August 29, 2020
Center Left Capitalism as the Key to Prosperity, By Victor Menaldo
Capitalism, in its modern form, is only about 250 years old and was ushered in during the industrial revolution. The advent of general-purpose technologies (GPT) transformed the scale of production and put productivity on an exponential growth path for the first time in human history. This ended the Malthusian Trap whereby increased economic productivity engendered bigger populations that then outstripped the ability of the land to feed them—and, in turn, represented a perennial regression to the mean when it comes to living standards.
The first generation of innovations include the steam engine and the modern production of cheap and plentiful steel. Next came electricity and the internal combustion engine. Then came the transistor and semiconductors, as well as computer hardware and software. Plus, the internet.
Legal innovations have also mattered, including limited liability corporations with modern corporate governance structures, modern securities markets, and specialized investment banks that financed things such as railroad expansions and the infrastructure that made international trade at long distances possible. Swashbuckling multinational firms now bestride the world doing business in diverse markets; they are characterized by global supply chains bankrolled by big banks, corporate bonds, and stock markets that represent trillions of dollars in value. Tech startups nurtured by venture capital and so-called Angel Investors are yet another example of the financial plumbing that makes modern capitalism work.
Indeed, capitalism is now driven by a digital revolution in which multi-sided platforms that did not exist 25 years ago have disrupted everything from currency and banking to transportation, hospitality, advertising, and communication. The automation of automation, in which computers and robots will communicate with each other and make their own “decisions”, which in turn will be made possible by impressive improvements in AI and the anticipated advent of the internet of things, is capitalism’s next big thing.
Capitalism has not been without its ups and downs. It has been through several of them during its short, fraught history. Some pundits argue that it reached its apogee after the Fall of the Berlin Wall when trade liberalization and free capital flows were embraced by more nations than ever before and private property and the allocation of goods and services through markets became the closest we’ve come to a new gospel.
There is increasing evidence, however, that, in the face of resurgent protectionism and mercantilism, as well as a growing backlash against it by politicians, citizens, and intellectuals, capitalism’s triumph may have proven to be short-lived. Echoing Joseph Schumpeter, who observed the same thing during end of World War II and beyond, that strikes me as strange and unfortunate. I will try to explain why ahead.
For now, consider that capitalism has produced a lot of good. This includes vast and almost impossible to express improvements in living standards. We are much, much richer than our forebearers could ever dream of being. Plus, there are many, many more of us alive today and most of us enjoy more and better food, higher-quality clothing at a fraction of the price, cheaper and safer travel, medical devices that detect and treat almost every malady known to humans, and supercomputers in our pockets with more processing power than the machines who put men on the moon.
Capitalism unleashed specialization and innovation that allowed for an unprecedented escape from the Malthusian cycle of diminishing returns and immiseration experienced by our ancestors. In per capita terms, we now produce and consume much, much more with fewer resources.
As reported by Deirdre McCloskey and many others, between 1820 (the consolidation of the first industrial revolution) and today, capitalism and its spread are associated with about a 30-fold increase (2,990%) in average living standards for the average developed country. That means for an individual living in Sweden, for example, going from earning $3 dollars a day to $100 dollars a day. For middle-income countries, such as Brazil, it means going from earning $3 dollars to $70 dollars a day. And these are lower-bound estimates that do not adequately address flaws in consumer prices indexes or quality-adjusted prices (see Gordon 2017). Nor do they measure consumer surplus, which means the difference between what consumers pay for things and what they are willing to pay for them—which means that many “free” digital services such as Google are completely omitted from these figures.
Consider, also, the Asian Tigers (Taiwan, South Korea, Singapore): capitalism was put on warp speed there—and consequently, so were its astounding results. These countries have experienced 20+ fold increases in living standards since the 1960s/70s.
Or, think about the Eastern European countries since the fall of the Berlin Wall as freer markets took root there. In Poland, Hungary, the Czech Republic, improvements in average living standards have been five-fold, six-fold and eight-fold, respectively.
Why does this matter? Higher income per capita is highly correlated with increases in consumption, higher caloric intake, and better health and longer life expectancies, among several other things. The relationship is not perfectly linear, of course – but it’s quite strong nonetheless.
Yet, capitalism has been blamed by some critics for a lot of bad stuff. It is currently under sustained assault by both the Left, its typical detractor, and, to the surprise of many pundits, the Right.
The Left accuses capitalism of oppression, exploitation, inequality, and corruption. It maintains that capitalism fuels consumerism run amok, preying on people’s fears and insecurities. Capitalism celebrates greed and ruthless competition. This elevates big businesses that underpay and mistreat their workers and capture the government to increase their profits at the expense of their communities. It is also inherently racist and sexist and leads to the unsustainable plunder of resources. The biggest losers are the poor in rich countries and poor countries in general. Darker and historically marginalized communities are therefore capitalism’s biggest victims.
Contrary to conventional wisdom, the Right’s growing suspicion of capitalism should not come as too much of a surprise. Capitalism is the warp and woof of liberalism: that individualism, rationality, choice, and industriousness should be preeminent, not collectivism, superstition, tradition, or a leisurely pace of life that is stuck in the old ways. Capitalism is, as the Schumpeterian cliché avers, about creative destruction after all or, as Ken Arrow and Clayton Christensen argue, disruptive innovation. These things are perceived by many conservatives to be threats to community, stability, and the established order.
There’s a simpler reason why the Right has grown weary of capitalism too: its spread is not just about poorer countries joining transnational markets for capital, inputs, and products and displacing workers in rich countries by making cars and smartphones more cheaply. A concomitant boom in the migration of poorer and darker people from the Global South has been perceived by many citizens in the Global North as a threat to their identity, culture, and prosperity. This has greatly contributed to the recent backlash against Capitalism.
While some of the critiques from both the Left and Right are well taken, most are incomplete, wrong, or shortsighted. They are also dangerous because Capitalism, for all its flaws—and there are many—is the best hope we have for improving the living standards of a global population that has exceeded 8 billion people and for solving pressing problems. That includes serious environmental crises such as climate change and water shortages, for example. Or pandemics too.
This is due to the accumulation of capital, both tangible and intangible, and human capital too, the accumulation of labor, and, most importantly, the explosion in productivity due to technology. Robert Solow won a Nobel Prize in the 1980s for his work illustrating these mechanisms and providing evidence for them (mostly for US long-run economic data) in the 1950s. His most potent contribution was emphasizing the inimitable role of productivity; the basics have been corroborated by many other economists since then, including William Easterly, Ross Levine, and Paul Romer, among others.
Trade liberalization and more market-oriented activity in China (beginning in 1979) and India (beginning in 1989) are associated with lifting over a billion people out of poverty. Similar improvements (at a much smaller scale) have been registered in Vietnam and other countries that have liberalized their economies.
On the back of the global spread of markets, the global rate of poverty has been cut in half since the 1960s, from over 50 percent of the world’s population to less than 10 percent today (2 dollars a day adjusted for inflation and purchasing power differences between countries). The jury is still out on whether the Covid-19 pandemic might reverse this progress.
To put Capitalism’s success in perspective, consider Sweden. Contrary to popular belief, it is quite capitalist. It boasts strong property rights and allows big profits for several internationally competitive firms. In fact, Sweden has the most billionaires per capita. [Take that China and the United States!] This is because it allows goods and services to be allocated via prices. The state does not own firms or banks and, in fact, did not bail out banks during the early 1990s banking crisis or Saab motors when it went bankrupt. [The same cannot be said about the United States after the 2008 Financial Crisis.] Moreover, also unlike the United States, Sweden does not put restrictions on the foreign acquisition of companies and allowed China to buy both Saab and Volvo. Indeed, Sweden is completely open to international trade and Foreign Direct Investment.
These policies allow Sweden to boast top companies such as Ikea, Spotify, and Ericsson. It allows it to have lots of entrepreneurship—again, more than the United States—and provide plentiful venture capital to finance it.
Yet, Sweden has strong unions, a very strong safety net, and robust redistribution. There does not seem to be a contradiction between markets and greater equality there. Sweden is home to aggressive social insurance and redistribution based on social spending and direct transfers such as old-age pensions, family allowances, health insurance, and housing subsidies.
This has allowed Sweden to achieve a high standard of living but also relatively equal distribution of assets and income. Sweden’s Per Capita Income is comparable to that of the US and It has achieved greater improvements for the middle class than other OECD countries. It has virtually eliminated poverty. Also, Sweden boasts very high upward mobility—much higher than the United States—due to high spending on education across all levels and strong social safety net.
In other words, social democracy has delivered results! But this has been married to very strong markets and businesses that are internationally competitive and an economy open to trade, investment, technology, and immigrants. This means mature and functional markets for labor, capital, and technology.
Here is another way to think about the benefits of capitalism: migrants who move from poor countries marred by dysfunctional or non-existent markets to developed countries with better institutions, the rule of law, and well-functioning markets make three to six times as much money as they did at home when they perform the exact same job, simple findings described by Mancur Olson during the 1990s and corroborated by other economists for future periods. And they often send a significant share of the money back home in the form of remittances. Let me add: this really helps their families who are left behind, including assisting with basic things such as clean drinking water and basic sanitation. Not to mention education. I’ve seen this with my own eyes during my travels across Mexico and other Latin American countries.
Now, consider what has happened to countries that have abandoned or severely distorted markets. Venezuela, a country I used to live in, where my younger brother was born, where I have done fieldwork in, a place from where many dear friends are from, and where my parents in law were living until just recently, has experienced an unprecedented catastrophe under its self-styled experiment in populist socialism. The short of it is: Hugo Chavez and Nicolas Maduro expropriated land, oil fields, mines and factories, imposed price controls, and ran the printing presses to pay for checks the country could not cash.
Therefore: It went from being the most prosperous country in Latin America to one of the poorest. Almost 5 million people (1/6 of the population) have fled; yes, the wealthy have decamped to Miami, but the lion’s share of economic and political refugees are from the middle class and the poor, who have left to Colombia, Peru, and Brazil.
The reason? They no longer had access to food, medicine, diapers, baby formula, or toilet paper. The average Venezuelan lost 19 pounds of bodyweight in 2016. Millions of Venezuelans resorted to scrounging the streets for food or eating bark. Babies died of diarrhoea because they could not get access to Pedialyte. Diabetics died in droves because they could no longer import insulin. Oil fields, factories, and farms were abandoned and/or pillaged. I could go on and on and on…
Why does Capitalism have so many critics if its track record is so successful and it potentially holds so much promise? Why have many folks on the Right, who pundits typically associate with support for capitalism, turned their backs on this system? Why have folks on the Left who, very recently, recognized the benefits of private property, markets, competition, and innovation when modified by regulation oriented towards the common good, become so sceptical of, if not hostile to, Capitalism?
Perhaps these criticisms may be disarmed by a proper understanding of Center-Left Capitalism like that practiced by Sweden. It is a political-economic system moored by a strong government that protects property rights, enforces contracts, provides public goods and offers solutions to myriad market failures when markets go missing because property rights are ill defined or transaction costs are too high for supply and demand curves to intersect on their own. This is a Capitalism that is able to fuel innovation and increase productivity by putting economies on a path of increasing returns. This is a Capitalism that is able to reduce poverty by increasing absolute living standards. It is also compatible with a relatively equal distribution of income, consumption, and opportunity, both as a function of vibrant market competition and an able government that helps provide and improves education, conducts research into basic science and the development of ideas, products, and services when the market will not or cannot do it on its own, and solves other market failures. That means guaranteeing social insurance to reduce the risks and uncertainties that accompany creative destruction.
This is also a Capitalism that can help mitigate climate change by creating a tradable property right to pollute below the critical threshold required to keep the world at 2 degrees Celsius above the recent historical temperature norm. It is also a Capitalism that can help foster the type of innovation in battery storage for renewable energy, safer nuclear power at a smaller and more viable scale, and improvements in carbon sequestration. Only Capitalism produced, regulated, and perfected by governments can help save humanity from the worst effects of climate change and also produce innovations that may have salutary effects on other areas of life, as surely better and cheaper batteries promise to do. This is a Capitalism we can all be proud of and celebrate.
What is Capitalism?
Capitalism encompasses several interconnected dimensions. It includes the:
1) Allocation of inputs to production process based on prices/exchange of goods and services based on prices.
2) Competition between firms to provide goods/services.
3) Incentives/opportunities to innovate: new ideas, technology, new business methods & ways to organize production and exchange.
4) Financial markets that allocate scarce savings to their highest-value use & foster trade, capital accumulation, efficient corporate governance & innovation.
[N.B.: this definition encompasses countries as diverse as Sweden and Singapore and, although it empirically implies private property and contract enforcement, I treat these as separate concepts; see more on that below.]
This definition is really about the microeconomics of markets and the structure of markets and exchange after the industrial revolution. It does not really entail any hard prescriptions about monetary or fiscal policy. In terms of government regulation, it implies a rather strong role. Consider the second part of the definition, for example.
Or, consider the fourth point: it implies prudential financial regulation to curtail excessive risk-taking. I would also argue that the third point calls on the provision of important public goods such as basic R&D.
Finally, each of these points presuppose that an impartial government that assigns and enforces property rights, enforces contracts, and abides by the rule of law. It also entails the provision of essential public goods.
This is not the first place to define capitalism in this manner. The all-time classic on how capitalism is fundamentally about competition and innovation (creative destruction) is Joseph Schumpeter, “Capitalism, Dictatorship and Democracy.” Paul Romer, who won the Nobel Prize in 2018, has adduced strong connections between trade, FDI, and innovation. He makes the case that intangible capital and ideas are more important than physical capital in fueling prosperity. By extension, Romer argues that technology transfer is the key benefit to global trade for developing countries, not specialization along comparative advantage and the efficiencies entailed by that. Perhaps my favorite piece of his, because it is quite simple, is “Idea Gaps and Object Gaps in Economic Development” (published in 1993 in the Journal of Monetary Economics).
Finally, there is Joel Mokyr, an economic historian who documents the birth and evolution of modern capitalism as the marriage of markets, science, and innovation. There is a lot to choose from, including opuses such as “The Gifts of Athena” (2002) and “A Culture of Growth” (2016). An accessible primer is a chapter in an edited volume: “Long-Term Economic Growth and the History of Technology” (in Handbook of Economic Growth, 2005).
What is not Capitalism?
Capitalism is not the caricature of modern market economies espoused by Karl Marx and his followers. To be sure, there was a lag between the industrial revolution (the onset of British textile factories, the production and widespread use of steam engines and the large scale production of cheap wrought iron) and the rise in real wages for unskilled factory labor. But Marx did not predict a lag, he predicted the widespread and continued immiseration of the so-called proletariat. Yes, there were developed capital markets, some financed by imperialism and colonialism in London before industrialization, but the vast majority of factories were financed by the friends and family of entrepreneurs and reinvested profits. Yes, capital accumulation mattered to a certain extent, in that textile looms, blast furnaces, puddling furnaces, steam engines, all matter of machines, and eventually railroads and steamships are, by their very nature, “capital intensive.” But so where the Egyptian Pyramids and the Medieval Castles that dotted Europe before the industrial revolution and modern capitalism. And so was the Stone Age, for that matter…
Capitalism is also much different than “crony capitalism” or “mercantilism” or the other bastardized markets that satisfy some of the criteria listed above but do violence to the theoretical foundations of capitalism in terms of concept and mechanics. Those other forms of ersatz capitalism are about picking winners and losers and manipulating markets to produce rents (profits) through government regulation.
At least since World War II, there has been an unholy trinity in which authoritarianism feeds into crony Capitalism, and both fuel trade protectionism. All three rely not on the rule of law, which is the linchpin of democracy and well-functioning markets but on the personal discretion of rulers. Rulers with authoritarian tendencies, or who operate in an authoritarian system, use the law to favor their friends and punish their enemies.
To benefit their friends, these rulers dispense favors, exemptions from regulations, provide subsidies and extend cheap loans that may never be repaid, except by taxpayers. They also exempt them from the import tariffs and quotas that everybody else has to abide by.
To harm their enemies, they expropriate their land, mines, factories, and servers, tax them into oblivion, or hit them with antitrust suits. This is not because their enemies are monopolists who artificially ration supply and earn monopoly rents but, in an inversion of common sense and what’s best for consumers, because they are competitive and innovative — and therefore pose a threat to authoritarians. Authoritarians like to pick winners and losers, not allow the market to do so. When the market does so, it diminishes authoritarians’ power, which is vested in using regulation, taxation and the state’s coercive powers capriciously to flatter and enrich themselves and their friends.
The purpose of resorting to crony capitalism and trade protectionism is precisely to distort economic decision-making. In allocating resources inefficiently, based on politics instead of competition, it creates a system in which supplicating to the ruler to dispense favors and artificially increase your profits is rewarded, instead of competition and innovation. This creates a culture of graft and corruption that erodes trust in the law and confidence in politicians to act fairly, prudently, and in the service of the greater good.
While market capitalism, trade openness, and democracy do not brook favoritism or exemptions and self-correct to approximate an even playing field where everyone has to play by the rules, the unholy trinity achieves the opposite result. It is explicitly designed to do so.
Consider President Trump and his penchant for undermining the rule of law, picking winners and losers, and turning to trade protectionism. Right after taking office, he jawboned Carrier, an HVAC maker, to keep an inefficient plant open in Indianapolis, ostensibly to save jobs — even though it was merely political theatre to appeal to his base. This idea that the government should have a right to weigh in on how businesses should allocate resources was subsequently codified in the United States Mexico Canada Trade Agreement. This “update” to the North American Free Trade Agreement features so-called content requirements…
Or take Trump’s steel and aluminum tariffs: they might be good for a smattering of American steel and aluminum manufactures that don’t also import some of these metals themselves, but they hammered the aerospace industry, automobile makers, appliance makers, canned goods manufacturers, and the construction industry. They have inevitably been passed on, in the form of higher prices paid by consumers. Worse, consider the onslaught of new tariffs and the constant, capricious threat of tariffs against countries as diverse as China and France and across industries. These have been meted out in retaliation for policies and outcomes that the Trump Administration does not like, including things that are not under any foreign government’s control, like the value of Brazil’s free-floating currency. This has ratcheted up uncertainty about supply chains and production costs, depressing business investment in the United States and across the world.
And Trump’s fixation with Jeff Bezos is particularly disconcerting. Against all logic and evidence, he has contemplated bringing antitrust measures against Amazon, as well as directed the Post Office to investigate whether it’s being taken to the cleaners when delivering Amazon packages, even though Amazon-related business has been a godsend that has helped it staunch its losses. This defies common sense since the purpose of antitrust is to stop monopoly pricing and encourage innovation: prices on Amazon goods and services keep falling like a stone as its costs keep declining. Plus, the company keeps plowing its profits into research and development, which has allowed it to innovate across its divisions, including e-commerce, cloud computing, entertainment, and retail. This promises even better products and services and lower prices in the future.
Trump has treated some of America’s most productive farmers as supplicants, offering them aid to redress their losses from Chinese retaliation for tariffs on Chinese imports. This means Americans will pay for these tariffs twice, in the form of both higher prices and higher debt and taxes. Given the recent track record, nobody should hold their breath about the U.S. rejoining the TPP Trade Agreement.
Finally, modern capitalism is not about laissez-faire economics (whatever that means), nor so-called Neoliberalism and the Washington Consensus, both rooted in the idea that getting macroeconomics right—views that seem to change faster than haute couture fashion—is what matters for growth and prosperity. These supply-side ideas are centered on tinkering with short-run market cycles and have sometimes condoned policies such as austerity and shock therapy.
Unlike Marxist views and critiques of capitalism, it is not an economy characterized by the accumulation of capital nor any other factor of production, but how efficiently those factors are used. Nor is it the maximization of profits at the expense of labor—by paying workers below their marginal productivity—or the plundering of natural resources that are obtained as “free gifts of nature.”
Revisiting Capitalism as it should be properly understood
What is the best way to think of modern capitalism’s underlying machinery then? It is the process by which economic growth has been sustained since the industrial revolution: An economy driven by constant innovation and therefore consistent improvements in productivity. Rather than the endless accumulation of blast furnaces, for example, it is the replacement of this time-honored steelmaking technique with the electric arc furnace: a more efficient, coke-free way of smelting iron that has a smaller footprint and saves energy. But, even more important than that new machine, it is the ideas, proprietary technology, software, and engineering know-how that powers it.
Examples such as this, magnified across almost every good and many services, speak to the triumph of dynamic efficiency over static efficiency. This is the idea that the lion’s share of improvements in human welfare since around 1820 are best envisioned, not as a reduction in deadweight losses per se, but instead the process by which supply curves and demand curves are shifted out. That is to say, process and product innovations. Of course, static efficiency, conceived as greater quantities exchanged and reductions in prices, has mattered on the margin—it means that resources have been allocated and produced more efficiently. And more capital has also mattered, in so far as exponential population growth and the growing sophistication of markets means that more tools, machines, and computers have been distributed into more hands.
But, even on that last count, it is notable that the type of capital that has mattered has changed. Beginning in the late 1980s, the American economy and others like it reached an inflection point, in which the importance and value of intangible capital surpassed that of the tangible variety. And ever since it has been things such as reputation, intellectual property, goodwill, and customer lists and similar data that have added more value to companies than their buildings, factories, and machines.
These insights follow in the footsteps of recent work on capitalism. Deirdre McCloskey, an economic historian and self-styled philosopher, is a key inspiration. She has argued that culture is the key to capitalism and industrialization; the key values are liberalism and individualism. McCloskey claims that the origin and evolution of these ideas in England catalyzed entrepreneurship at a small scale and the bourgeois ambitions and ethos that fostered capital accumulation and innovation.
On the descriptive side, she documents, with great aplomb, the tremendous material improvements associated with the spread of capitalism and the industrial revolutions. She does this deploying basic facts and a variety of easy-to-understand methods.
McCloskey recently completed a trilogy on this topic (each entry is a tome in itself, rife with descriptive data, historical anecdotes, and even short vignettes from her own life; each is incredibly erudite, engaging, and entertaining). The three books are: “Bourgeois Virtues,” “Bourgeois Dignity,” and “Bourgeois Equality.” My favorite is the second book.
The thesis I put forth here also echoes many of the incisive points made in “Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History.” This book is coauthored by Douglass North, John Wallis, and Barry Weingast. It makes the argument that liberalism, democracy, and capitalism are conceptually and logistically the most compatible systems.
The main idea is that political competition and economic competition feed off each other and that creative destruction in the economic realm goes hand in hand with innovation and adaptation in the political realm. The conduit linking them is a large and vibrant civil society in which individuals enjoy political and economic liberties; this engenders pluralism and is a consequence of free entry into the political and economic realm. Moreover, the authors argue that liberal democracies that are capitalist will tend to have large, active governments that are quite involved in the economy in terms of correcting market failures and responding to rising problems (public goods, social insurance, redistribution). They argue that this is for sound logical reasons and, therefore, their book also works, in a sense, as a critique of the view that capitalism requires small governments and should be a laissez-faire affair. In other words, it’s Sweden that best embodies modern capitalism, not the Wild Wild West.
A chapter in an edited volume (Handbook of Economic Growth, published in 2005) entitled “Institutions as the Fundamental Cause of Long Run Growth” coauthored by Daron Acemoglu, Simon Johnson, and James Robinson is also illuminating. Besides outlining the political-economic basis of modern capitalism (as above, liberal democracy), the authors address issues such as natural resources, colonialism, and slavery in a comparative perspective. One key contribution is their argument that, in some cases, colonialism led to a mercantile system that was oppressive and highly unequal, in which a small minority of Europeans extracted resources and rents at the expense of indigenous peoples and slaves. And, in other cases, colonialism led to liberal democracies that were more egalitarian and featured a capitalist system that was competitive and innovative—indeed, one that, in the United States, fueled the second industrial revolution. This is because large numbers of Europeans settled places that had lower densities of native populations and therefore adopted institutions that benefited themselves: provided property rights, enforced contracts, and financed public goods.
There are also other noteworthy contributions in that piece. The authors argue that you cannot separate efficiency (economic development) from distribution (the winners and losers). For them, initial differences in the distribution of resources or power affect bargaining between parties. These differences may preclude parties from reaching more efficient outcomes and influence a government’s regulatory response. The potential losers from a political-economic system that promises to be more efficient (liberal democracy and capitalism) may fight to keep an “extractive” system that makes them narrowly better off at the expense of everybody else in society. Ergo, some societies may end up with mercantilism or crony capitalism – systems in which elites capture the government and regulate the economy to distort it to their advantage (generate rents).
Another paper that is very similar to the one mentioned above is: “Factor Endowments, Inequality, and Paths of Development Among New World Economics” by Stanley Engermann and Kenneth Sokoloff (NBER 2002). It has a lot to recommend as well.
Where my thesis departs from those illuminating tracts, is in clarifying the essential, inimitable role of the state in driving dynamic efficiency since the second industrial revolution. Part of that is through its traditional provision of property rights and enforcement of contracts. But, more importantly, it is the creation of a modern intellectual property rights regime undergirded by a formidable legal and administrative infrastructure, huge investments in the research that powers basic science and human capital, and the government’s procurement of new technologies that have allowed fledgling businesses in semiconductors, informatics, and telecommunications to flourish by reaching economies of scale.
How does the US go forward from here?
In my book manuscript in progress, I outline the theory, history, and empirical evidence that illustrates this process of Center Left Capitalism. It is tentatively entitled “The Twilight of the Third Industrial Revolution and the Dawn of the Fourth.”
I also broach how we can move forward, despite the vast challenges that beset the US political system and economy. We need a much more productive economy that grows faster so that there is a larger pie to tax and transfer. For me, that means healthier and more vibrant markets tied to more international trade and FDI, more immigration for highly skilled laborers, to pre-911 levels and beyond, but also more government financing of basic science, education (especially STEM), and R&D in renewables and other cutting edge technologies where market failures abound. Finally, a stronger role for the state in helping to build a national 5G network and associated infrastructures for the internet of things to help standardize and diffuse AI. Indeed, one of the big things I look at in my book in progress is what role the government can play in diffusing technology and encouraging companies to adopt and refine new technologies faster.
To help fund some of this stuff, I argue in favor of a nationwide value-added tax and revenue-neutral carbon tax and the elimination of a lot of the pathologies of America’s income and corporate taxation, including exemptions and associated carve-outs, that distort savings, investment, and depress technological acquisitions and exchanges. Consider that Sweden largely finances its generous welfare state with a value-added tax that carves out exceptions for certain consumer goods that hit the poor especially hard and income taxes that are more regressive than ours (the highest marginal rate kicks in at a far lower threshold than ours).
Conclusions
The logical, political, and even normative implications of capitalism are a Center Left system in which the state does several things and has to keep changing to take up more and more complex responsibilities as the economy evolves. It must:
1) Provide strong property rights, including for intellectual property.
2) Enforce contracts.
3) Uphold the rule of law.
4) Provide a robust panoply of public goods and services. As the economy becomes more complex, these become more diverse and expensive. To repeat an example from above: a lot of the infrastructure behind 5G wireless coverage is simply not going to build itself.
5) Reduce a complex web of market failures, including reducing negative externalities and promoting positive ones. Obviously addressing climate change is one of the former, but there are several others too…
6) As a subset of 5 and 6, that includes undertaking a lot of financing of basic science, R&D, and providing and improving education at all levels.
7) As a subset of 5, it involves providing robust social insurance. This includes subsidizing and regulating healthcare because it suffers from strange adverse selection and moral hazard problems (as does banking, which the government should also regulate in a prudential manner) and providing unemployment insurance, disability insurance, maternity and paternity leave, and all kinds of other insurance programs where there is an insufficient private incentive to provide the level and quality of coverage needed.
8) To make the system more legitimate, moral, and compatible with democracy, the government should go beyond mere insurance and redistribute income and foster myriad opportunities for upward mobility to underpin the innovative/entrepreneurial spirit that makes creative destruction possible. In other words, in order for modern capitalism to work folks have to take risks, sometimes crazy ones, like moonshots, and the best way to make that work is to throw spaghetti at the wall sometimes and offer a creative safety net mixed with institutions, norms, and policies that will encourage this. Perhaps redistribution has a big role to play in, that, along with social insurance, it can weaken ossified social strata associated with wealth and privilege that discourages creativity, entrepreneurship, and risk-taking in general.
9) As an extension of all of this, the state should use cost-benefit analysis and evidence-based techniques to constantly fine-tune these responsibilities because as the economy changes and the demands of dynamic efficiency evolve, new market failures arise, as do new opportunities for the government to promote science, education, and innovation without tampering with the market in an unproductive manner. Distortions that kill the Golden Goose are just not a good idea.
10) Finally, and this is again an extension: since all of this is very expensive and capitalism is inherently disruptive, unpredictable, and potentially creates distributional conflict, it’s very important for modern societies to grow the pie continuously. That means fueling high productivity growth and increasing real wages, which means the constant promotion of science, education, and technology. The good thing is that the above laundry list is fully compatible with that objective. In fact, that is what sets modern, industrial capitalism apart from the type of commercial activity and limited growth opportunities that anteceded it: consistent and self-sustaining economic growth driven by a more efficient use of resources, instead of the more intensive use of them.
Therefore, contrary to popular belief, Sweden, Denmark, and Norway are the most capitalist countries on earth, probably followed by Singapore, which does a lot of this stuff too…
Readers may be interested in continuing the line of inquiry I outlined above by taking a look at the following four UW Political Economy Forum sources:
The Perils of Economic Populism, by Beatrice Magistro & Victor Menaldo
https://soundcloud.com/political-economy-forum-at-university-of-washington/podcast-8-13-2020
