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Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity
by William J. Baumol, Robert E. Litan and Carl J. Schramm
Reviewd by David Binns, Beyster Institute Staff
Most people today live in some version of a capitalist economy, but just as the breakup of the bipolar world of capitalism versus communism didn’t really herald the end of history, capitalism itself continues to evolve and change in an increasingly integrated global economy. As Good Capitalism, Bad Capitalism makes clear, not only are there are several distinctly different types of capitalism, but some forms of capitalism are clearly better at fostering and sustaining long-term economic growth and dynamism than others and other forms of capitalism can even be counter-productive in terms of promoting economic growth and broadening economic opportunity.
What will it take to sustain economic growth through the next century in developed economies and how developing economies obtain higher standards of living for their citizens? The authors contend that the answers to these questions lie within capitalist economies, though the various forms of “capitalism” differ in important respects. The four main forms of capitalism analyzed in Good Capitalism, Bad Capitalism are:
- State-guided capitalism, in which government tries to guide the market, most often by supporting particular industries that it expects to become “winners”
- Oligarchic capitalism, in which the bulk of the power and wealth is held by a small group of individuals and families whose main objective is patronage, not economic growth
- Big-firm capitalism, in which the most significant economic activities are carried out by established giant enterprises
- Entrepreneurial capitalism, in which a significant role is played by small, innovative firms that develop and commercialize radical or breakthrough innovations.
There are advantages and disadvantages in each approach to capitalism and many economies manifest a mixture of traits. But clearly it’s the latter two versions – and in particular, entrepreneurial capitalism that holds the greatest promise for sustained and renewable economic growth.
In state-guided capitalism, particularly prominent in many Asian economies, governments typically own the lion’s share of banks and other financial institutions and therefore control the flow of capital to favored industries. In some cases state-guided export growth strategies have been successful, particularly in low-wage economies producing affordable goods or services for world markets. Problems encountered by this form of capitalism include excessive investment in favored industries, picking the wrong industries to back and the inability of centralized bureaucracies to respond to changing market opportunities.
Oligarchic capitalism, which is prevalent in the former Soviet Union, most of the Middle East and much of Africa, is characterized by domination by well-entrenched elite that does little to foster broad-based growth and/or innovation. This often results in the growth of an informal economy which limits the ability of the economy to grow through collaboration and consolidation and interaction with more established market players. Corruption among the insider-elites and over-reliance on natural resources in lieu of the development of new products and services are hallmarks of oligarchic capitalism.
Big-firm capitalism is typified by the economies of Western Europe and Japan. While big firms are often market leaders, on average they tend to produce lower rates of innovation (though big firms often buy innovation by acquiring smaller firms) and rarely produce breakthrough technologies that spur strong economic growth. Toyota and Nokia demonstrate that big firms can be innovative market leaders, but the lack of a robust set of newly emerging entrepreneurial firms limits macro-economic growth potential in economies dominated by big firms. Economies dominated by big firms have a tendency to live for the status quo, though they have some success at fostering incremental innovation. The authors suggest that the aging populations of Japan and Western Europe – and the expectations for social protections from health care to pensions – will require these economies to grow more rapidly in order to generate the wealth needed to sustain their standard of living.
The radical breakthroughs in innovation tend to be disproportionately developed and brought to market by a single individual or new firm (even if the original ideas were developed in universities or big-firm labs) that are typical of entrepreneurial capitalism that is most characteristic of the United States (though the U.S. obviously benefits from the stability and economic power of established big firms as well). The authors make the case that entrepreneurial capitalism is better at fostering the opportunities for these innovators to risk new ventures and ideas and to more consistently produce the big changes that create new markets and spur more rapid and renewable economic growth and dynamism. As management guru Peter Drucker emphasized, “not every new small business is entrepreneurial or represents entrepreneurship.” An entrepreneurial company is defined as any entity that provides new products or services or methods to deliver goods and services at a lower cost. Not just any small business (many of which are “replicative entrepreneurs”) but growth-oriented innovators are the X-factor that distinguishes the ability of entrepreneurial capitalism to sustain higher growth rates.
To realize all the economic, social, and political benefits that capitalism affords requires an understanding of the right blend of entrepreneurial and established firms. Of equal importance are the right mix of policies to foster the development of a more dynamic blend of free market incentives. The authors suggest that there are four key elements needed to promote economic growth:
- Make it easy to start and grow a business. Governments need to promote policies to streamline the process whereby entrepreneurs can both easily establish new business and abandon failed ones through bankruptcy. These new companies also need to be supported by reasonably well-functioning financial systems and flexible labor markets to enable the successful companies to attract workers to help them grow.
- Establish a dependable rule of law. Property and contract rights protections are particularly important, as well as the need to provide an institutional framework to reward socially useful entrepreneurial activity by enforcing patent rights and giving private companies the ability to operate independently of governmental structures.
- Government institutions should focus on economic growth versus redistribution. A global economy in particular is not a zero-sum game. Growth facilitates greater opportunities for wealth creation that can raise living standards more effectively over the long-term.
- Government must preserve incentives to ensure that entrepreneurs continue to have incentives to innovate. Enforcement of antitrust laws are important in that regard, but less so than an openness to trade which can serve both to attract needed investment and acquire access to new markets.
Good Capitalism, Bad Capitalism makes the case that developing countries, many of whose economies are today typified by the less productive forms of state-guided or oligarchic capitalism, can nevertheless introduce innovations at the margins to begin to foster innovation. The authors suggest that evidence for the efficacy of foreign aid in promoting economic growth is decidedly mixed and that developing countries must eventually find the means of growing on their own. That requires the development of the kinds of supporting institutions – legal, financial and educational – to foster entrepreneurship. They cite the growth of micro credit as a positive trend in accelerating the formation of new businesses, but note that such firms are mainly characterized by replicative rather than innovative entrepreneurship. These small companies are unlikely to be engines of long-term economic growth in a global economy.
The authors of Good Capitalism, Bad Capitalism bring impressive credentials to their analysis of economic development strategies. William J. Baumol is Harold Price Professor of Entrepreneurship and academic director of the Berkley Center for Entrepreneurial Studies in the Stern School of Business, New York University, and senior economist and professor emeritus at Princeton University. Robert E. Litan is vice president for research and policy at the Kauffman Foundation and senior fellow at the Brookings Institution. Carl J. Schramm is president and chief executive officer of the Kauffman Foundation and a Batten Fellow at the Darden School of Business, University of Virginia. Their collaboration on this provocative book offers compelling evidence of the importance of promoting entrepreneurship as a means of sustaining economic growth in both mature and developing economies.
©2007 The Beyster Institute and its authors and their entities. All rights reserved.
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