Econ 309: Capitalism’s Record of Success

1. Econ 309: Capitalism’s Record of Success July 10th

2. Background on Schumpeter: Austrian vs. English traditions English Austrian Adam Smith (1776) David Ricardo Thomas Malthus Karl Marx (1850s-70s) J.S. Mill (c. 1850) Karl Menger (1860s) Stanley Jevons Leon Walras “Marginal revolution” Alfred Marshall (c. 1900) Francis Edgeworth Textbook micro Eugen von Bohm-Bawerk Friedrich Wieser Chicago school Milton Friedman Robert Lucas Gary Becker Friedrich Hayek Ludwig von Mises Joseph Schumpeter Keynes Paul Samuelson Textbook macro Paul Krugman Modern “Austrians,” e.g., GMU’s Peter Boettke

3. Schumpeter’s Capitalism, Socialism and Democracy • Historical significance: • Primary source of the concept of “creative destruction” • Conceives democracy as a “competitive struggle for the people’s vote” • Today, Schumpeter’s name symbolizes the idea of dynamic change in economics

4. Schumpeter’s Capitalism, Socialism and Democracy • Thesis: “Can capitalism survive? No, I do not think it can.” Why? • Growing hostility to capitalism in public opinion • “Obsolescence of the entrepreneurial function”: commerce and innovation were being taken over by bureaucracies • Bourgeoisie poor at providing political leadership • Overestimated ability of socialism to organize prosperity and innovate • However, Schumpeter doubts that socialism can be democratic

5. Schumpeter: Contemporary relevance • Since 2008, a storm of existential questions about the viability of capitalism are being raised again, e.g., Richard Posner, A Failure of Capitalism (2009)

6. Schumpeter’s Contemporary Relevance: Growing Hostility to Capitalism • In 2005: Sarkozy blames French model for riots Chirac's riot speech criticised as timid The "sickness in the suburbs" was a reflection of a wider French "malaise", and the blockages in French society caused by selfishness and corporatism, M. Sarkozy said. "The troubled suburbs are the extreme expression of a country which despairs for the future. They are not another France but France as we have built, and managed it, for the past 30 years.“ • In 2009: Sarkozy, who is frequently attacked what he calls “Anglo Saxon capitalism” said the global economic crisis has created a catastrophe that requires us all to question the ideas, values and decisions that’ve led to such results.   Sarkozy, who has frequently attacked what he calls “Anglo Saxon capitalism” said the “global economic crisis has created a catastrophy that requires us all to question the ideas, values and decisions that’ve led to such results.”

7. Growth • As the Beatles say: “I do admit it’s getting better, just a little better all the time…” • What do the themes of Smith, Keynes, Schumpeter, Becker, Wolf, Pritchett and Boudreaux have in common? Growth • Contrast: myths of a past “Golden Age” in many cultures

8. Smith (1776) Observe the accommodation of the most common artificer or day-labourer in a civilized and thriving country, and you will perceive that the number of people of whose industry a part, though but a small part, has been employed in procuring him this accommodation, exceeds all computation… if we examine, I say, all these things, and consider what a variety of labour is employed about each of them, we shall be sensible that without the assistance and co-operation of many thousands, the very meanest person in a civilized country could not be provided, even according to what we very falsely imagine, the easy and simple manner in which he is commonly accommodated. Compared, indeed, with the more extravagant luxury of the great, his accommodation must no doubt appear extremely simple and easy; and yet it may be true, perhaps, that the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.

9. Keynes (1919) What an extraordinary episode in the economic progress of man that age was which came to an end in August 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot. But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages... He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighbouring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

10. Schumpeter (1942) • Applies extrapolation: if the growth rate continues at the pace of 1878-1928, then it will rise to… • Is extrapolation (induction) valid? • (We use induction all the time, though David Hume claimed to prove it lacks logical foundation) • There is no tendency for the rich to get richer and the poor, poorer (argues S.) • On the contrary, growth specially benefits the masses

11. Schumpeter (1942) “I have stated above that, broadly speaking, relative shares in national income have remained substantially constant over the last hundred years. This, however, is true only if we measure them in money. Measured in real terms, relative shares have substantially changed in favor of the lower income groups. This follows from the fact that the capitalist engine is first and last an engine of mass production, which unavoidably means also production for the masses… The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within reach of factory girls in return for steadily decreasing amounts of effort.” (Schumpeter, 67)

12. Wolf “In the period after 1820, the rate of global growth greatly accelerated. Between 1820 and 1998, world population rose almost six-fold, its GDP forty-nine-fold and its GDP per head almost nine-fold. Between 1820 and 1998, real GDP per head rose nineteen-fold in western Europe, the former British colonies of North America and Australasia. In Japan, which was relatively poor in 1820, standards of living had risen thirty-one fold. In the rest of the world, real GDP per head rose only five-fold.” (p.44)

13. Yes Smith Wolf Becker Boudreaux (Pritchett) The optimists have been vindicated No / Doubtful Schumpeter Keynes The growth skeptics have been proven wrong… so far Can capitalism’s record of success continue?

14. Keynes: Why capitalism’s record of success is unlikely to continue • The economic situation in Europe after 1870 was “unstable and peculiar” • Emigration and imports of food ensured that Europe could feed itself • Internationalization of finance, trade • The “psychology of society” • Bourgeoisie were brought up to be savers, not spenders • “It was precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital improvements which distinguished that age from all others…” • The system depended on a “double bluff or deception”: (a) lower classes got very little of the social product, (b) the rich were encouraged to save for “posterity”

15. Why does the economy grow? • Smith: division of labor (with an honorable mention for technology) • Keynes: capital accumulation (irrational) is a big factor • Schumpeter: technology and innovation, with accompanying “creative destruction” • Boudreaux: “the free market” • Wolf: many factors, morality is mentioned • Pritchett is looking at the empirical record to derive desiderata for a theory of growth

16. Wolf on morality and markets • Markets both require morality and, to some extent, encourage it: “Markets also require, reward and reinforce valuable moral qualities: trustworthiness, reliability, effort, civility, self-reliance and self-restraint” (p. 55) • But conflicts of interest also arise in business, e.g., in corporations “Economists are very uncomfortable with the notion of morality. Yet it seems to have a rather clear meaning in the business context. It consists of acting honestly even when the opposite may be to one’s advantage. Such morality is essential for all trustee relationships. Without it, costs of supervision and control become exorbitant.” (p. 50)

18. Pritchett’s “lower bound” • Pritchett estimates that the lowest level of GDP per capita consistent with survival is $250/annum • This implies that: • There could not have been much economic growth in Europe before 1820 or so • Growth rates in today’s rich countries must have been much faster than in today’s poor countries since 1870: “divergence, big-time” • Leading growth theories, e.g., the Solow model, predict convergence

19. Pritchett vs. Smith • Smith: “it may be true, perhaps, that the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.” (in 1776) • Pritchett: Income differences cannot have been too large prior to 1820, because Europeans weren’t far above the survival threshold • Who is right?

20. Pritchett’s desiderata for a theory of economic growth • The last 125 years have seen massive divergence in… incomes. • Steady and near equal growth among the leaders over the long haul. • The poorest countries have historically had very very low growth. • Some countries that began poor in 1960 continued to stagnate.

21. Pritchett’s desiderata for a theory of economic growth 5. Some countries that began poor in 1960 have had extremely rapid growth. 6. Cross-sectionally, growth has varied enormously in developing countries 7. Growth has been much more variable not only across but also within developing countries. 8. Growth rates, especially in developing countries, have shown very little persistence.

22. Why have so many poor countries been left out of economic growth? • Institutions / politics: dictatorship, corruption, lack of property rights (Rodrik) • Geography: trade, transportation, and malaria (Sachs) • Culture? (not a politically correct answer!) • Exploitation / colonialism / core-periphery narratives • Becker has an answer: Taiwan grew because it’s capitalist, Cuba didn’t because it’s communist

23. What determines the rate of long-run growth? • The standard answer (among economists as well as the general market): technology • But market capitalism seems to be best able to generate and economically exploit new technologies • Competing theories • “Neoclassical” theorists attribute growth to factor accumulation plus “exogenous” technological change • “Endogenous growth” theorists emphasize how R&D is driven by market incentives • Knowledge is an excludable,non-rival good • Is the answer to “What are the determinants of long-run growth?” the same as the answer to the question, “Why are some countries poorer than others?”

24. Conclusions • Long-run trends are positive all over the world • Capitalism