Good Capitalism/Bad Capitalism

The above title is a portion of the title of an excellent book written in 2007 by Baumol, Litan, and Schramm.  They distinguish four different types of capitalism. The posting below focuses solely on two types: that based on competitive market forces and that based on close relationships between large businesses and politicians.  Inspiration for this post comes from both Luigi Zingales’ A Capitalism for the People (2012) and recent policy regarding Foxconn and Kimberly Clark emanating from the Governor of Wisconsin and the Wisconsin State Legislature.

crony capitalism

The case for competitive market capitalism rests on the notions of free entry and exit for producers of goods and services, resource availability to new or expanding enterprises, and a level playing field for all competitors. Under such an ideal system, American capitalism – in contrast with other versions that exist in Europe and Asia – has the ability to make competence and experience, along with hard work, the primary forces that yield sustained economic prosperity.

Recent Wisconsin public policy initiatives to lure Foxconn Corporation and keep open one of the facilities of Kimberly-Clark Corporation suggest how far we have strayed from competitive market capitalism.  Many such instances exist in other states and at the Federal level.

The ideal competitive market system has never existed in the U.S., but at present it’s clear that numerous forces inhibit market competition. An ideal system would require intervention only if a clear market failure, such as significant air or water pollution or pervasive income inequality, markedly reduced the well-being for a sizeable share of the population. The appropriate public policy response should be done at minimum cost to taxpayers.

In contrast, co-opted market capitalism (sometimes called crony capitalism) does not seek to generate economic welfare for the population at large. It operates under the notion that what is good for large entities, both for-profit and not-for-profit, is good for the population at large. As Secretary of Defense designate Charles Wilson put it in 1953, “… what was good for the country was good for General Motors and visa versa.” The implicit assumption was that the benefits would be broadly shared. Our experience with public policy that assists (or even bails out) large companies, however, has resulted in increasing concentration of power in the hands of large organizations, be they manufacturers, banks or hospital systems not widely shared improvements in economic well-being.

True competitive market capitalism encourages businesses and entrepreneurs to invest in productivity improvements that yield higher wages, improved product and service quality, reduced cost, and increased prosperity for the vast majority of the population. Such prosperity enables policy makers to implement decent safety net policies to ensure that those who don’t benefit from such improvements aren’t made destitute.

In contrast, public policy that seeks to manipulate markets invites extensive lobbying. Such co-opted market policy induces businesses and politicians to look out for each other’s interests – the essence of “crony capitalism.” Furthermore, it undermines the public perception that governments serve the legitimate interests of those they represent in anything close to a fair way. As Luigi Zingales describes it, “The system that allocates finance allocates power and rents.” Here rents and rent seeking refer to business strategies that attempt to redistribute rather than increase income. It often involves lobbying to manipulate public policy or economic conditions with the expressed purpose of benefiting those who lobby at the expense of the population at large. The stronger the government links are with specific businesses, the more likely that rent seeking rather than productivity improvement will predominate.

Public policy focused on specific businesses yields a concentration of power in large organizations that leads to political pressure needed to economically sustain them. Japan’s keiretsu (conglomerates) provide a perfect example of how close links between business and government lead to the generation of “zombie” enterprises that are economically unsustainable yet continue to draw public funds away from addressing major market failures and infrastructure improvement that lay the ground work for competitive markets and entrepreneurial initiatives.
Rather than concentrating on the survival of large, influential firms, public policy should seek to establish and implement clear rules for market behavior and to foster the education of a talented, flexible workforce that can generate economic prosperity and security for all.

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