Arnold Kling  

Phelps on the Future of Capitalism

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Nobel Laureate Edmund Phelps writes a long interesting article. Excerpts and my comments below the fold.

Note that a new commercial idea in a country may be an application of an invention or discovery made by scientists outside the economy or an innovation made by a business in another economy. That was Josef Schumpeter's early view of how commercial ideas came to a country. Or the new idea might come from within the nation's economy: an original idea inspired by the observations and imagination of producers, employees, managers or consumers - people "on the spot." This was the view of Friedrich Hayek and of most experts today. If innovation were mere Schumpeterian application or imitation, a socialist system could approximate the results of a capitalist system.
I was not aware of that contrast between Hayek and Schumpeter. Maybe I should have read more of their original work, instead of waiting for Phelps to distill it for me.

He says later,


One has to conclude that "generation of wealth" is not special to capitalism. Corporatist economies are quite good at that.

...As for freedom...some of the relatively socialist and corporatist economies of western Europe appear to be pretty tolerant of deviance from the mainstream.

Good news, since we seem to be making a sharp turn in the corporatist direction. However, he goes on to say,

My research using survey data supports the widespread impression that, in the relatively capitalist economies, people in ordinary jobs have freedoms that they value - more so than workers in the relatively socialist or corporatist economies. In the former economies more than in the latter, workers say they want jobs offering chances to take initiative and responsibility (which reveals that they know that such jobs are available), while acknowledging also the value of teamwork - thus the need both to give and take orders. Relatedly, earning one's way in the impersonal world of business - supporting oneself - is, for most people, necessary for what John Rawls called self-respect.

Key question: do we think that the connection between making a living and self-respect is strongly ingrained, or might it go away?

Phelps wants to maintain our dynamism while doing something about the sort of speculative swings that we recently experienced.


There are ways of fortifying the financial sector against the speculative fever of investors and entrepreneurs in the business sector without obstructing the speculative investment waves that are emblematic of a healthy capitalism. One suggestion,which comes from my colleague Richard Robb, calls for a small tax on the short-term indebtedeness of financial companies such as banks. So much of the banks' problems arose from excessive short-term borrowing of little or no social utility. Let us tax that in order to force banks to finance their lending with long-term borrowing instead...A suggestion from my long-time collaborator Roman Frydman calls for the introduction of a band around the index of housing prices, a band around the main index of stock market prices, and so forth. When the index rises or falls outside the band, the government will increase margin requirements, short-selling requirements, and various other costs so as to dampen - but not outlaw - speculation on a further move of the asset price index.

Phelps' own ideas include wage subsidies for low-wage workers and the chartering of banks that would only make loans to the business sector (as opposed to housing). I would note that wage subsidies could take the form of progressivity in the employer portion of the payroll tax. That is, employers would pay a lower payroll tax for low-wage workers.


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COMMENTS (9 to date)
Randy writes:

"...do we think that the connection between making a living and self-respect is strongly ingrained, or might it go away?"

I don't think the connection between "earning" a living and self respect will go away. But we have already reached a point where many people have "jobs" that are not technically "earning" a living (e.g., government). Then again, I haven't noticed that these people suffer from any loss of self-respect, in fact, they seem to have heaps of it. It makes me wonder if "self respect" is or ever has been a real problem - for anyone.

And, as more and more jobs become more "art" than "production", I expect that "self respect" will become more and more akin to "community" or "network" respect - with artists respecting artists, steel workers respecting steel workers, bureaucrats respecting bureaucrats, and libertines respecting libertines.

Steve writes:

Is self-respect binary? In other words, does one who makes $100,000 have more self-respect than one who makes $30,000, or do they both have an equal amount of self-respect while someone who is unemployed has none?

adam writes:

What do economists really know about capitalism? Most of us don't live it. We just occasionally imagine it in abstract math and figures. Yes, we write a few books and play at it--a few of us can make millions. But we never really take the risk of freedom. We have safe university jobs, each with very clear goals for advancement and, in the end, tenure. Our world is hierarchical (1st tier "institutions", 2nd tier, 3rd tier, and so on) and political. We do everything we can to eliminate Hayekian uncertainty from our lives, governments, and colleges.

Capitalism is remade by those who live it. The foundation of capitalism is free exchange between free people. The best we can do as economists is to work to remove the shackles of central control, regulation and politically determined barriers to trade.

The alternatives to liberty and capitalism are not good. Corporatism may do an adequate job of Schumpeterian imitation, but it doesn't do Hayekian innovation. The result of corporatism is stagnation.

Socialism, fascism, and all the other forms of tyranny kill both imitation and innovation. The Soviet Union tried to imitate capitalism by importing its prices. The result was abject failure--too many prices and too many interactions for any centralized system. Moreover, as soon as prices are measured, they are out of date, useless for trade and transaction. Doubts about perishability of prices? Try to use yesterday's or even last hour's stock prices now. It doesn't work. The best socialism can do is to run by coercion, fear, and force. Eventually, socialism's force ends up killing both minds and bodies.

Economist are easily deceived by the siren calls of statism and central planning. The late great Paul Samuelson was well known for his admiration of the Soviet Union. Only a few years before the Union's collapse, Samuelson's 1985 text argued:

“What counts is results, and there can be no doubt that the Soviet planning system has been a powerful engine for economic growth.... The Soviet model has surely demonstrated that a command economy is capable of mobilizing resources for rapid growth.”

Let's not make the late Samuelson's mistake again. That which really works, really raises us up from poverty to prosperity is free exchange between free people. That's the goal. We have a long way to go.

paul writes:

Adam, well put!

Economists, heal thyself

Ryan Vann writes:

When I first glanced over this post, I thought Michael Phelps was getting into Econ.

Mike Rulle writes:

"Key question: do we think that the connection between making a living and self-respect is strongly ingrained, or might it go away?"

The less freedom one feels regarding an activity that is 30-50% of one's waking hours, the more dissatisfied they become. Think of imprisonment as the extreme. I don't know if that dissatisfaction can be equated with low "self-respect", but it is not indifference.

Of course, there is probably always a price for each person that makes that dissatisfaction tolerable (e.g., what's your price to be willing to be incarcerated for 1, 3, or 5 years etc.). But its still not satisfaction.

Tracy W writes:

Adam - what you are talking about is only relevant to economists working at universities. There are plenty of economists working in the private sector, most obviously at consultancies, who do indeed take the risk of freedom.

Jeremy, Alabama writes:

Re: first paragraph (internal vs external source of innovation). Socialist/government adoption of technologies often fail even when every detail of the innovation is known.

E.g., French government-run iron foundries failed for 80 years to adopt the new British method, despite the fact that everything about the process was known, including hiring a team of British experts to do it for them, BECAUSE the French insisted on using low quality French iron ore. One supposes that a privately-owned business would have tried different iron ore.

PJ writes:

Bravo Adam! Well said.

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