Formal Book Review / Essay on Entrepreneurial Capitalism

Below is a book review / essay on the ideas in the book Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity by Baumol, Litan, and Schramm, in which the authors argue that “entrepreneurial capitalism” is crucial for economic growth. Other books were consulted but it’s difficult to paste footnotes into a blog post, so if you want all citations, email me.

Economic growth is desirable for all countries because it improves the material standard of living and spawns moral benefits, i.e. it “fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.” Of the various causes of economic growth, I believe one value is paramount: entrepreneurship. William Baumol, Robert Litan, and Carl Schramm call the importance of this value “entrepreneurial capitalism,” which is when small firms play a significant role in an economy. Countries which prize entrepreneurship make it easy to start a business by minimizing bureaucratic roadblocks. These economies also have cultures conducive to entrepreneurial thinking; they adopt entrepreneurship as a local value. I will briefly explore how the U.S. and China embrace this to different extents – and how Japan and Western Europe do not.

•••What makes an economy entrepreneurial? First, it must be easy to start a new business. The less red tape, the better. Second, there must be incentives for entrepreneurs to innovate. Creativity should be rewarded with a functional intellectual property system, for example. There also should be a cultural / social incentive – starting a business should not be frowned upon by friends and family as a low status undertaking. Third, there must be big firms which can refine and scale the innovations created by small firms. A successful entrepreneurial economy has a blend of small and big firms, with the small firms producing the radical innovations and the big firms honing and building upon those inventions. Fourth, entrepreneurial capitalism requires capitalism – that is, minimal government intervention in the market so as not to pervert incentives for the small business owners trying to succeed. Beware of the government which tries to arbitrarily “divide up the economic pie rather than increase its total size.”

•••The United States is the most successful model of entrepreneurial capitalism. First, it is extremely easy (and inexpensive) to start a business (only in Denmark and New Zealand is it cheaper). Second, there are appropriate incentives to encourage innovation and a legal structure to protect innovation. Culturally, there is a “cool” incentive: the media and society glorify entrepreneurs. Third, there is the right mix of big and small firms. In the technology sector, start-ups like Yahoo or Google were supported by established companies like HP or Apple. Finally, for the most part, the government does not over regulate industry and allows maximal flexibility for competition in the market. The US was ranked fifth in that regard in the 2007 Economic Freedom of the World report. At its founding, America’s leaders – Benjamin Franklin, Thomas Jefferson, George Washington, others – enshrined the country with entrepreneurship as a key local value by celebrating self-determination, and that value persists and has made the U.S. the largest economy in the world.

•••China is an example of a developing country that increasingly but perhaps begrudgingly accepts entrepreneurial values as a necessary ingredient to economic growth. And what growth it’s been: China reported 11.2% fourth quarter 2007 GDP, its fastest growth rate in years, making it the world’s fourth largest economy. While once heavily centrally planned, China now shelters bounties of entrepreneurs and start-up ventures:

Whether by design or by necessity, Beijing has decentralized economic and political decision-making to the provincial and municipal governments, which in turn have used their expanded freedom to engage in productive ventures…Chinese officials have tolerated the formation of countless numbers of other entrepreneurial ventures that have sprung up largely in the eastern, richer half of China, and by at least one measure, small- and medium-sized enterprises by 2003 accounted for half of the economy’s GDP.

To be sure, government regulatory infrastructure there is not yet mature. A basic legal framework to protect inventions hardly exists. Corruption and other institutional failings plague the entrepreneur. Still, China’s amazing economic prosperity the past decade can in part be attributed to the rise of entrepreneurial capitalism; they ditched state-run banks for private ones, for example, and made it on average 13 days quicker per person to start a business.

•••Part of the imperative for entrepreneurial capitalism is that the global economy is fast paced and interconnected and punishes countries unwilling to adapt to a new, “flatter” competitive landscape. Japan and Western Europe are two examples of developed regions and mature democracies which risk stagnant growth in the future if they do not embrace entrepreneurial capitalism. Already, there are troubling signs: over the past ten years per capita GDP growth rates in Western Europe and Japan slowed relative to the U.S. Unemployment rates in Europe have hovered in double digits; in Japan they’ve stayed at 4-5 percent. Both have sizable elderly populations: 30% of citizens are over age 65 in Japan, 25% in Western Europe.

Why the slow growth?

First, both regions are defined by dominant big firms, with small, innovative firms either not being started or not scaling to any meaningful size. Consequently, Western Europe lacks much “creative destruction”: of the twenty five of the largest companies in 1998, all twenty five were already large in 1960. Contrast this to the US, where eight of the top twenty five companies did not exist or were very small in 1960. When there’s not turnover, there is not enough destruction and creation and entrepreneurial dynamism. In Japan, it is difficult to identify any new company which has emerged of late; behemoths like Sony, Panasonic, and Toyota still dominate.

Second, entrepreneurial capitalism requires capitalism itself. But capitalism is not a given in some places in Western Europe. A survey of 22 countries reported that only France’s residents did not believe the “free market economy” was the best economic system.  Capitalism also necessitates the free movement of labor, but both Western Europe and Japan restrict their labor market so that hiring and firing employees is exceedingly difficult. Some countries mandate 35 hour work weeks.

Third, economist Edmund Phelps has argued that Western Europe’s slow economic growth could be because of a lack of entrepreneurial culture. Culture is essential for entrepreneurial attitudes. Yet “culture” is nebulous – it is hard to pinpoint how mores become entrenched, and how one goes about changing them. To start, it seems obvious that no matter how much a country talks about shaping the hearts and minds of the next generation with a flair for entrepreneurship, in the end government policy and regulation matter most. The brightest entrepreneurial spirit will still be quashed by onerous government regulation or a capital markets system which disadvantages the small business looking for a loan or a labor market which prevents the hiring and firing of the best talent. It seems that the most important commitment places like Japan or Western Europe can make at this point is to align official government policy with its entrepreneurial aspirations, assuming they have them.

In summary, Japan and Western Europe need to move toward entrepreneurial capitalism if they’re to remain competitive against rising Asian powers.

•••Global capitalism comes in many flavors. Countries which are experiencing economic growth emphasize entrepreneurial capitalism: they make the doings of innovative, small firm entrepreneurs a central focus. Even non-democratic countries like China can be entrepreneurial and realize economic growth, and ultimately, the moral benefits that follow material prosperity. Just as China (and India) in the developing world and the United States in the developed world show the positive impact that entrepreneurial attitudes can have, Japan and Western Europe are examples of the sluggishness that can occur in its absence. The next 50 years are certain to bring a change in world order. American hegemony is nearing its end. Which countries will emerge as economic players and which will fall behind? Which countries will implement capitalism in a way that jibes with local culture? How will increasing economic interdependence in the world affect a nation’s domestic economy? For the answers to these and other questions, pondering the entrepreneurial nature of a country, its people, and its economic framework would be a fruitful starting point.