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Two versions of capitalism and economic justice
Posted by: McQ on Tuesday, October 17, 2006

Last week, due to my travel schedule, I was unable to comment on an article found in the WSJ by Edmund S. Phelps, a professor of economics at Columbia and this year's winner of the Nobel Prize for Economics. With a little more time this week, I thought I'd throw it out there.

What interested me in Phelps WSJ piece was his topic - "Dynamic Capitalism" with the subtitle "Entrepreneurship is lucrative—and just."

It is a fascinating read. Phelps contrasts two forms of capitalism, most easily labeled American capitalism and European (or Continental) capitalism, and presents, in way easily understood, why they differ, and more importantly, why one is superior to the other. He bases his analysis in which delivers "economic justice".

You can read his description of each in the first two paragraphs, but a distillation would be American: "private-ownership system marked by great openness", Continental: "though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners.""

It is the modifications, Phelps argues, which make all the difference in the world, both in function, outcome and justice.
The American and Continental systems are not operationally equivalent, contrary to some neoclassical views. Let me use the word "dynamism" to mean the fertility of the economy in coming up with innovative ideas believed to be technologically feasible and profitable—in short, the economy's talent at commercially successful innovating. In this terminology, the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.
Phelps ably describes how the "Continental system" does what he claims. While that wasn't the intent, it is the outcome of a deliberate effort on the part of the systems designers to ameliorate the cyclical nature (or 'fluid market conditions')of capitalism:
When building the massive structures of corporatism in interwar Italy, theoreticians explained that their new system would be more dynamic than capitalism—maybe not more fertile in little ideas, such as might come to petit-bourgeois entrepreneurs, but certainly in big ideas. Not having to fear fluid market conditions, an entrenched company could afford to develop radical innovation. And with industrial confederations and state mediation available, such companies could arrange to avoid costly duplication of their investments. The state and its instruments, the big banks, could intervene to settle conflicts about the economy's direction. Thus the corporatist economy was expected to usher in a new futurismo that was famously symbolized by Severini's paintings of fast trains. (What was important was that the train was rushing forward, not that it ran on time.)
The problem is, with the rise of the corporatist economy, the entrepreneurs were stifled. Change was not welcomed. And, of course, entrepreneurs are the guys who cause the market conditions to be fluid. The "Continential system" was designed to prevent that very thing. So the "little ideas" on which entrepreneurs build their businesses and in turn make the system dynamic were simply unable to bloom in large measure. The companies certainly became entrenched, as planned, but few if any then attempted to develop radical innovation. With guaranteed markets, they had no real incentive to do so (and that is arguably the major design flaw in the Continental system).

Phelps argues that the biggest asset of capitalism, that which creates economic justice, is dynamism, and to his eternal credit, cites Frederich Hayek's work:
Friedrich Hayek, in the late 1930s and early '40s, began the modern theory of how a capitalist system, if pure enough, would possess the greatest dynamism—not socialism and not corporatism. First, virtually everyone right down to the humblest employees has "know-how," some of what Michael Polanyi called "personal knowledge" and some merely private knowledge, and out of that an idea may come that few others would have. In its openness to the ideas of all or most participants, the capitalist economy tends to generate a plethora of new ideas.
So part of it is an "ideas gap" which differentiates the two systems. One system encourages ideas and innovation by its openness. The other mostly discourages (although that wasn't its intent) by being basically closed to new ideas.

There is a second difference as well:
Second, the pluralism of experience that the financiers bring to bear in their decisions gives a wide range of entrepreneurial ideas a chance of insightful evaluation. And, importantly, the financier and the entrepreneur do not need the approval of the state or of social partners. Nor are they accountable later on to such social bodies if the project goes badly, not even to the financier's investors. So projects can be undertaken that would be too opaque and uncertain for the state or social partners to endorse. Lastly, the pluralism of knowledge and experience that managers and consumers bring to bear in deciding which innovations to try, and which to adopt, is crucial in giving a good chance to the most promising innovations launched. Where the Continental system convenes experts to set a product standard before any version is launched, capitalism gives market access to all versions.
The Skeptical Optimist explains, characterizing the two differing capitalist economies as Carrot economics (American) and Stick economics (Continental):
What is apparently not clear to many subscribers to Stick economics is that the people mostly responsible for growth are newcomers whose new ideas and inventions upset the old applecarts; it is usually not the entrenched old-applecart owners. The result of successful Carrot economics is that new, better ideas displace older, obsolete ideas; new, better jobs displace older, obsolete jobs; new, more lean and effective companies displace the older, sluggish, entrenched fat-cats.

Schumpeter called it “creative destruction.” One camp concentrates on the first of those two words, optimistic that things can be made much better than they are today, and that’s what drives our economy upward and onward. The other camp concentrates on the second word, deeply disappointed that growth makes older, obsolete jobs go away, and that’s a friction that slows the growth process.
That is the argument in a nut shell. You should read the entire article as there is much there to absorb, and while I'd love to spend the time necessary to go through it paragraph by paragraph, I don't have the time and you probably wouldn't read it if I did.

But his conclusion makes his point:
I want to conclude by arguing that generating more dynamism through the injection of more capitalism does serve economic justice.


To argue that the consequences of capitalism are just requires some conception of economic justice. I broadly subscribe to the conception of economic justice in the work by John Rawls. In any organization of the economy, the participants will score unequally in how far they manage to go in their personal growth. An organization that leaves the bottom score lower than it would be under another feasible organization is unjust. So a new organization that raised the scores of some, though at the expense of reducing scores at the bottom, would not be justified...

What would be the consequence, from this Rawlsian point of view, of releasing entrepreneurs onto the economy? In the classic case to which Rawls devoted his attention, the lowest score is always that of workers with the lowest wage, whom he called the "least advantaged": Their self-realization lies mostly in marrying, raising children and participating in the community, and it will be greater the higher their wage. So if the increased dynamism created by liberating private entrepreneurs and financiers tends to raise productivity, as I argue—and if that in turn pulls up those bottom wages, or at any rate does not lower them—it is not unjust. Does anyone doubt that the past two centuries of commercial innovations have pulled up wage rates at the low end and everywhere else in the distribution?
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.


Actual capitalism departs from well-functioning capitalism—monopolies too big to break up, undetected cartels, regulatory failures and political corruption. Capitalism in its innovations plants the seeds of its own encrustation with entrenched power. These departures weigh heavily on the rewards earned, particularly the wages of the least advantaged, and give a bad name to capitalism. But I must insist: It would be a non sequitur to give up on private entrepreneurs and financiers as the wellspring of dynamism merely because the fruits of their dynamism would likely be less than they could be in a less imperfect system. I conclude that capitalism is justified—normally by the expectable benefits to the lowest-paid workers but, failing that, by the injustice of depriving entrepreneurial types (as well as other creative people) of opportunities for their self-expression.
Capitalism is certainly a process of "creative destruction" and it has proven that while it does indeed economically displace and inconvenience some, for the most part, its dynamism does end up "lifting all boats" as the well-known cliche asserts. Unleashing entrepreneurs, as Phelps argues, in a system based in private property and open to their ideas and to change is indeed the most just system of all, economically.
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Previous Comments to this Post 

There was the myth, or mayhap not a myth, in the 1980’s that German and Japanese firms, being insulated from the "90 stock market cycle" could make better long-term investments than their more "short-sighted" American manger counter-parts. At least one report by the Economist suggested that this, too, was untrue. that European and Japanese managers had LESS return on investment, in the long-run, than their US counter-parts. Being freed from Quarterly Reports didn’t liberate them to make sound investments, it just liberated them from oversight.

To me the Continental System is a scam against the Consumer. Note it is designed to help the "social stakeholders" NOT the consumer. BMW or Renault is going to help the worker, and the banker before it helps the consumer, because THEY sit on the board and the system gives them lots of say over corporate decisions. Needless to say corporate decisions tend to reflect things good for the status quo, not necessarily good for the populace at large. Groups make decisions that benefit THEM, the less the end user has to say about the group, the less the group cares about the end user.
Written By: Joe
URL: http://
I am profoundly encouraged that the Nobel Prize Committee, not known for being receptive to capitalists or to the USA, has selected Phelps for his trenchant analysis of the kind of entrepreneurship which has been the backbone of the American economy since the days of Benjamin Franklin.

Even the magnates like Rockefeller, Carnegie and Edison in the ninteenth century and Ford, Chrysler, Firestone, Gates, Jobs and Wozniak in the twentieth, and now those multi-millionaires Chad and Steve the YouTube entrepreneurs of the twenty first are prime examples of this phenomenon.

Kinda cool if you ask me.

Written By: vnjagvet
Kinda cool if you ask me.
Me too.

Reality ... finally penetrating even the Nobel Prize Committee.
Written By: McQ
So, Phelps has proven that entrepreneurship (as represented by my company) beats corporatism. So . . . when will conservatives and libertarians and "Fair Tax" (no tax for corporations) supporters and so on stop beating the corporatist drum here in the US? When will policy not be decided by energy-company execs? When will we see a return of support for the real entrepreneurship that Phelps studied, but which has been in disfavor for decades? If winning a Nobel proves you’re right, when will the many Nobel winners who recently called for a minimum wage increase get one?

Corporatism takes two forms: governments running companies, and companies running the government. It seems to me that certain other people just want to replace one with the other. I’d rather minimize both at once.
Written By: Platypus
What?!? Has this fellow really spent all this effort to demonstrate that "entreprenuership" is better than "corporatism in interwar Italy"? I’m shocked to hear that facsism is not the most "just" form of economic organization. Shocked.
Written By: Retief
URL: http://
No corporate tax for corporations would encourage entrepreneurs.

Written By: Harun
URL: http://
It is an interesting Dialectic.

First off: The structure of European corporatism (or Japanese) does not totally stifle new Ideas. In Finland, little Nokia became the biggest cell phone company in the world (for a while) because of innovation.

However, in general he is correct. The costs in red tape and actual money for new business startup in Europe is much much higher than in the USA.

Now for the Idea of "social Justice", I cannot buy it. It is too ill defined, and I suspect that no two people would ever agree on specifics. I would rather view it as "freedom".

You see, freedom is a good unto itself and needs no marginal utility to elaborate it. Bureaucrats, statists, do-gooders, socialists, they none of them have a right to the fruit of my labor or the means of my production. Where the state does have some claim on me it must be valid as having no greater claim than it does upon all other citizens.
Written By: kyle N
Platypus, what the h*ll are you talking about? What libertarians are beating the corporatist drum? Are you saying all corps are bad? And who’s saying that winning a Nobel proves one is right? Didn’t read that at all. I do think, however, that it’s nice that every once in a blue moon the Nobel committee doesn’t give its prize to a socialist.

Written By: Unknown
URL: http://
Corporatism takes two forms: governments running companies, and companies running the government.
Corporatism has not one thing to do with "corporations" as we understand them:
Historically, corporatism or corporativism (Italian corporativismo) is a political system in which legislative power is given to civic assemblies that represent economic, industrial, agrarian, and professional groups. Unlike pluralism, in which many groups must compete for control of the state, in corporatism, certain unelected bodies take a critical role in the decision-making process. These corporatist assemblies are not the same as contemporary business corporations or incorporated groups.
It is, however, the view that anti-capitalists push.
Written By: MichaelW
Hayek is my hero, but what on earth do you guys mean by critiquing the Nobel committee. American after American has won, and most of them, like Coase, Hayek, and Phelps have been freedom-oriented. You could try, some of you, to do a post once in a while without trying to snipe at the Europeans. After all, Adam Smith and Bastiat were both Europeans.
Written By: william
URL: http://
Hayek is my hero, but what on earth do you guys mean by critiquing the Nobel committee.
It might have something to do with awarding the Peace Prize to a known terrorist (Arafat).
Written By: Jordan
URL: http://
American after American has won, and most of them, like Coase, Hayek, and Phelps have been freedom-oriented.
uhhh, Hayek was Austrian, dude.
Written By: Come on, Please
URL: http://
Kissenger won the peace prize too.

I am talking about the Economics prize, which usually goes to free marketeers. And obviously Hayek was Austrian and Coase is English, but they have won as American residents and professors, along with many American citizens. Here are a few more free market winners that you might remember: Gary Becker, James Buchanan (from GMU), George Stiegler, Milton Friedman.
Written By: william
URL: http://
Yes, Hayek was Austrian but he taught at the University of Chicago from 1950-64 and won the Nobel in 1974. 23 of the 50 Nobels in economics went to scholars associated with the University of Chicago. That includes Fridman and Gary Becker. P.S.—Thomas Sowell received his PhD at the University of Chicago in 1968.
My belief is that the Nobel committees are similar to hiring committees at universities. The humanities will chose Arafat while the sciences will chose the Hayek’s, Friedman’s etc.
Written By: tom scott
URL: http://

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