Justice for the entrepreneur

Edmund Phelps has an op-ed in today's Wall Street Journal in which he defends a dynamic form of capitalism. He contrasts this dynamic form of capitalism found in America with the Continental European system.

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.

One minor quibble that I would have is that the three economies he holds up as representative of the dynamic form of capitalism are quite different even among themselves in terms of how dynamic (i.e. conducive to entrepreneurial activity) they are. Indeed, states and provinces themselves differ. But I digress. The real issue is still to come...

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.

...

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.

I think a lot of us have given a lecture in class something along those lines, haven't we? And we might even use it as a springboard to talk about social/economic justice. Phelps writes,

... 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.

Though this defense of capitalism probably will not satisfy the most adamant free-marketers (he takes a little jab at Hayek and Ayn Rand) it is a reasoned defense. It is a plea for justice for the entrepreneur. And yet, it is difficult within our political system to craft policies that encourage the entrepreneur without also aiding established wealth. "Corporatism" as a mutation of capitalism carries with it an ability to seek (and often obtain) rents from government (regardless of who is in power). To that extent, the street protesters have a point. Corporatism is not the dynamic capitalism that Phelps wants.

But we must rememeber that, as Phelps says in his concluding paragraph, that "Capitalism in its innovations plants the seeds of its own encrustation with entrenched power." Perhaps that means that while we must allow business to grow, we also need to prune it back once in a while for its own health. One of the most important policy debates will be how we can increase the dynamism of the U.S. economy without allowing corporatism to stifle it. This is both a macro and a micro question. On the macro side, how do we formulate tax policy that encourages small businesses when large corporations and their lobbies use the process to further their own objectives (which may run counter to broader social objectives)? On the micro side, how do you regulate intellectual property--the new wealth driver? How do we prevent firms from exercising their market power to pre-empt entrepreneurial entry into their markets? These are the big questions. These are the tough questions. Our record in dealing with them has been mixed. The consequences of failing to deal with them are dire. Economists are more likely than politicians or the mainstream media to bring up these questions. Perhaps it is where we are most useful. The lens of economics can bring these issues into sharp focus. Debate and disagreement is inevitable, but the alternative--ignorance of the economic consequences--is much worse.

UPDATE: Felix Salmon has a harder time overlooking the problems with the first couple paragraphs that I allude to above.

He starts off with a strong and almost certainly wrong assertion ("There are two economic systems in the West") – meaning the US, Canada, and the UK on the one hand, and continental Europe on the other. He never tries to show that his assertion is true, but he loves to ride it into weird wonderlands:

Yeah. The writing is not as sharp as what we have come to expect from Milton Friedman. But there is something worth taking away from it nonetheless.

UPDATE 2: The free link to the article is now provided, with a tip of the hat to Greg Mankiw.