Capitalism comes in many blends and varieties around the globe.
Which flavor is most effective at promoting economic growth?
By William J. Baumol
ith the crumbling of the Soviet empire in 1989 and the remarkable transformation of China’s economy, one of recent history’s great conflicts seems to have been settled. When it comes to the prosperity and growth of an economy, the choice is no longer between socialism (or communism) and capitalism. Rather, the choice is between forms of control of the economy that are all arguably capitalistic, in the sense that the bulk of the means of production are in private hands.
Yet across the globe, we see a remarkable variety in capitalist systems – and in performance. There are capitalist societies whose record of innovation and growth is remarkable and, indeed, historically unprecedented. The United States is a prime example, as are many of the most industrialized countries of Europe and several other economies that are moving toward the forefront. And there are several apparently capitalist nations, including several in South America, in which growth has been slow – and, in some instances has managed to decline – despite the outpouring of productivity-enhancing innovations in the world economy.
he uneven record begs several questions and has stimulated a great deal of research into the different types of capitalism and how well they work. The results are discussed in the upcoming book, Good Capitalism, Bad Capitalism, co-authored by Robert Litan and Carl J. Schramm, president and vice president, respectively, of the Ewing Marion Kauffmann Foundation, and myself. Good Capitalism, Bad Capitalism seeks to create what Benjamin Franklin called “useful knowledge,” specifically, the determination of ways in which the pursuit of economic growth and the reduction of world poverty can be carried out more effectively. To do so, it helps to deal with a more nuanced view of capitalism today. Carl Schramm provides an important insight by pointing out that capitalist economies assume several forms, which are fundamentally different. We found it useful to discuss four different forms of capitalism: Oligarchic Capitalism, Bureaucratic Capitalism, Oligopolistic Capitalism, and Entrepreneurial Capitalism. Reality, of course, is generally populated by hybrids, but these categories are useful for the purpose of classification and argument.
Oligarchic Capitalism, a system in which the most critical of the economy’s productive resources are in the hands of a few extremely wealthy individuals or families, is the most indefensible form of capitalism from the point of view of growth. In such economies, the wealthy few characteristically siphon off greatly disproportionate shares of the output of their economies, lead the lives of royalty, and are surrounded by a desperately impoverished population. The oligarchs generally do nothing to promote growth and have little interest in doing so. After all, they are apt to be aware that any changes can trigger threats to their positions. As a result, in such economies methods of production are frequently all but stagnant and evolve slowly only when their retrograde character threatens foreign markets or domestic unrest, so that the oligarchs are reluctantly forced to yield and to permit an iota of economic progress. It should hardly be surprising that the oligarchic economies in Africa, Latin America, and parts of Asia are models of stagnation and economic misery.
“When it comes to the prosperity and growth of an economy, the choice is no longer between socialism (or communism) and capitalism. Rather, the choice is between forms of control of the economy that are all arguably capitalistic, in the sense that the bulk of the means of production are in private hands.”
Bureaucratic Capitalism, in contrast, has a more mixed record. This form of capitalism entails substantial government intervention and control. Today, China provides a prime example of this approach, although it still has substantial vestiges of communism, with a very substantial portion of the larger firms still owned by the state. There are countries in Africa that are similarly organized. As a rule, economists tend to express distaste for government intervention in the economy. But it must be admitted that in a number of places, such as South Korea, governmental influence in the economy has been very successful in getting growth started. The transformation of South Korea from a desperately poor, war-ravaged nation in the 1950s into a highly industrialized economic powerhouse has been one of the great success stories of the past half-century. Such stimulation of start-up is not easy to achieve, as repeated unfortunate experiences have shown. But in Korea’s case, government intervention, including industrial policy, played a significant role.
The downside of bureaucratic capitalism is that the government does not always make the right choices. On the contrary, bureaucratic capitalist economies have had their share of dismal failures. Still, the record shows that this form of organization is not to be dismissed out of hand – as a start-up mechanism.
It’s in the next phase of development that bureaucratic capitalist economies appear to have experienced quite consistent failure. Many nations find it difficult to preserve the incentives that ensure continued innovation and growth and do not sink the economy in the morass of traditional ways of operation. In order to spur continued growth, there must be some mechanism that does not permit those who guide the economy to sit on their laurels and simply enjoy their initial achievement.
The third form, Oligopolistic Capitalism (or Big Firm Capitalism), is widely prevalent, notably in Asia. In these economies, preeminent portions of activities are carried out by large – or even gigantic – enterprises. Japan is a prime example. Japanese firms like Sony, Toyota, and Mitsubishi have been successful in capturing large shares of the world markets with their products. Moreover, they have been leaders in innovation, providing products that are constantly improved, and may even regularly be one step ahead of those of their prime competitors.
“Relentless competition enmeshes the larger innovative firms in an arms race with start-ups, in which each is constantly seeking to outperform its rivals by providing new innovations.”
In the early 1980s, after having enjoyed several decades of growth, the Japanese economy appeared to be unstoppable and threatened to leave all of its rivals in the dust. But the juggernaut came to a screeching halt at the end of the 1980s. For much of the past 16 years, Japan’s economy has been mired in stagnation. This stagnation is at least partly attributable to the fact that the giant corporations that dominate Japan’s economy are inherently very conservative in their innovative activities. They tend to invest only after the market for any invention has been thoroughly explored and the firm’s engineers have carefully pre-assessed the technical difficulties a proposed project entails. The big firms, therefore, have tended to specialize in small, cumulative, incremental improvements. While never a sure thing, these efforts are selected to keep the risks to a minimum.
The fourth, and most successful, form of capitalism is Entrepreneurial Capitalism. It is a variety of economy that may no longer exist in its purest form, but it characterized the way the world’s leading economies were organized during or soon after the British industrial revolution at the end of the 18th century. To a greater or lesser degree, it was replicated in the United States, France, and Germany when they entered periods of remarkable industrialization in Great Britain’s wake.
In such an economy, most of the activity is carried out by firms that today would be considered tiny. Entry to markets is easy, and upstarts encounter comparatively few impediments. Innovation is characteristically carried out by independent inventors and their entrepreneur partners who ensure adaptation of the inventions to prevailing market conditions and play a key role in actually bringing the inventions to market. This was often done by arranging for the inventor-entrepreneurs themselves to produce the final products and arrange for their sale. Think of Henry Ford building his first car in a shed behind his house, or Cyrus McCormick perfecting the reaper on a farm. But there also soon arose lively markets in inventions, in which the new products and technology were sold to others, or in which licenses were regularly issued.
Today, in the United States, Great Britain, Ireland, Israel, and a number of other countries, entrepreneurship continues to be subject only to minimal impediments. Thus, it is relatively easy to acquire patents – a special feature of US arrangements since the earliest days of the nation, well before it happened in other countries. The preliminaries for establishing a number of firms are a matter of days or at most weeks, while in some other nations more than a year is typically required. Funds are obtainable with comparative ease, with special institutions such as venture capitalist firms specializing in the provision of the needed resources.
In contrast to the pervasive conservatism of research and development and other innovative activities in the large firms, the smaller enterprises have become the prime providers of breakthrough innovations. Consider this remarkable list from the US Small Business Administration of breakthrough innovations of the 20th century for which small firms are responsible (Table 1). It literally spans the alphabet, from the airplane to the zipper.
Now, small companies are not alone in spurring innovation. Indeed, it is important not to overlook how the incremental contributions of large companies can add up and compound to results of enormous magnitude. Take the stunning progress in computer chip manufacturing engineered by Intel Corp., which has brought to market successive generations of chips and transistors, on which the performance of computers is so heavily dependent. Moore’s Law, named after Intel founder Gordon Moore, holds that that the transistor density of semiconductor chips would double roughly every 18 months.
ndeed, between 1971 and 2003, the “clock speed” of Intel’s microprocessor chips – that is, the number of instructions each chip can carry out per second – has increased by some 3 million percent, reaching about 3 billion computations per second today. Between 1968 and 2003, the number of transistors embedded in a single chip has expanded more than 10 million percent, and the number of transistors that can be purchased for a dollar has grown by 5 billion percent. Added up, these developments have surely contributed far more computing capacity than was provided by the original invention of the electronic computer.
To be sure, that initial invention of the integrated circuit was an indispensable necessity for all of the later improvements. But it is only the combined work of the two – the small firms and the large – that together made possible the powerful and inexpensive apparatus that serves us so effectively today.
This is a key dynamic for entrepreneurial capitalism. Relentless competition enmeshes the larger innovative firms in an arms race with start-ups, in which each is constantly seeking to outperform its rivals by providing new innovations. Such a competitive race permits no lagging and time off to the participants, because that way lies insolvency. In the metaphor of Lewis Carroll, each firm is forced, without letup, to run as quickly as it can in order just to retain its market position. And while it is certainly exhausting for executives and managers, it is difficult to think of a more effective incentive mechanism for the innovation process.
I noted at the outset that reality is populated by hybrid capitalisms. Just the same holds when it comes to evaluating the relative efficacy of different modes of capitalism. Our conclusion is that it is neither pure entrepreneurial capitalism nor unalloyed oligopolistic capitalism that holds the greatest promise for our economic future and its growth performance. Rather, it is a combination of the two, such as we now have in the United States, which offers the greatest prospects for continued success.
William J. Baumol is Harold Price Professor of Entrepreneurship, professor of economics, and academic director of the Berkley Center for Entrepreneurial Studies at NYU Stern.