There are two economic systems in
the West. Several nations--including the U.S., Canada and the U.K.--have a
private-ownership system marked by great openness to the implementation of
new commercial ideas coming from entrepreneurs, and by a pluralism of
views among the financiers who select the ideas to nurture by providing
the capital and incentives necessary for their development. Although much
innovation comes from established companies, as in pharmaceuticals, much
comes from start-ups, particularly the most novel innovations. This is
free enterprise, a k a capitalism.
The other system--in Western
Continental Europe--though also based on private ownership, has been
modified by the introduction of institutions aimed at protecting the
interests of "stakeholders" and "social partners." The system's
institutions include big employer confederations, big unions and
monopolistic banks. Since World War II, a great deal of liberalization has
taken place. But new corporatist institutions have sprung up:
Co-determination (cogestion, or Mitbestimmung) has brought "worker
councils" (Betriebsrat); and in Germany, a union representative
sits on the investment committee of corporations. The system operates to
discourage changes such as relocations and the entry of new firms, and its
performance depends on established companies in cooperation with local and
national banks. What it lacks in flexibility it tries to compensate for
with technological sophistication. So different is this system that it has
its own name: the "social market economy" in Germany, "social democracy"
in France and "concertazione" in Italy.
Dynamism and Fertility
The American and Continental
systems are not operationally equivalent, contrary to some neoclassical
views. Let me use the word "dynamism" to mean the fertility of the economy
in coming up with innovative ideas believed to be technologically feasible
and profitable--in short, the economy's talent at commercially successful
innovating. In this terminology, the free enterprise system is structured
in such a way that it facilitates and stimulates dynamism while the
Continental system impedes and discourages it.
Wasn't the Continental system
designed to stifle dynamism? When building the massive structures of
corporatism in interwar Italy, theoreticians explained that their new
system would be more dynamic than capitalism--maybe not more fertile in
little ideas, such as might come to petit-bourgeois entrepreneurs, but
certainly in big ideas. Not having to fear fluid market conditions, an
entrenched company could afford to develop radical innovation. And with
industrial confederations and state mediation available, such companies
could arrange to avoid costly duplication of their investments. The state
and its instruments, the big banks, could intervene to settle conflicts
about the economy's direction. Thus the corporatist economy was expected
to usher in a new futurismo that was famously symbolized by
Severini's paintings of fast trains. (What was important was that the
train was rushing forward, not that it ran on time.)
Friedrich Hayek, in the late 1930s
and early '40s, began the modern theory of how a capitalist system,
if pure enough, would possess the greatest dynamism--not socialism and not
corporatism. First, virtually everyone right down to the humblest
employees has "know-how," some of what Michael Polanyi called "personal
knowledge" and some merely private knowledge, and out of that an idea may
come that few others would have. In its openness to the ideas of all or
most participants, the capitalist economy tends to generate a plethora of
new ideas.
Second, the pluralism of
experience that the financiers bring to bear in their decisions gives a
wide range of entrepreneurial ideas a chance of insightful evaluation. And,
importantly, the financier and the entrepreneur do not need the approval
of the state or of social partners. Nor are they accountable later on to
such social bodies if the project goes badly, not even to the financier's
investors. So projects can be undertaken that would be too opaque and
uncertain for the state or social partners to endorse. Lastly, the
pluralism of knowledge and experience that managers and consumers bring to
bear in deciding which innovations to try, and which to adopt, is crucial
in giving a good chance to the most promising innovations launched. Where
the Continental system convenes experts to set a product standard before
any version is launched, capitalism gives market access to all versions.
The issues swirling around
capitalism today concern the consequences of its dynamism. The main
benefit of an innovative economy is commonly said to be a higher level of
productivity--and thus higher hourly wages and a higher quality of life.
There is a huge element of truth in this belief, no matter how many tens
of qualifications might be in order. Much of the huge rise of productivity
since the 1920s can be traced to new commercial products and business
methods developed and launched in the U.S. and kindred economies. (These
include household appliances, sound movies, frozen food, pasteurized
orange juice, television, semiconductor chips, the Internet browser, the
redesign of cinemas and recent retailing methods.) There were often
engineering tasks along the way, yet business entrepreneurs were the
drivers.
There is one conceivable
qualification that ought to be addressed. Is productivity not finally at
the point, after 150 years of growth, that having yet another year's
growth would be of negligible value? D.H. Lawrence spoke of America's "everlasting
slog." Whatever the answer, it is important to note that advances in
productivity, in generally pulling up wage rates, make it affordable for
low-wage people to avoid work that is tedious or grueling or dangerous in
favor of work that is more interesting and formative.
Of course, productivity levels in
the smaller countries will always owe more to innovations developed abroad
than to those they develop themselves. Some might suspect that the
domestic market is so tiny in a country such as Iceland, for instance,
that even in per capita terms only a very small number of homemade
innovations would bring a satisfactory productivity gain--and thus an
adequate rate of return. In fact, most of the Continental economies,
including the large ones, have been content to sail in the slipstream of a
handful of economies that do the preponderance of the world's innovating.
The late Harvard economist Zvi Griliches commented approvingly that in
such a policy, the Europeans "are so smart."
I take a different view. For one
thing, it is good business to be an innovative force in the "global
economy." Globalization has diminished the importance of scale as well as
distance. Tiny Denmark sets its sights on markets in the U.S., the EU and
elsewhere. Iceland has entered into European banking and biogenetics.
France has long done this--and can do more of it. But it could do so more
successfully if it did not insulate its innovational decisions so much
from evaluations by financial markets--including the stock market--as
Airbus does. The U.S. is already demonstrably in the global innovation
business. To date, there is an adequate rate of return to be expected from
"investing" in the conception, development and marketing of innovations
for the global economy--a return on a par with the return from investing
in plant and equipment, software and other business capital. That is a
better option for Americans than suffering diminished returns from
investing solely in the classical avenue of fixed capital.
I would, however, stress a benefit
of dynamism that I believe to be far more important. Instituting a high
level of dynamism, so that the economy is fired by the new ideas of
entrepreneurs, serves to transform the workplace--in the firms developing
an innovation and also in the firms dealing with the innovations. The
challenges that arise in developing a new idea and in gaining its
acceptance in the marketplace provide the workforce with high levels of
mental stimulation, problem-solving, employee-engagement and, thus,
personal growth. Note that an individual working alone cannot easily
create the continual arrival of new challenges. It "takes a village,"
preferably the whole society.
The concept that people need
problem-solving and intellectual development originates in Europe: There
is the classical Aristotle, who writes of the "development of talents";
later the Renaissance figure Cellini, who jubilates in achievement; and
Cervantes, who evokes vitality and challenge. In the 20th century, Alfred
Marshall observed that the job is in the worker's thoughts for most of the
day. And Gunnar Myrdal wrote in 1933 that the time will soon come when
more satisfaction derives from the job than from consuming. The American
application of this Aristotelian perspective is the thesis that most, if
not all, of such self-realization in modern societies can come only from a
career. Today we cannot go tilting at windmills, but we can take on the
challenges of a career. If a challenging career is not the main hope for
self-realization, what else could be? Even to be a good mother, it helps
to have the experience of work outside the home.
I must mention a "derived" benefit
from dynamism that flows from its effects on productivity and
self-realization. A more innovative economy tends to devote more resources
to investing of all kinds--in new employees and customers as well as new
office and factory space. And although this may come about through a shift
of resources from the consumer-goods sector, it also comes through the
recruitment of new participants to the labor force. Also, the resulting
increase of employee-engagement serves to lower quit rates and, hence, to
make possible a reduction of the "natural" unemployment rate. Thus, high
dynamism tends to bring a pervasive prosperity to the economy on top of
the productivity advances and all the self-realization going on. True,
that may not be pronounced every month or year. Just as the creative
artist does not create all the time, but rather in episodes and breaks, so
the dynamic economy has heightened high-frequency volatility and may go
through wide swings. Perhaps this volatility is not only normal but also
productive from the point of view of creativity and, ultimately,
achievement.
Ideals and Reality
I know I have drawn an idealized
portrait of capitalism: The reality in the U.S. and elsewhere is much less
impressive. But we can, nevertheless, ask whether there is any evidence in
favor of these claims on behalf of dynamism. Do we find evidence of
greater benefits of dynamism in the relatively capitalist economies than
in the Continental economies as currently structured? In the Continent's
Big Three, hourly labor productivity is lower than in the U.S. Labor-force
participation is also generally lower. And here is new evidence: The World
Values Survey indicates that the Continent's workers find less job
satisfaction and derive less pride from the work they do in their job.
Dynamism does have its downside.
The same capitalist dynamism that adds to the desirability of jobs also
adds to their precariousness. The strong possibility of a general slump
can cause anxiety. But we need some perspective. Even a market socialist
economy might be unpredictable: In truth, the Continental economies are
also susceptible to wide swings. In fact, it is the corporatist economies
that have suffered the widest swings in recent decades. In the U.S. and
the U.K., unemployment rates have been remarkably steady for 20 years. It
may be that when the Continental economies are down, the paucity of their
dynamism makes it harder for them to find something new on which to base a
comeback.
The U.S. economy might be said to
suffer from incomplete inclusion of the disadvantaged. But that is less a
fault of capitalism than of electoral politics. The U.S. economy is not
unambiguously worse than the Continental ones in this regard: Low-wage
workers at least have access to jobs, which is of huge value to them in
their efforts to be role models in their family and community. In any
case, we can fix the problem.
Why, then, if the "downside" is so
exaggerated, is capitalism so reviled in Western Continental Europe? It
may be that elements of capitalism are seen by some in Europe as morally
wrong in the same way that birth control or nuclear power or sweatshops
are seen by some as simply wrong in spite of the consequences of barring
them. And it appears that the recent street protesters associate business
with established wealth; in their minds, giving greater latitude to
businesses would increase the privileges of old wealth. By an
"entrepreneur" they appear to mean a rich owner of a bank or factory,
while for Schumpeter and Knight it meant a newcomer, a parvenu who
is an outsider. A tremendous confusion is created by associating "capitalism"
with entrenched wealth and power. The textbook capitalism of Schumpeter
and Hayek means opening up the economy to new industries, opening
industries to start-up companies, and opening existing companies to new
owners and new managers. It is inseparable from an adequate degree of
competition. Monopolies like Microsoft are a deviation from the model.
It would be unhistorical to say
that capitalism in my textbook sense of the term does not and cannot exist.
Tocqueville marveled at the relatively pure capitalism he found in America.
The greater involvement of Americans in governing themselves, their
broader education and their wider equality of opportunity, all encourage
the emergence of the "man of action" with the "skill" to "grasp the chance
of the moment."
I want to conclude by arguing that
generating more dynamism through the injection of more capitalism does
serve economic justice.
We all feel good to see people
freed to pursue their dreams. Yet Hayek and Ayn Rand went too far in
taking such freedom to be an absolute, the consequences be damned. In
judging whether a nation's economic system is acceptable, its consequences
for the prospects of the realization of people's dreams matter, too. Since
the economy is a system in which people interact, the endeavors of some
may damage the prospects of others. So a persuasive justification of
well-functioning capitalism must be grounded on its all its consequences,
not just those called freedoms.
To argue that the consequences of
capitalism are just requires some conception of economic justice. I
broadly subscribe to the conception of economic justice in the work by
John Rawls. In any organization of the economy, the participants will
score unequally in how far they manage to go in their personal growth. An
organization that leaves the bottom score lower than it would be under
another feasible organization is unjust. So a new organization that raised
the scores of some, though at the expense of reducing scores at the bottom,
would not be justified. Yet a high score is just if it does not hurt
others. "Envy is the vice of mankind," said Kant, whom Rawls greatly
admired.
The 'Least Advantaged'
What would be the consequence,
from this Rawlsian point of view, of releasing entrepreneurs onto the
economy? In the classic case to which Rawls devoted his attention, the
lowest score is always that of workers with the lowest wage, whom he
called the "least advantaged": Their self-realization lies mostly in
marrying, raising children and participating in the community, and it will
be greater the higher their wage. So if the increased dynamism created by
liberating private entrepreneurs and financiers tends to raise
productivity, as I argue--and if that in turn pulls up those bottom wages,
or at any rate does not lower them--it is not unjust. Does anyone doubt
that the past two centuries of commercial innovations have pulled up wage
rates at the low end and everywhere else in the distribution?
Yet the tone here is wrong. As
Kant also said, persons are not to be made instruments for the gain of
others. Suppose the wage of the lowest- paid workers was foreseen
to be reduced over the entire future by innovations conceived by
entrepreneurs. Are those whose dream is to find personal development
through a career as an entrepreneur not to be permitted to pursue their
dream? To respond, we have to go outside Rawls's classical model, in which
work is all about money. In an economy in which entrepreneurs are
forbidden to pursue their self-realization, they have the bottom
scores in self-realization--no matter if they take paying jobs
instead--and that counts whether or not they were born the "least
advantaged." So even if their activities did come at the expense of the
lowest-paid workers, Rawlsian justice in this extended sense requires that
entrepreneurs be accorded enough opportunity to raise their
self-realization score up to the level of the lowest-paid workers--and
higher, of course, if workers are not damaged by support for
entrepreneurship. In this case, too, then, the introduction of
entrepreneurial dynamism serves to raise Rawls's bottom scores.
Actual capitalism departs from
well-functioning capitalism--monopolies too big to break up, undetected
cartels, regulatory failures and political corruption. Capitalism in its
innovations plants the seeds of its own encrustation with entrenched
power. These departures weigh heavily on the rewards earned, particularly
the wages of the least advantaged, and give a bad name to capitalism. But
I must insist: It would be a non sequitur to give up on private
entrepreneurs and financiers as the wellspring of dynamism merely because
the fruits of their dynamism would likely be less than they could be in a
less imperfect system. I conclude that capitalism is justified--normally
by the expectable benefits to the lowest-paid workers but, failing that,
by the injustice of depriving entrepreneurial types (as well as other
creative people) of opportunities for their self-expression.
Mr. Phelps, the McVickar
Professor of Political Economy at Columbia, was yesterday awarded the 2006
Nobel Prize for economics. Click
here to read a selection of his previous articles from The Wall Street
Journal.
...Entrepreneurship is lucrative--and just. ..article
de Mr. Phelps, the McVickar Professor of Political Economy at
Columbia, was yesterday (09.10.06 ) awarded the 2006 Nobel Prize for
economics