There is no doubt in my mind that we are achieving an increasing consensus among both economic historians and economists, regarding the origins, logic, and essence of Western capitalist durability as an engine of growth. Economist William Baumol, in his book, The Free Market Innovation Machine: Analyzing the Growth Miracle of Capitalism, states that “Free market” capitalism may not be the ideal system for promoting technological progress, but it does it more effectively than any other system.1
I agree. So, I am willing to give it two sincere cheers, and it gets three when it delivers on “human betterment” (which it often, but not always, does). To steal from singer and songwriter Brian Wilson: “Wouldn’t it be nice . . . “
This article presents Baumol’s perspective on the workings of this growth machine. He’s smart, open-minded, a leader in entrepreneurship studies, and a potential Nobel Prize winner. I am not choosing him just for his brains or because he has said the last word, since he has not done so. But he certainly tells a clear, persuasive story.
The article then takes what looks like a right turn, which is in fact more of an effort to be in the center lane, politically, as it presents the ideas of Progressive Policy Institute alumni. Then it suddenly veers left (Wildly? Habitually? Persuasively? You are the judge) as the article tackles two key questions. What sort of politics and policies are needed to fuel this Machine? Which Americans are benefiting from the Growth Miracle?
It is common knowledge that the last few decades in the United States have been impressive in terms of its technological virtuosity, entrepreneurship, and heightened productivity, but its wealth generation has barely trickled down to America’s working families. 2
Let’s have three boisterous cheers when workers get the raise that they deserve.
Achieving Durable Growth
In this book, Baumol states his problem directly. Although he uses the rich source of scholarship on why innovation, growth, and a higher standard of living became a self-sustaining dynamic in many countries in the West “way back when,” he’s primarily focused on how it keeps the machine running today.
More specifically, historians have documented the major role of technological change in elevating the standard of living in these countries. On the other hand, mainstream economics has tended to identify some, market imperfections, regarding adequate investment in research and development. Neo-classical economists treat ideas and innovation as an almost public good, where society benefits far more than any single inventor and the property rights to all the proceeds are impossible for him to nail down. Supposedly, 80 percent of the benefits of a new gadget go to other people. Shouldn’t this be an area where externalities are such a problem that it does take a miracle to motivate an efficient and creative process for technological change?
Baumol argues that the system works, because there is a need in a fast-changing, competitive global marketplace for both incremental change and for breakthroughs. Ironically, big business oligopolies and the pioneering entrepreneur have important roles to play. What’s important is quality, not just price, in this technological arms race among competitors. The entrepreneur is the source of much of the innovative breakthroughs. He gets back what he invested and much, much more, because he positions himself with a patent-protected product or service that generates super-profits (e.g., economic rents). But rather than creating a permanent monopoly, the entrepreneur really makes her money on creating new markets around this new knowledge, which is better served and disseminated more rapidly by licensing these technologies to those who can make best use of them.
This entrepreneurial birth and trajectory cannot be blueprinted and codified. It depends too much on luck and the ability of an entrepreneur to see an opportunity that nobody else sees (or sees in the same way). Plus, it is imperative she gets there first. Incremental innovation, however, can be “routinized” to a degree. Historian Joel Mokyr names these, “micro-inventions” – those “cumulative small improvements in existing technologies that are responsible for most of the productivity gains that technological progress provides us.” 3 Established large businesses are good at this; they can be consciously invested in and coaxed along. But without “breakthroughs,” these smaller changes would gradually slow to a trickle and the machine would succumb to a kind of entropy.
Baumol further contends that it is for these reasons that the conditions for breakthrough entrepreneurship are so important: an educated workforce, world class institutions for higher learning, a culture of risk taking, venture capital, angel investors, a tax and regulatory system that allows for high returns on large sunk costs, and even lots of churn – high numbers of firm births and even firm deaths.
And oligopolies – the creators of micro-innovations, the acquirers of successful entrepreneurial firms and products, the license grantors of emerging markets – what do they need? They do not need any heavy handed anti-trust actions by government, according to Dr. Baumol. He argues that accelerating product cycles and global trade and investment will keep the competitive juices flowing and the market system open to new entrants.
However, he does not take the point of view that all bigness is good and what’s good for the multinational corporation, take-over artist, and investor banker is good for all. One of his other books discusses in detail the dangers posed by corporate takeovers and litigation, as well as better rules for the game that would avoid wasteful rent-seeking.
Growth, for Baumol, cannot be explained by investing more capital or ”the accumulation of various factors of production per se, be they ideas, physical capital, workforce skills; human creativity and productive entrepreneurship are needed to combine inputs in profitable ways.” 4
Yet, this machine can be undermined if public policy runs amok and creates the conditions and incentives for making lots of dough in unproductive rent-seeking ways. For example, the ‘stagflation’ of the Carter years and early Reagan Presidency is an example of a time when financial return, productivity, and the common good were disconnected. Those with dough were investing in gold, collectables, and other such items – all in the name of getting their investment return ahead of inflation and the erosion of the value of any fixed income assets.
Innovation Economics
But the climate for innovation and entrepreneurship is not nurtured by more Bush Administration-styled tax cuts. Robert Atkinson argues this point well in his recent work, Supply Side Follies: Why Conservative Economics Fail, Liberal Economics Falter, and Innovation Economics Is the Answer. In nine meaty chapters he takes apart supply-side doctrine and demonstrates the futility of an over-reliance on tax cuts as the answer to every economic distress. Do tax cuts boost work? Savings and investment? Higher tax revenues? Create less inequality? Lead to high rates of growth? No, no, no, no and no.
Atkinson then argues that old-style liberal democrats are both too interventionist and not interventionist enough. They are too prone to reach for the redistributionist “hammer,” take production for granted, and rely too much on demand side Keynesianism. They need to jump on the New Growth Theory wagon.
Few demonstrate the curiosity, the boldness, and the mastery of the workings and needs of the New Economy. Here new policy interventions are needed.
Many of Atknson’s specific critiques draw blood as he outlines his innovation-based economics platform for states and the federal government. It’s a terrific and politically feasible list. Also exemplary are his key design principles. Here are the first five.
- Growth economics focuses more on boosting productivity and innovation and less on “allocative efficiency”.
- Active, smart government policies to boost innovation and competition foster growth.
- Our collective prosperity depends on our willingness to embrace change.
- While some companies compete competitively, all countries do.
- Growth economics distinguishes between subsidizing industry and helping them become more innovative and productivity.
Concerning the fifth, Atkinson argues that a statement by Republican economist Greg Mannkiw is very misleading and poses a false choice – heavy-handed industrial policy versus entrepreneurship, state socialism versus free markets: “Policymakers should not try to determine precisely which jobs are created, or which industries grow.” 5 Mannkiw, then reaches for the frightening “B” word, when he argues that federal bureaucrats are not equipped to pick “winners or losers.”
In reply, innovation economics does not focus its attention and funds like this. With rare exceptions – technical assistance to small manufacturers to modernize via the state Manufacturing Extension Services-- he is not calling for aiding specific firms. This is not the failed US Synthetic Fuel Corporation or the French approach to subsidizing national leaders in particular industry sectors. Instead, “it does focus on increasing government support for key generic inputs to growth and higher-value-added economic activities on the public and private side, including research, skills, and investment.” 6
Along with fiscal discipline and a prudent monetary policy, we do need to practice these new microeconomic interventions. Executed well, these constitute the foundations for being able to embrace and run a non-inflationary full employment policy.
I have one peeve. Except for the full employment endorsement and his plan for a Rural Prosperity Corporation, he doesn’t craft the language to turn on those that are not today’s wired workers, policy wonks, university administrators, academic scientists, and engineering professionals. Moreover, he does not demonstrate ways his agenda will raise all boats, displaying some insensitivity to those who are not making it in the job market at all, or need a little help moving up a notch in pay and responsibility, or are embracing self-employment for the first time.
This may be a bit unfair. Nobody is an expert on everything. Likewise, a single book cannot do it all. But, given his strongly worded critique of “demand-side democrats”, it should be noted that he, in many respects, offers less options, than they do in this policy territory. And not all old ideas are bad ideas: socializing the risks from ill health through national health insurance, for instance. 7
Improved education and training is not the answer to all woes either. It’s become the knee-jerk default policy of democrats without a real economic program. Need to compete with foreign industries? Educate. Need to lower the numbers of the working poor? Educate. Help the dislocated worker? Educate.
We can be more nuanced than this. After all, increasing skill standards for some employment are not the sole reason for widening inequalities and stagnant wage growth for working families. There are lots of other culprits. Trade, De-unionization Immigration. A significant decline in the value of the minimum wage. Regressive tax reforms. Deindustrialization. Increasing numbers of high paid two-breadwinner households. Scandalous growth in CEO pay. Stock options for the already affluent.
Out-sourcing and off-shoring. Increasing numbers of temp and contingent workers.
In reality, we not only need a more skilled and adaptive workforce: we also need a more humane workplace, one that better balances family and job responsibilities and pays a living wage.
Something Nicer
I vaguely remember a true or made-up story that one of the protestors at the Seattle trade meetings had a sign that made an effort to not be merely anti-this and anti-that. The sign said: “I am against capitalism, and for something nicer.”
Markets are harsh and impersonal as they deliver their blessings and woe. 8 Nobody knows that better than Andy Stern, the President of the Service Employment International Union (SEIU). In A Country That Works: Getting America Back on Track, he cites chapter and verse, regarding growing CEO pay, and tax cuts for the wealthy, while the competitive pressures on jobs intensifies and firm after firm downsize, cut fringe benefits, and walk away from long-term employee pension obligations. This is not nice.
Stern’s book has the usual list of essential progressive reforms – national health insurance, a new retirement system, labor law reform, fair taxation of income and wealth, and so forth. I heartily endorse these measures.
But even more important is his call for radically new approaches to trade union strategies, tactics, organizations, membership, participation, and services beyond and in some cases, instead of the collective bargaining model – all dedicated to better balancing the differential of power between management and employees, finding “win-win” solutions based on teamwork not worker disposability, and having workers share in company productivity gains – a 21st century management and employee accord regarding “mutual gains.” 9 This is where we really need to let our imagination soar and call on all of our policy and organizational creativity.
Sounds a lot nicer than Enron, doesn’t it?
It makes you want to cheer.
1 So far, of course. There may be something better in the future. However, I know that my lefty buddies are grinding their teeth. Free enterprise? What does that ideological “feel-good” word mean? All markets are embedded in culture and fostered by the actions of a state. “Free enterprise” is so worn of a concept, that it’s almost useless. Plus, the state is not neutral: it has biases. The Republican controlled government tilts strongly toward business and protecting its subsidies. Many on the left would question this consensus about how the West became rich, differing, for example, on the role of colonialist exploitation versus indigenous technological change in the imperialist country. It’s not hard to come up with hundreds of theoretical difference and empirical challenges on this large topic between researchers. True. But here I am trying to approach this issue, along the lines of Ken Wilber’s notion of “orienting generalizations.” Here we are discussing these subjects on a fairly high level of abstraction, looking for common ground. Wilber contends in A Brief History of Everything that “if we look at the various fields of human knowledge – from physics to biology to psychology, sociology . . . certain broad, general themes emerge, about which there is little disagreement.” He uses the example of moral or intellectual development (remember Piaget). Probably every developmental psychologist would say that there are at least three stages in a human’s development – preconventional, conventional, and post-conventional. In other words, there is the infant just being socialized into a culture, the child thinking his world is the only world, and the adult using “reflexivity” to question some conventions, because they are created by society and not cast in stone.
2 See Baumol, William J. The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism. Princeton, NJ: Princeton University Press, 2002. Stern, Andy. A Country That Works: Getting America Back on Track. New York: Free Press, 2006.
3 Mokyr, Joel. Rev. of The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism by William J. Baumol. Reviewed for: www.eh.net, July 26, 2002.
4 Eliasson, Gunnar, and Henrekson, Magnus. “William J. Baumol: An Entrepreneurial Economist on the Economics of Entrepreneurship.” Small Business Economics. SSE/EFI Working Paper Series in Economics and Finance No 532, p. 8.
5 Atkinson, Robert D. Supply-Side Follies: Why Conservative Economics Fails, Liberal Economics Falters, and Innovation Economics is the Answer. Lanham, MD: Rowhan & Littlefield, 2006.
6 Atkinson, p. 224.
7 This should not be taken personally. I know Rob and he would fight for national health insurance and oppose social security privatization.
8 For two short, lucid discussions of these issues, read: James Fulcher, Capitalism: A Very Short Introduction (2004) and Alan Aldridge, The Market (2005).
9 Paul Osterman coined the phrase “mutual gains enterprise.”