Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity

Published by EH.NET (May 2009)

William J. Baumol, Robert E. Litan and Carl J. Schramm, Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity. New Haven: Yale University Press, 2007. x + 321 pp. $30 (hardcover), ISBN: 978-0-300-10941-2.

Reviewed for EH.NET by William R. Keech, Department of Political Science, Duke University.

This is a good book that celebrates capitalism as practiced in the United States just as features of that capitalism were bringing the world into the deepest financial crisis since the Great Depression. But it would be a great mistake to ignore this book because it did not anticipate events that have for some observers called into question whether capitalism is a reliable and desirable system. The book is a unique addition to the expanding literature on economic growth, and its main contribution is highlighted by the title of the first chapter: ?Entrepreneurship and Growth: The Missing Piece of the Puzzle.? While highlighting the role of innovation in economic growth, the book delineates four different types of capitalism according to the role of entrepreneurship in them. These ?archetypes? are oriented largely to how production is organized. They are to be contrasted with other treatments of the varieties of capitalism, such as the contrast between ?liberal market capitalism? and ?coordinated market capitalism,? which is oriented more toward different degrees of dependence on markets or non-market institutions to coordinate financial and industrial relations systems. (See Hall and Soskice, eds. 2001, especially chapter 1).

?Why Economic Growth Matters? is the topic of chapter 2, which defends growth against several familiar criticisms, such as resource constraints and the relationship between growth and happiness. Chapter 3 is a readable introduction to modern growth theory. It stresses the importance of innovation, and reviews empirical evidence. Baumol, Litan and Schramm show how the Washington Consensus has broken down as a consensual explanation of a path to growth, and suggest that the four faces of capitalism is a new and more constructive way to understand growth.

The core of the book is in chapter 4, which differentiates four types of capitalism and their impacts on economic growth. In doing so, the authors make an important contribution to the literature on economic growth. In state-guided capitalism, the government decides which sectors shall grow. This type of capitalism is found in many countries, but has been most common in Asia and Latin America. Initially motivated by a desire to foster growth, this type of capitalism has several pitfalls: excessive investment, picking the wrong winners, susceptibility to corruption and difficulties of ending support when it is no longer appropriate.

Oligarchic capitalism differs from the state-led variety largely in the motivations of its leaders. The oligarchic variety is oriented towards protecting and enriching a very narrow fraction of the population, and perhaps even the ruler. Economic growth is not a central objective, and countries with this variety have a great deal of inequality and corruption.

Big-firm capitalism is a variety that takes advantage of economies of scale and network effects. This type is important for mass production of products, but although its firms have research and development capabilities, these are not central, and big firms often lose their competitive edge and engage in rent-seeking.

Entrepreneurial capitalism is the kind that produces new breakthroughs like the automobile, the telephone and the computer. These innovations are, according to the authors, usually the product of individuals and new firms. However, it takes big firms to mass produce and market them, so the optimal combination of capitalism is a mix of big-firm and entrepreneurial varieties. This is the kind that characterizes the United States more than any other country. But that is the same capitalism in which the current financial crisis began, and this crisis is undermining the faith that some have in capitalism itself.

?Growth on the Cutting Edge? (chapter 5) elaborates four basic elements of a well-oiled growth machine, the successful entrepreneurial economy. It must be easy to form a business. There must be rewards for productive entrepreneurial activity, based in the rule of law, and especially property and contract rights, including ?proper regulation (or deregulation)? (p. 106). Government must discourage activity that aims to divide up the economic pie rather than increase its size. And government must assure continued incentives to innovate with trade policy and antitrust enforcement. The roles of macroeconomic stability and democracy are discussed in this chapter.

Chapter 6 applies the perspective to less developed economies, by giving suggestions for moving away from state guidance and from oligarchic varieties of capitalism, and encouraging entrepreneurship. Chapter 7 gives suggestions for preventing retreat and stagnation in wealthy economies, and for mobilizing the growth that will be necessary to meet coming demographic challenges.

A long concluding chapter reviews the advice of chapter 5 and reflects rather inconclusively on the political economy of growth. The authors suggest that it may take a crisis for politicians to act, and ?in the absence of a crisis that impels them to act, policy makers cannot be expected to take apparently radical actions to raise long-term growth by creating the right mix of ?capitalisms?? (p. 273). Well there is a crisis now, and little evidence that the radical actions of the U.S. government reflect the good ideas of this book.

I have two main misgivings about this fine book. One is that the archetypes of capitalism are not clearly operationalized, and are described with a broad brush. Specific industries might be described in terms of the four types at any given time, and countries might be similarly characterized by aggregating industry descriptions. The authors are aware of this weakness and devote an appendix to measurement issues. The other is that the occasional references to regulation, such as the Glass-Steagall and Sarbanes-Oxley Acts do not address the kinds of conditions that might have avoided the current crisis.

The book is a unique and original contribution to the literature on economic growth, which for the most part does not consider varieties of capitalism and does not emphasize the kinds of institutions that are discussed here. Baumol, Litan and Schramm highlight the importance of innovation in economic growth, the role of the entrepreneur in creating innovation, and the institutional setting in which new ideas are put into production and create economic growth.

Reference:

Peter A. Hall and David Soskice, editors, 2001. Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. New York: Oxford University Press.

William R. Keech is Research Professor of Political Economy in the Department of Political Science at Duke University. He was previously on the faculties of the University of North Carolina at Chapel Hill, and of Carnegie Mellon University. He is working on a book entitled Economic Politics in Latin America: Rethinking Democracy and Authoritarianism. His email address is wkeech@gmail.com.