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 / Winter 2007 / Issue 49(originally published by Booz & Company)


Best Business Books: Capitalism

But Schumpeter always wrote about capitalism as more than an economic system. He appreciated that it was a human order with social, political, and cultural implications. A study of Schumpeter’s ideas is particularly timely now, as he is one of the few economists to have studied the impact of new technologies and the dynamics of how companies are born and die. With one dot-com boom and bust in recent times and another such cycle under way, and with globalization also bringing corporate upheaval, few other thinkers from the past seem as relevant. Schumpeter’s great work, Capital­ism, Socialism and Democracy (1942), is no one-sided hymn to capitalism, although its purpose is clearly to praise capitalism and condemn socialism. Schumpeter was highly skeptical about the ability of those who live off the state to practice “democratic self-restraint” and for them to abstain from interfering in the lives of others; his predictions about the retreat of democracy in the socialist states were amply confirmed by events in the second half of the 20th century. The key factor in his analysis of the political form of capitalism is that it limits the scope for interference with individual choice: “Modern democ­racy rose along with capitalism, and in causal connection with it,” Schumpeter wrote, a hy­pothesis that will surely be tested by China’s experiment with a capitalist economy and a Communist polity.

The Four Capitalisms
In their book, Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity, New York Univer­sity Harold Price Professor of Entrepreneurship and Economics William J. Baumol, and Robert E. Litan and Carl J. Schramm of the Kauffman Foundation divide capitalism into four main types and highlight the differences among them. The four types are the state-guided (industrial subsidies and attempts to pick winners are common features); the oligarchic (a small group of families run much of the economy); the big firm (very large business groups account for most of the economy); and the entrepreneurial (small and startup firms play a significant role). The authors note that all economies have some elements of each of these stylized types, but one form often predominates. In the present-day United States entrepreneurial capitalism is dominant, whereas in some major European economies, state guidance outweighs entrepreneurship, big firms remain central in Japan and Korea, and oligarchy is frequently found in emerging Asian economies.

The authors deftly capture the trade-offs among different types of capitalism. In their view, entrepreneurial capitalism is clearly superior to the other varieties because it is essential to growth. However, they also note how demanding and disruptive the dynamism of entre­preneurial capitalism is compared with Europe’s state-guided model. (Baumol has made this former type of capitalism his expertise: The Economist recently dubbed him “the leading thinker about the economics of innovation since Schumpeter.”) Of the 25 largest firms in the U.S. in 1998, eight had not existed in 1960, whereas every one of Europe’s top 25 in 1998 had roots that stretched back at least 38 years. The kind of churning of livelihoods exemplified by the U.S. makes properly constructed safety nets essential, although Americans clearly find it a struggle to create them.

Further, those safety nets come at a price. The trio of economists take a dim view of the “avoidance of work” ethic that they diagnose in the culture. It is not clear to me that this is a question of culture so much as politics. After all, the French have just overwhelmingly voted in a president who has pledged to make them work harder. Whatever the explanation, though, the differences among the various forms of capitalism translate into differences in growth rates. “Countries where activities that promote growth are rewarded will grow faster than countries where this is not the case,” the authors write. And they are firm in their view that the contribution of entrepreneurs to growth is fundamental. To this end, the book offers four key pieces of advice to policymakers: make it easy to start a business; enforce property and contract rights effectively and fairly; focus government policies on growth rather than redistribution, to minimize unproductive lobbying; and ensure an open economy with strong antitrust policies to keep up the pressure from competition.

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