In 1957, Anthony Downs published “An Economic Theory of Political Action in a Democracy” in the Journal of Political Economy. In that paper he laid out what came to be called the Downsian model of political competition. According to this model, political entrepreneurs seeking office position themselves in the spectrum of policy in order to appeal to a sufficiently large set of voters so as to win the election. The central result of this theory is the Median Voter Theorem: policies of a democratic state will reflect the preferences of the median voter. This is usually formulated in terms of the provision of a given public good. Voter preferences are expected to be normally distributed around a median value. Political parties competing for votes will therefore converge to the median value.

There are obviously many small bore critiques one can immediately level at the Downsian model. Voter preferences are unlikely to be known to politicians, one-dimensional policy spectrums are unsuitable for analyzing electoral politics, and so on and so forth. Such criticisms may be valid, however, they accept the fundamental premise of the Downsian model. Namely, that political entrepreneurs position themselves in the spectrum of voters’ policy preferences, and appeal, primarily and exclusively, to voters. We have here the equivalent of the myth of perfect competition in the political sphere.

Thomas Ferguson proposed an alternative that he calls the investment theory of party competition.[1] In this model, candidates for political office and political parties appeal not to voters, but to investors, who are the fundamental constituency. According to Ferguson, “parties are more accurately analyzed as blocs of major investors who coalesce to advance candidates representing their interests.” The policy platforms of political parties reflect the interests of major investors, and which minor investor-voters are virtually incapable of affecting, save in the negative sense of voting “no confidence”. As the cost of political campaigns have skyrocketed in the era of tele-democracy, the logic of money driven political systems has become more and more applicable. The investment theory expects that whole areas of policy will not be contested. This will occur as a matter of routine because major investors across parties may have virtually identical preferences on many policy issues. Since major investors will all hail from the upper classes and the bulk of the voters from the popular masses, the theory expects a sharp bias in public policy towards the rich wherever class interests are at stake. Once the central implications of this theory are digested a revised approach to party systems and critical realignments immediately becomes available. Several of these can be distinguished historically.

The first of these is the Jacksonian system of 1812 in the Era of Good Feeling. This system of the early Republic was dominated by southern plantation interests. The railroad boom around mid-century undermined the dominance of the southern planters. The central axis of antebellum American rotated from a north-south to an east-west orientation as the transportation revolution annihilated distance and forged a true national economy.

The fortunes of northern industrialists, especially railroads, gained at the expense of the southern plantation owners. The Republican party was founded in 1854, and came to dominate the northern states by 1858. It was more or less a front for northern industrial, especially railroad, interests. The opposition of southern planters led them to secede from the union once Lincoln was elected to the White House. The success of the North in preserving the union ensured the dominance of the Republican party, and in it that of the railroads. The railroads formed a hegemonic bloc of investors not only because of their financial strength, which was substantial. They were a new breed of political-economic actors, being the first of the large modern business corporations with resources and national reach that no other industry could even begin to match.

By 1890, the unrivaled dominance of the railroads was a thing of the past. More powerful industrial interests had emerged: oil, steel, and finance. The party system of 1860 began crumbling in the 1880s with the relative decline of the Republican party. In fact, as Governor of New York, Grover Cleveland took on the railroad baron Jay Gould, and in his campaign for the presidency attacked his opponents for being in the pockets of the railroads. As President, he ordered an investigation into the transfer of government lands to the railroads. The party alignments of the post-Civil War era had disappeared by 1890. A new configuration reflecting the balance of forces in industrial America became established in 1896 after a highly charged election. We will return to this crucial election shortly.

The system of 1896 was dominated by the Republican party. However, a new cast of investors had taken over. By this time finance, oil, and steel interests had become dominant. Around the same time there was a remarkable transformation in the foreign affairs of the United States. The US started building a blue-water navy, conquered Hawaii, the Philippines, and invaded a string of Central American countries. It went to war with Spain and finally imposed the Monroe Doctrine which had been more bravado than reality in the nineteenth century. It declared an “Open Door” policy in China, and balanced Japan in the Pacific. Quite suddenly, in 1898, the United States become a great power.

This was also a period of financial hegemony. New York financiers started investing more and more in American industry. The climax of this process was the merger wave of 1897-1901, which placed bankers on the boards of hundreds of corporations. This gathering of the reins of the economy in New York was symbolized by the biggest merger of them all, United States Steel: Andrew Carnegie, the industrialist, had sold out to J.P. Morgan, the investment banker. At the same time, the former hegemonic bloc, the now bankrupt railroads, was gobbled up by finance. With this unprecedented unity of interests, policy making became easier, as in 1909, when Morgan fine-tuned the tariff bill by telegraph from his yacht.

Why did the Democrats not challenge the repressive character of the system of 1896? For instance, labor unions were under relentless attack throughout the period. Why didn’t the Democrats take up their mantle and electorally challenge the GOP? The answer is clear when we consider the most serious mass based challenge in US history. In the run up to the election of 1896, the People’s Party, also known as the Populists, was highly organized and popular. They were solidly rooted in local organizations. They tried to secure control of the Democratic party but were easily knocked over, not by the business community as a whole, but by a single sector.

The silver mining companies poured money into the party, hoping to secure government aid. The Populist candidates were defeated in state after state by the mining interests. Then the mining companies sealed their triumph by installing an editor of one of their own newspapers, William Jennings Bryan, as the Democratic party’s nominee for the Presidency. “The largest, best-organized, and most cohesive mass political movement in American history could not compete with even a part of the business community.” [Emphasis in the original.]

Although the system of 1896 survived till the Great Depression, it started coming under strain in the aftermath of the First World War. US multinationals had been gaining wealth and revenue since the beginning of the century. After the war, the United States suddenly became a major creditor nation. This meant that US firms couldn’t sell to Europeans and the Japanese unless they could earn enough dollars through the tariff walls set up to protect US manufacturers. Being more capital intensive, the multinationals were also less concerned about wage bills than the nationally oriented industrials that had hitherto dominated the Republican party. During the great boom of the 1920s, the relative strength of the multinationals gained substantially. This was especially true of the new fanged automotive industry. By the time of the stock market crash in 1929, the system of 1896 had already disintegrated amid spiraling conflicts over trade, labor, and foreign policies.

During the 1920s, a genuine labor movement had also developed. By the mid-thirties, unionization rates were reaching their historic peaks. Organized labor, quite consciously and for the first time, became a major investor in the Democratic party. The New Deal era coalition that emerged in 1936 was unusual in that it had as a major investor someone outside the business community. The novelty of FDR’s coalition was that it put together US multinationals, internationally oriented investment banks, and moderate sections of organized labor. Working-class activism and union power lasted through the Great Depression and into the Second World War. During the war, and especially in the early postwar period, it was tamed. Labor unions began a slow decline that did not accelerate until the Reagan assault. However, the more radical sections of organized labor came under brutal attack. The radicals in the Democratic party were eliminated. The New Deal coalition silently morphed into the Bretton Woods coalition as organized labor was reduced to docility within the Democratic party. Major gains that had been made were, however, left in place. They would not be dismantled until the eighties.

The New Deal era was a period of broad based growth. This was possible not just because of the policy mix of high taxes on high incomes and expanding welfare spending. Pre-tax, pre-transfer working class wages grew at a fast clip for a generation (1940-65) because of an unprecedented growth in the productivity and global market share of US manufacturers. The system of fixed exchange rates made fiscal policy effective and New Deal regulations on finance – especially regulation Q that set limits on what interest rates could be offered at depository institutions – acted as automatic mechanisms that regulated the economy with “hydraulic efficiency”. The United States accounted for half the world’s income in the first twenty years after the Second World War. Strong growth in the US thus pulled the entire world economy with it. Not surprisingly, the political system was highly stable.

The story of how the system of 1936 unraveled begins in 1965. In that year, the growth in productivity of US manufacturers began to fall behind their Japanese and German rivals. The profit rates of US firms began to come under pressure. The container revolution started gathering steam at the same time, making Japanese manufacturers even more competitive in the United States and Europe. Inflation started climbing under impact of the military-Keynesian stimulus of the war effort in Indochina. US policy making became more conflictual with the onset of the structural crisis.

Trade and fiscal deficits continued to expand and inflationary expectations kept rising with the result that the oil price revolution of 1973 led to the collapse of the fixed exchange rate regime and the onset of the stagflation crisis. US policymakers did not have the tools to fight both inflation and unemployment. At first, per New Deal era norms, the Carter administration geared policy to fight unemployment. However, with the onset of double digit inflation rates, a consensus emerged in the business community to tame inflation at all costs. Firms abandoned the Democrats to support the only party capable of delivering the bitter medicine. The New Deal era coalition had come undone. Amid the escalating crisis, with the election approaching, rivers of cash began flowing to all manner of “New Right” and “New Conservative” candidates in the Republican party. Under the inflexible clock of the election cycle, a more or less articulate compromise emerged in the candidacy of Ronald Regan.

Even before the critical election of 1980, Carter had already signed the Depository Institutions Deregulation and Monetary Control Act of 1980 that deregulated interest rates. In November 1979, he had appointed Paul Volcker as Chairman of the Federal Reserve. Volcker promptly set about delivering the bitter medicine. He sharply raised interest rates and kept raising them in a bid to tame inflationary expectations. These measures, along with the dismantling of the fixed exchange rate regime, led to an unanticipated financial explosion that changed the underpinnings of the emerging party system. The sky-high interest rates led to a flow of surplus from industry to finance, thereby increasing its bargaining power. At the same time, the now freed-up currency and capital markets sharply increased the uncertainty of cost of capital and foreign currencies faced by US firms. US firms reoriented themselves towards the financial markets in what amounted to a ‘Copernican revolution’.

The big winner was finance, which gained not just a larger share of the surplus, but also increased its bargaining power vis-à-vis both industry and the politicians. A massive wave of mergers and acquisitions began as financiers pooled their resources to acquire control of nonfinancial corporations. The eighties merger wave was more intense than even the Great wave of 1897-1901. Thus began a new, longer-lasting period of financial hegemony in American history.

Meanwhile, the Reagan administration launched an unprecedented attack on labor and welfare, and sent broad streams of cash flowing to its supporters through the Pentagon funnel. The Reagan coalition was much broader than finance, which was not yet a hegemonic bloc of investors, but Reagan fell in will Volcker’s high interest rate policy. This was because even manufacturers who were being pummeled by the high interest rates and the strong dollar agreed on the pressing need to tame inflation which was still in double digits.

The strong dollar was a direct result of the high interest rates. This was because the differential in the returns to US treasuries and other risk-free assets like German government bonds, prompted a massive flow of capital to the United States and hence bid up the price of US dollars. This primacy of the financial markets was a new phenomena and not yet well understood even by business elites. For instance, the Business roundtable published the Caterpillar report in 1985, which blamed Japanese policy for the strength of the dollar and the weakness of the yen. Treasury understood the fallacy but played along anyway, going as far as sending a contingent with Secretary of State Shultz to press Japan to stop manipulating its currency and deregulate its financial markets; even though they knew that deregulating Japan’s financial markets would make capital outflows easier and increase the upward pressure on the dollar.

This silent revolution whereby finance gained control of US policy in the early eighties has not received the attention of historians that it deserves. What is clear is that, by the time of Reagan’s reelection, the party system of 1980 had stabilized with finance as a hegemonic bloc of investors. This financial hegemony in the US political system was consolidated further by a takeover of the Democratic party as witnessed by the Clinton coalition. This does not mean either that no other investors have any say. Finance accounts for around half of all political contributions. The California based technology firms are major investors in the Democratic coalition, as are the still-independent large multinational corporations for both parties. Nor does it mean that the financial sector is a monolith: the financial services industry and finance capitalism – hedge fund managers, large private investors, and private equity moguls – sometimes have conflicting interests.

However, with the virtual absorption of the upper echelons of most corporations into finance broadly understood, business today displays the same unity it did in the pre First World War days of the system of 1896. The invariants of the system are not quite the same. Whereas, in the system of 1896, there was a consensus on protectionist tariffs, in the current system, the consensus is on finance-led neoliberal globalization.

The dominance of a hegemonic bloc of investors makes the current system structurally similar to the railroad dominated system of 1860. Unlike that period, the current regime is not dominated by a single party. This makes the current system more robust. For instance, one might have expected the financial crisis of 2007-08 to undermine the system, and constitute a “crisis of neoliberalism”. [Duménil and Lévy] However, the response of major investors was simply to shift allegiance to the other party whilst keeping all the policies in place. Ergo, the system is much more stable than previously recognized.

The contradictions inherent to the current party system and the neoliberal order, wherein the underlying weakness of the US economy and its failure to produce enough jobs or increase the standard of living of the bulk of the populace, will not be resolved easily. The pressure to apply constant monetary stimulus in the face of jobless recoveries will propel more asset bubbles, and further expand the trade and budget deficits. As these asset bubbles burst, the ‘reverse wealth effect’ will cause prolonged ‘balance sheet recessions’. The same dynamic will further strengthen the bargaining position of the financial sector which implies that it will be mighty hard to displace as a hegemonic bloc of investors.

It has become customary every election season to find a leaked audio or video of a candidate addressing investors behind closed doors. These are rare instances when the ‘bewildered herd’ is allowed a glimpse into the real mechanics of US electoral democracy: the physics of American political economy.