Tuesday, May 29, 2007

Capitalism: Good, Bad and Ugly

William J. Baumol, Robert E. Litan and Carl J. Schramm, Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity. Yale University Press, 2007.

This is another book on the importance of economic institutions (see below for related books by Barry Eichengreen, Kenneth Dam and Frederic S. Mishkin). Baumol, Litan and Schramm (henceforth "the authors"), argue that that the institutional set up of capitalist societies matters a lot, especially when it comes to the ability to encourage and sustain activities that produce economic growth. They differentiate among four types of capitalist institutions, which I think of as falling into three categories: good bad and ugly.

The good types of capitalism are Big-Firm Capitalism (think Europe and Japan) and Entrepreneurial Capitalism (think USA). These systems are successful in encouraging growth driven by economies of scale using existing technology and technological change respectively. The United States has a combination of these two "good" capitalist systems, the authors argue, which is why it has experienced such fast growth. Small firms create new products and ideas, big firms develop them and reward the innovators. Strong economic growth results. Europe lacks the more dynamic entrepreneurial capitalism gene, which holds it back somewhat. It can exploit the new ideas of others, but doesn't have the right institutions to encourage small business risk taking. (See Eichengreen for more on this).

State-guided capitalism (think Latin America) is bad capitalism in this way of thinking, but it is not so bad as oligarchic capitalism (think Russia), which is so bad that it is ugly in my "Dirty Harry" categorization.

Significantly, the authors go far beyond simply taxonomy (classifying different economies into their four categories). They provide detailed analysis drawing upon recent research to discuss how Europe might introduce reforms that would encourage more risk taking and innovation, how the state-centered systems of many less developed countries might be reorganized, and -- most difficulty of all -- how political and economic oligarchies might be overcome. The final chapter looks at the "care and feeding" of entrepreneurial capitalism -- what the U.S. must do to prevent its economic advantage from slipping away.

When I started this book I thought that it was merely clever. Now that I am at the end I think it is brave. If economic growth is as important as the authors (and I) believe, then this sort of brave big idea thinking about the obstacles to growth is essential.

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