Dynamic capitalism

Monday 30 October 2006 4:06PM (view full episode)

We speak to the winner of the 2006 Nobel prize for economics, Professor Edmund S Phelps, about the potential for unfettered capitalism to promote not just wealth, but innovation and self-realisation. He says 'we often hear about capitalism at its worst, or the dark side of capitalism, but we seldom hear about the bright side.' And he calls it 'Dynamic Capitalism'.


Michael Duffy: Edmund Phelps is professor of political economy at Columbia University and this year he won the Nobel prize for economics for challenging the long-held view that if unemployment goes down, inflation must surely go up. But the reason I'm so keen to talk to him today is because of a much noticed essay that he published recently in the Wall Street Journal. It's a description and a defence of what he called dynamic capitalism, capitalism at its best. Edmund Phelps, welcome to the program.

Edmund Phelps: Thank you.

Michael Duffy: You start in the article by distinguishing the economic system of the Anglosphere from that in Western Europe. What is the difference?

Edmund Phelps: In the Anglosphere, as you say (United States, Canada, UK, I'm glad to include Australia), capitalism is more or less the real thing, the classic thing, it's all about new ideas and entrepreneurs who are prepared to develop them and financiers who are prepared to back those ideas, and there is relatively little pressure on financiers to back this kind of thing or back that entrepreneur rather than some other one. So we have a shot at getting a good selection of ideas and having, as a result, an economy that is not only innovative but also innovative in commercially promising directions. In Europe, the continental Western Europe, the problem is that there is an extensive involvement of the government in the economy and there is so much emphasis upon the rights of the social partners, labour, communities and so forth and so much emphasis on stake holders, the employees, that as a result it's almost as if there had to be unanimity before a new investment project could be approved or an innovation could be developed.

Michael Duffy: In terms of outcomes, what's the difference? Why is the American system better?

Edmund Phelps: Because you don't have all the filtering out. Entrepreneurs have more incentives because they don't anticipate that they're going to meet road blocks and impediments along the way so the entrepreneurs have more incentive to dream up new ideas and to seek financing for them, and the enterprisers themselves are freer to operate, so they're going to be able to do better with the innovations. That's part of it anyway.

Michael Duffy: Why do we actually need more growth? And I know this is something you look at in the essay. Why shouldn't we be happy with what we've got now, which in historical terms is pretty good?

Edmund Phelps: I don't think that we should be flailing ourselves in dissatisfaction with what we've got now, while I do think that our economies probably could be more dynamic than they are, but it's particularly continental Western Europe that seems to be experiencing a deficiency of dynamism, and it's continental Western Europe that I'm mostly worried about.

Michael Duffy: From what you've been saying, those economies in Western Europe almost seem like free riders; they've benefited by the advances made by the US without taking many of the risks. Is that a fair depiction?

Edmund Phelps: Yes, that's absolutely true, but it's also true that they deprived themselves of the fun of innovating and the job satisfaction that employees derive from having problems to solve and developing their talents as a result, so expanding their capabilities. So yes, they're avoiding the risks but they're also missing out on the stimulation and the personal development.

Michael Duffy: And that for me was the most interesting single part of your essay and it's something that we don't hear very often, the fact that capitalism can allow large numbers of ordinary people to liberate or express their creativity.

Edmund Phelps: Yes, I think so.

Michael Duffy: That's very important, isn't it? And capitalism at its worse is a terrible thing, but we don't often hear about capitalism at its best.

Edmund Phelps: Yes, that's right. We usually hear about capitalism at its worst or the dark side of capitalism, but we seldom hear about the bright side, and I've been pursuing that because I think it's very important for us in the west, including the US and Australia, to value what we have and try to avoid falling into the morass or the miasma that continental Europe seems to have fallen into.

Michael Duffy: Do you have any idea why we don't hear about this more? There are obviously international movements now against various forms of capitalism and globalisation and free trade and so on. Why in general, in our public debate...even though many of us in our own lives derive great benefits and liberation from capitalism, why is public debate dominated by the negatives?

Edmund Phelps: Maybe public debate always tends to be dominated by people who are critical. Maybe it's kind of boring to come to the defence of the status quo but I think it is a responsibility to stand up for the system we have, not that it can't be improved but just that there are important values that it serves.

Michael Duffy: Professor Phelps, what about the equity aspect of all this? We often hear critics saying that American style capitalism is bad for poor people. Do you think it is? And if it is, is that an argument against it?

Edmund Phelps: I think it's a total confusion. It's not capitalism that's bad for poor people, it's the legislatures that don't pay enough attention to the distribution of income and in particular don't pay enough attention to the wage rates in the low end of the labour market. For more than a decade I've been doing the best I can to persuade the public and persuade the US congress here in the United States to get behind a program of low wage employment subsidies paid to companies for their current employment of low wage workers. That would pull up the demand for low wage workers and that would pull up their employment and eventually pull up their pay rates too. There's nothing inherent in capitalism that implies that the working poor have to be neglected or treated like dirt or...the government intervenes every day of the week in many, many ways and here's an intervention that would be really good.

Michael Duffy: Have you had much luck with the proposal?

Edmund Phelps: No, not at all, although the Netherlands has a program like that and France has a program like that amid 50 other programs dealing with the low end of the labour market, and it has to be said in fairness that the US and the UK both have something that used to be called the Family Assistance Plan. In Britain I think they've changed the name now, and in the United States it's called the Earned Income Tax Credit. If you are a low wage worker and you're lucky enough to be able to find a job and stay in a job that pays the statutory minimum wage or better, then the government will top it off with a tax credit geared to how much or rather how little your earned income was in your income tax report declaration. So that's the way that system works. The trouble is it's highly politicised, so for decades and decades it only went to women, mothers with young dependant children, when the big problem with the low end of the labour market in the United States...the big social problem was the young men who were unmarried, typically without jobs, without skills, very low wages who were falling apart and really need to be drawn into the economy.

Michael Duffy: Returning for a moment to dynamic capitalism which you define partly in your article as 'that which provides high levels of mental stimulation, problem solving, employee engagement and thus personal growth', do you think that the American economy has become more or less dynamic in the past 50 years?

Edmund Phelps: I think it is, for me, really hard to say. I know there are a lot of people who have broken out the champagne and said it would greatly increase the dynamism of the economy ever since President Carter began to deregulate a bit in the last years of the 1970s, followed by Ronald Reagan and some other presidents. But there are also things that the government has done that also increase regulation on the economy. For example, the notorious Sarbanes-Oxley bill that legislated a few years ago which is quite a problem for companies.

Michael Duffy: Can you tell us what that does?

Edmund Phelps: It kind of hamstrings the CEO on what he can do. He has to justify a little more to the board of directors what he can do, there are more constraints on him. After all, the whole idea of capitalism is you don't have accountability, you don't have to justify it to the community or to the head of state that you're undertaking a project that's convenient for everybody. The entrepreneur is supposed to be given his head and if he succeeds, that's great, and if he fails, well, those are the breaks of the game. But now under Sarbanes-Oxley I think the new thinking is that the CEO has to be very responsible to the board of directors, and the board of directors has to meet various responsibilities, so the US corporation is now much more bureaucratised or constrained than it was three or four decades ago.

Michael Duffy: Professor Phelps, if I could just finish with one last question, it's a general one, it may be unfairly so, but in terms of the way economic systems work and looking at your lifetime study of that subject, is it possible to say the most important thing you feel you've learned about that?

Edmund Phelps: The most important thing I've learned about how markets work or how economies work?

Michael Duffy: Yes, how markets work.

Edmund Phelps: Offhand I can't think of the most important thing that I've learned. Maybe it is that when I was starting out in the subject I had little sense of the uncertainty under which the economic actors in the economy have to operate. I was very much under the influence of textbook models that I'd been studying in college and in graduate school, and it's only very, very slowly over decades and decades that my conception of what a healthy market economy is all about has developed. So I think maybe that's the biggest thing I've learned, is that the future is highly uncertain, the start-up entrepreneurs and even the CEOs and the established companies are aware of the uncertainties, financiers are aware of these uncertainties, everybody acts accordingly, and that makes the economy quite different from the way it is still described in the textbooks.

Michael Duffy: Edmund Phelps, thanks very much for joining us today, we appreciate your time.

Edmund Phelps: I enjoyed it, thank you.

Michael Duffy: Edmund Phelps, professor of political economy at Columbia University and this year's winner of the Nobel prize for economics.


Professor Edmund S Phelps
McVickar Professor of Political Economy, Columbia University


'Dynamic Capitalism'
Edmund S Phelps
Opinion article for The Wall Street Journal

Further Information

Nobel Prize for Economics 2006


Michael Duffy
Lucy Kingston