left the spirit of 1848 far behind. Instead it was Eugene Pottier’s song ‘The Internationale’ that became the anthem of Marxism. Set to music by Pierre De Geyter, it urged the ‘servile masses’ to put aside their religious ‘superstitions’ and national allegiances, and to make war on the ‘thieves’ and their accomplices, the tyrants, the generals, princes and peers.

Before identifying why they were wrong, we need to acknowledge what Marx and his disciples were right about. Inequality did increase as a result of the Industrial Revolution. Between 1780 and 1830 output per laborer in the UK grew over 25 percent but wages rose barely 5 percent. The proportion of national income going to the top percentile of the population rose from 25 percent in 1801 to 35 percent in 1848. In Paris in 1820, around 9 percent of the population were classified as ‘proprietors and rentiers’ (living from their investments) and owned 41 percent of recorded wealth. By 1911 their share had risen to 52 percent. In Prussia, the share of income going to the top 5 percent rose from 21 percent in 1854 to 27 percent in 1896 and to 43 percent in 1913. Industrial societies, it seems clear, grew more unequal over the course of the nineteenth century. This had predictable consequences. In the Hamburg cholera epidemic of 1892, for example, the mortality rate for individuals with an income of less than 800 marks a year was thirteen times higher than that for individuals earning over 50,000 marks.

It was not necessary to be an intellectual to be dismayed by the inequality of industrial society. The Welsh-born factory-owner Robert Owen envisaged an alternative economic model based on co-operative production and utopian villages like the ones he founded at Orbiston in Scotland and New Harmony, Indiana. It was in a letter to Owen, written by Edward Cowper in 1822, that the word ‘socialism’ in its modern sense first appears. An unidentified woman was, Cowper thought, ‘well adapted to become what my friend Jo. Applegath calls a Socialist.’ Five years later, Owen himself argued that ‘the chief question … between the modern … Political Economists, and the Communionists or Socialists, is whether it is more beneficial that this capital should be individual or in common.’ The term ‘capitalism’ made its debut in an English periodical in April 1833—in the London newspaper the Standard—in the phrase ‘tyranny of capitalism,’ part of an article on ‘the ill consequences of that greatest curse that can exist amongst men, too much money-power in too few hands.’ Fifteen years later, the Caledonian Mercury referred with similar aversion to ‘that sweeping tide of capitalism and money-loving which threatens our country with the horrors of a plutocracy.’

Yet the revolution eagerly anticipated by Marx never materialized—at least, not where it was supposed to, in the advanced industrial countries. The great bouleversements of 1830 and 1848 were the results of short-run spikes in food prices and financial crises more than of social polarization. As agricultural productivity improved in Europe, as industrial employment increased and as the amplitude of the business cycle diminished, the risk of revolution declined. Instead of coalescing into an impoverished mass, the proletariat subdivided into ‘labor aristocracies’ with skills and a Lumpenproletariat with vices. The former favored strikes and collective bargaining over revolution and thereby secured higher real wages. The latter favored gin. The respectable working class had their trade unions and working men’s clubs. The ruffians had the music hall and street fights.

The prescriptions of the Communist Manifesto were in any case singularly unappealing to the industrial workers they were aimed at. Marx and Engels called for the abolition of private property; the abolition of inheritance; the centralization of credit and communications; the state ownership of all factories and instruments of production; the creation of ‘industrial armies for agriculture’; the abolition of the distinction between town and country; the abolition of the family; ‘community of women’ (wife-swapping) and the abolition of all nationalities. By contrast, mid-nineteenth-century liberals wanted constitutional government, the freedoms of speech, press and assembly, wider political representation through electoral reform, free trade and, where it was lacking, national self-determination (‘Home Rule’). In the half-century after the upheaval of 1848 they got a great many of these things—enough, at any rate, to make the desperate remedies of Marx and Engels seem de trop. In 1850 only France, Greece and Switzerland had franchises in which more than a fifth of the population got to vote. By 1900 ten European countries did, and Britain and Sweden were not far below that threshold. Broader representation led to legislation that benefited lower-income groups; free trade in Britain meant cheap bread, and cheap bread plus rising nominal wages thanks to union pressure meant a significant gain in real terms for workers. Building laborers’ day wages in London doubled in real terms between 1848 and 1913. Broader representation also led to more progressive taxation. Britain led the way in 1842 when Sir Robert Peel introduced a peacetime income tax; by 1913 the standard rate was 14 pence in the pound. Prior to 1842 nearly all British tax revenue had come from the indirect taxation of consumption, via customs and excise duties, regressive taxes that take a proportionately smaller amount of your income the richer you are. By 1913 a third of revenue was coming from direct taxes on the relatively rich. In 1842 the central government had spent virtually nothing on education and the arts and sciences. In 1913 those items accounted for 10 percent of expenditure. By that time, Britain had followed Germany in introducing a state pension for the elderly.

Marx and Engels were wrong on two scores, then. First, their iron law of wages did not exist. Wealth did indeed become highly concentrated under capitalism, and it stayed that way into the second quarter of the twentieth century, but income differentials began to narrow as real wages rose and taxation became less regressive. Capitalists understood what Marx missed: that workers were also consumers. It therefore made no sense to try to grind their wages down to subsistence levels. On the contrary, as the case of the United States was making increasingly clear, there was no bigger potential market for capitalist enterprises than their own employees. Far from condemning the masses to ‘immiseration,’ the mechanization of textile production created growing employment opportunities for Western workers—albeit at the expense of Indian spinners and weavers—and the decline in the prices of cotton and other goods meant that Western workers could buy more with their weekly wages. The impact is best captured by the exploding differential between Western and non-Western wages and living standards in this period. Even within the West the gap between the industrialized vanguard and the rural laggards widened dramatically. In early seventeenth-century London, an unskilled worker’s real wages were not so different from what his counterpart earned in Milan. From the 1750s until the 1850s, however, Londoners pulled far ahead. At the peak of the great divergence within Europe, London real wages were six times those in Milan. With the industrialization of northern Italy in the second half of the nineteenth century, the gap began to close, so that by the eve of the First World War it was closer to a ratio of 3:1. German and Dutch workers also benefited from industrialization, though even in 1913 they still lagged behind their English counterparts.

Chinese workers, by contrast, did no so such catching up. Where wages were highest, in the big cities of Beijing and Canton, building workers received the equivalent of around 3 grams of silver per day, with no upward movement in the eighteenth century and only a slight improvement in the nineteenth and early twentieth (to around 5-6 grams). There was some improvement for workers in Canton after 1900 but it was minimal; workers in Sichuan stayed dirt poor. London workers meanwhile saw their silver-equivalent wages rise from around 18 grams between 1800 and 1870 to 70 grams between 1900 and 1913. Allowing for the cost of maintaining a family, the standard of living of the average Chinese worker fell throughout the nineteenth century. True, subsistence was cheaper in China than in North-western Europe. It should also be remembered that Londoners and Berliners by that time enjoyed a far more variegated diet of bread, dairy products and meat, washed down with copious amounts of alcohol, whereas most East Asians were subsisting on milled rice and small grains. Nevertheless, it seems clear that by the second decade of the twentieth century the gap in living standards between London and Beijing was around six to one, compared with two to one in the eighteenth century.

The second mistake Marx and Engels made was to underestimate the adaptive quality of the nineteenth-century state—particularly when it could legitimize itself as a nation-state. In his Contribution to a Critique of Hegel’s Philosophy of Right, Marx had famously called religion the ‘opium of the masses.’ If so, then nationalism was the cocaine of the middle classes.

Nationalism had its manifestos, too. Giuseppe Mazzini was perhaps the nearest thing to a theoretician that nationalism produced. As he shrewdly observed in 1852, the Revolution ‘has assumed two forms; the question which all have agreed to call social, and the question of nationalities.’ The Italian nationalists of the Risorgimento:

struggled … as do Poland, Germany, and Hungary, for country and liberty; for a word inscribed upon a banner, proclaiming to the world that they also live, think, love, and labor for the benefit of all. They speak the same language, they bear about them the impress of consanguinity, they kneel beside the same tombs, they glory in the same tradition; and they demand to associate freely, without obstacles, without foreign domination …

For Mazzini it was simple: ‘The map of Europe has to be re­made.’ In the future, he argued, it would be neatly reordered as eleven nation-states. This was much easier said than done, however, which was why the preferred modes of nationalism were artistic or gymnastic rather than programmatic. Nationalism worked best in the demotic poetry of writers like the Greek Rigas Feraios (‘It’s better to have an hour as a free man than forty years as a slave’), or in the stirring songs of the German student fraternities (‘The sentry on the Rhine stands firm and true’), or even on the sports field, where Scotland played England on St Andrew’s Day, 1872, in the world’s first international soccer match (result: 0–0). It was more problematic when political borders, linguistic borders and religious borders failed to coincide, as they did most obviously in the fatal triangle of territory between the Baltic, the Balkans and the Black Sea. Between 1830 and 1905 eight nation-states achieved either independence or unity: Greece (1830), Belgium (1830–39), Romania (1856), Italy (1859–71), Germany (1864–71), Bulgaria (1878), Serbia (1867–78) and Norway (1905). But the American Southerners failed in their bids for statehood, as did the Armenians, the Croats, the Czechs, the Irish, the Poles, the Slovaks, the Slovenes and the Ukrainians. The Hungarians, like the Scots, made do with the role of junior partners in dual monarchies with empires they helped to run. As for such ethno-linguistically distinct peoples as the Roma, Sinti, Kashubes, Sorbs, Wends, Vlachs, Székelys, Carpatho-Rusyns and Ladins, no one seriously thought them capable of political autonomy.

Success or failure in the nation-building game was ultimately about Realpolitik. It suited Camillo Benso, conte de Cavour, to turn the rest of Italy into a colonial appendage of Piedmont-Sardinia, just as it suited Otto Eduard Leopold von Bismarck, Count of Bismarck-Schönhausen, to preserve the prerogatives of the Prussian monarchy by making it the most powerful institution in a federal German Reich. ‘If we want everything to stay as it is, everything will have to change.’ The most famous line in Giuseppe Tomasi di Lampedusa’s historical novel The Leopard (1958) is frequently cited to sum up the covertly conservative character of Italian unification. But the new nation-states were about more than just preserving the cherished privileges of Europe’s beleaguered landowning elites. Entities like Italy or Germany, composites of multiple statelets, offered all their citizens a host of benefits: economies of scale, network externalities, reduced transaction costs and the more efficient provision of key public goods like law and order, infrastructure and health. The new states could make Europe’s big industrial cities, the breeding grounds of both cholera and revolution, finally safe. Slum clearance, boulevards too wide to barricade, bigger churches, leafy parks, sports stadiums and above all more policemen—all these things transformed the great capitals of Europe, not least Paris, which Baron Georges Haussmann completely recast for Napoleon III. All the new states had imposing façades; even defeated Austria lost little time in reinventing itself as ‘imperial-royal’ Austria-Hungary, its architectural identity set in stone around Vienna’s Ringstrasse. But behind the façades there was real substance. Schools were built, the better to drum standardized national languages into young heads. Barracks were erected, the better to train the high-school graduates to defend their fatherland. And railways were constructed in places where their profitability looked doubtful, the better to transport the troops to the border, should the need arise. Peasants became Frenchmen—or Germans, or Italians, or Serbs, depending where they happened to be born.

So effective was the system of nation-building that when the European governments resolved to go to war over two arcane issues—the sovereignty of Bosnia-Herzegovina and the neutrality of Belgium—they were able, over more than four years, to mobilize in excess of 70 million men as soldiers or sailors. In France and Germany around a fifth of the pre-war population—close to 80 percent of adult males—ended up in uniform. When the leaders of European socialism met in Brussels at the end of July 1914, they could do little more than admit their own impotence. A general strike could not halt a world war.

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