In the wake of the Great Recession and America's listless recovery from it, economists, policymakers, and media pundits have argued at length about what has gone wrong with the American capitalist system. Even so, few constructive remedies have emerged. This welcome book cuts through the chatter and offers a detailed, nonideological, and practical blueprint to restore the vigor of the American economy.

Better Capitalism extends and significantly expands on the insights of the ...

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Better Capitalism

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In the wake of the Great Recession and America's listless recovery from it, economists, policymakers, and media pundits have argued at length about what has gone wrong with the American capitalist system. Even so, few constructive remedies have emerged. This welcome book cuts through the chatter and offers a detailed, nonideological, and practical blueprint to restore the vigor of the American economy.

Better Capitalism extends and significantly expands on the insights of the authors' widely praised previous book, Good Capitalism, Bad Capitalism, co-written with William Baumol. In Better Capitalism, Robert E. Litan and Carl J. Schramm focus on the huge—but often unrecognized—importance of entrepreneurship to overall economic growth. They explain how changes in seemingly unrelated policy arenas—immigration, education, finance, and federal support of university research—can accelerate America's recovery from recession and spur the nation's rate of growth in output while raising living standards. The authors also outline an innovative energy strategy and discuss the potential benefits of government belt-tightening steps. Sounding an optimistic note when gloomy predictions are the norm, Litan and Schramm show that, with wise and informed policymaking, the American entrepreneurial engine can rally and the true potential of the U.S. economy can be unlocked.

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Product Details

  • ISBN-13: 9780300184693
  • Publisher: Yale University Press
  • Publication date: 9/25/2012
  • Sold by: Barnes & Noble
  • Format: eBook
  • File size: 3 MB

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Renewing the Entrepreneurial Strength of the American Economy
By Robert E. Litan Carl J. Schramm


Copyright © 2012 Robert E. Litan and Carl J. Schramm
All right reserved.

ISBN: 978-0-300-18469-3

Chapter One


It was not an American who coined the word "capitalism," which has long been used to describe the U.S. economy. That honor falls, ironically, to capitalism's most famous critic, Karl Marx, who inveighed against an economic system he believed was dominated by a few "capitalists"—owners of buildings, equipment, and the dreaded corporations—whom he believed exploited the masses.

But Marx the wordsmith was cleverer than Marx the economist. The emerging economic system that he decried for enslaving the poor turned out instead to be the greatest anti-poverty force the world has ever known, lifting living standards for ever-growing numbers of people beyond what they could have imagined. Economic output per capita has multiplied manyfold in most places around the world since the beginning of the nineteenth century, overwhelmingly because "capitalists" built companies with technologies that have vastly increased the productivity and wages of the workers they employed. The Economist was able to report in early 2009 that, by one measure, more than two billion people—close to half the people on the planet—were then living what could be called middle-class lives, a triumph that could not have happened unless "capitalists" had motives to profit from their risk-taking endeavors and investments.

Yet 2009 and the year before it, as all readers of this book surely know, were years that many would rather forget. During these years, the Great Recession in the United States began and then spread to the rest of the developed world, following the bursting of an unsustainable bubble in residential real estate prices heavily fueled in the United States by large volumes of unsound "subprime" mortgage loans that in the decade before had been packaged into securities and sold to banks, financial institutions, and other investors around the world. When the losses came, they ate into thin cushions of capital at many of these institutions, bringing some of them down and, by September 2008, threatening a systemwide financial panic in much of the developed world.

Governments of these economies responded with massive measures, "bailouts" of the creditors of large firms (not all of them financial), injections of government funds into many large financial firms themselves, unprecedented expansions of money and credit by central banks, and extraordinary fiscal stimulus packages. The emergency efforts stopped the bleeding, for the most part, but never really jump-started the economic "patients." Consumers remained hesitant to return to their prerecession free spending ways, and so businesses stashed away cash rather than ramp up investment spending. As a result, the postrecession recovery has been weak by historical standards. GDP advanced for the first two years after the recession at roughly just a 3 percent pace—barely fast enough to absorb new workers coming into the labor force and the continued rising productivity of U.S. firms. As a consequence, the unemployment rate that peaked at 10 percent (only the second time this has happened in the post–World War II era) only dropped to 8.3 percent through the spring of 2012.

Something clearly was seriously amiss. The 2009–10 fiscal stimulus in the United States in particular had bumped up federal spending to a historic high of 25 percent of GDP, roughly five percentage points above its forty-year average, and thus exacerbated what was already an upward trend toward higher spending to honor obligations made by many previous Congresses and administrations to support the incomes and medical costs of Americans when they retired and pay for the medical costs of the indigent. Just several years earlier, a Republican president and a Democratic Congress had agreed to add reimbursement of prescription drugs to the list of "entitlements," while in 2010, in a strictly partisan vote, the Congress and president added yet another health care program, subsidizing the costs of extending health care to all citizens, regardless of age.

By 2011, it dawned on politicians in Washington and many voters living outside the capital that the country could not afford all these obligations as baby boomers aged and began retiring en masse. By the summer of that year, the stage was set for an epic, and unprecedented, showdown between the two political parties (and a subset of the Republican party, the Tea Party, that had revolted against all this spending) over the magnitude of a long-term deficit reduction deal that would be tied to the otherwise routine matter of annually raising the ceiling on the amount of U.S. debt that could be issued for the coming year and beyond. In the end, the United States did the almost unthinkable: as July ended and August of that year began, the country had to choose either to default on its debt or massively cut into federal spending, perhaps not sending out Social Security checks to tens of millions of senior citizens who needed them to pay their monthly bills.

Yet even when a final deal came, the markets shrugged it off, focusing instead on recently revised statistics showing that the U.S. economy barely grew at all during the first half of 2011, despite record amounts of stimulus that was supposed to have kick-started the private economy. And then to pour salt into the economic wound, one of the three leading ratings agencies downgraded the quality of U.S. Treasury debt for the first time, citing the political dysfunction that was on full display during the deficit reduction negotiations and the failure of the August 2011 deal to really tackle the underlying source of the government's long-term fiscal imbalance: the huge and growing gap between tax revenues collected and the rising costs of the big three "entitlement programs": Medicare, Medicaid, and Social Security. Ever since, at least as of this writing, the U.S. economy has been weak, while a pall has continued to hang over much of Europe (except Germany and some of the Eastern European countries), whose governments have faced the same, or even worse, fiscal challenges.

Understandably, fingers point in all directions, looking for people and ideas to blame for these events. The United States and other developed economies that have suffered along with it had experienced and now confronted something they never thought would happen again after the Depression: an extended period, perhaps a decade or more, of anemic growth and high unemployment. The conventional macroeconomic tools—temporary fiscal stimulus (higher spending and tax cuts) and the printing of money—did not seem to work as the textbooks had said they would. And though deficit reduction over the long run is clearly necessary, the efforts to do it immediately in a fragile economic climate make it difficult, if not impossible, for the affected economies to mount a recovery sufficiently rapid to return most of the unemployed promptly to work.

Some of the fingers looking for blame have pointed to a fundamental failure in "capitalism." If by this term one means the unbridled financial capitalism that reigned in the United States in the run-up to the financial crisis, then the blame clearly is well deserved. With the benefit of hindsight, it was crazy to have allowed people with less-than-stellar credit histories to buy homes with little or no money down, outcomes made possible through the sale of securities backed by subprime debt that should never have been sold. Likewise, years of many different policy mistakes led financial institutions and individuals to become excessively leveraged, so that when the U.S. housing and subprime mortgage markets began melting down, the losses suffered by banks and households quickly depleted their limited amounts of net worth and thus amplified the economic damage well beyond the losses suffered by those holding mortgage securities.

Fortunately, this particular mutated form of opaque and reckless financial capitalism is now dead. But here's the surprising and not fully appreciated thing: the "entrepreneurial capitalism" that drove the U.S. economy positively for several decades until the financial crisis—the one that accounted for the proliferation of new "gee-whiz" products, technologies, and services introduced by a seemingly never-ending supply of new firms—has continued to be admired and envied not just in the United States, but throughout the world. It was entrepreneurs, after all, who commercialized the telegraph, telephone, and automobiles of the nineteenth and early twentieth centuries, the airplane, radio and television, computer, and transistors that followed, and most recently, personal computers, software, and an amazing array of medical therapies and technologies. No wonder that other countries, notably Brazil, India, Indonesia, and China, among others, even as they struggle with their own current economic difficulties (excessively rapid growth that has led to too much inflation) want to copy and improve on our entrepreneurial model even as—and indeed especially as—the global economy continues to struggle to recover from the financial crisis.

That is not the way things would have looked fifty years ago, had we been writing this book then. The 1950s and 1960s were the halcyon days of "managerial capitalism," when large firms such as General Motors, Ford Motor Company, U.S. Steel, IBM, and AT&T (in its previous monopoly incarnation), among others, were the driving forces of the U.S. economy. Taking advantage of the pent-up demand for consumer goods during World War II, large firms expanded their reach into new markets at home and abroad. They used their economies of scale, access to internal capital, and in-house research labs to generate new products, drawing on technologies that had been developed during or before World War II. This managerial capitalism delivered rapid growth and thus rising living standards for almost three decades after the end of the war. Indeed, our particular brand of this capitalism was not only envied, but feared. In the late 1960s, European intellectual Jean-Jacques Servan-Schreiber warned European governments and citizens that without aggressive countermeasures, the multinational companies birthed and headquartered in America—the quintessential managerial capitalists—would dominate the world economy.

But then the U.S. economy hit the proverbial wall in the early 1970s. Inflation had been edging up throughout the Vietnam War, eventually leading to a run on the dollar that forced the United States to quit exchanging gold at the price fixed after World War II. Soon thereafter, the fixed exchange rate system that had governed world currency markets and international trade that had been in place since World War II came undone. The coup de grace was the quadrupling of oil prices in 1973, which pushed both inflation and the unemployment rate nearly into double digits—then post-Depression highs. Even though growth later resumed and the unemployment rate fell back to near 6 percent, inflation stayed uncomfortably high until the economy was hit by yet another oil shock, this one in 1979 during the Iranian hostage affair. From 1973 to 1980, stock prices dropped in real terms (adjusted for inflation) by roughly 40 percent, reflecting a loss of faith in the managerial capitalism that at least until the first oil shock had produced such rapid growth and widely shared prosperity.

There was ample reason for the loss of faith. Big Auto and Big Steel—along with steadily Bigger Government—that helped define managerial capitalism proved too bureaucratic and uninventive to withstand the seeming onslaught of cheaper (and often better) imports from Japan and elsewhere. While many Americans feared the United States was thus losing out to the Japanese on the economic front, they had also been steadily losing faith in government. The U.S. military not only suffered its first-ever defeat in Vietnam, but the Watergate scandal that ultimately forced President Nixon to resign shocked Americans of both political parties. The decade ended with the seizure of the American Embassy in Iran and the humiliation of U.S. government employees being held hostage for over a year, unable to be rescued by the one failed military attempt to do so.

In one narrative, what saved America and rejuvenated its economy was the election of the optimistic, anticommunist, free market enthusiast Ronald Reagan to the presidency in 1980. Rather than wade into contentious political waters about the correctness of this explanation, we suggest here that an uncontroversial but important contributing reason for at least the economic turnaround was the transformation of the U.S. economy from managerial to entrepreneurial capitalism. This apparently new form of capitalism was not new at all, but is in fact what powered the American economy from Revolutionary times until the early 1900s: the cleverness and hard work of waves of entrepreneurs of all types whose efforts gradually lifted the living standards of American citizens. Entrepreneurs began to take center stage in the U.S. economy again in the 1970s (before Reagan was elected) with the formation of such companies as Intel, Microsoft, Apple, Federal Express, and Southwest Airlines, among others. But entrepreneurial capitalism really took off in the 1980s and 1990s and flowered under presidents of both major parties.

Five years ago, in Good Capitalism, Bad Capitalism, we described this remarkable transformation with our coauthor and distinguished colleague, New York University economist William Baumol. In that book, we argued nonetheless that economies perform best when they have a blend of dynamic entrepreneurial companies and larger, established enterprises. (Baumol has also made this argument in other papers and books authored by him.) A continuous supply of new firms, especially those that eventually scale, is required to develop and commercialize the disruptive technologies that are the key to sustained productivity growth and, hence, to rapid advances in living standards. A large base of large, established firms, meanwhile, is required to refine, incrementally improve, and mass produce the new disruptive technologies brought to market by entrepreneurs. The precise mix of new and established firms that best maximizes growth varies from economy to economy, but the notion that both are required was a central thesis of the prior book.

This book appears at a very different time—radically so—after a financial crisis that, frankly, we (and most others) did not foresee, followed by a budget-related loss of confidence in the United States, by Americans and citizens from elsewhere around the world, that we did warn about earlier (along with plenty of others). The challenge, clearly, is what to do now: not just to get economies back on track to recover from these recent traumas, but even more important, to sustain rapid growth once again for the indefinite future after some measure of recovery has been accomplished.

We modestly believe we have at least part of the answer and it is one reason we have written this book. Readers are unlikely to find this explanation in the expansive postcrisis literature on how to get out of our economic troubles, which tends to focus on the traditional macroeconomic fixes (tax cuts, spending increases, and expansionary monetary policy) that have worked in past recoveries. Instead, we offer a different, and we hope more compelling, narrative that focuses on the central role of the continued formation and growth of scale firms in driving economic growth, both in the short and long runs. To use terminology familiar to economists, we argue that to better the macro trends in overall jobs and output growth, citizens and policymakers must strengthen the micro underpinnings of our economy; specifically, the formation and growth of scale firms.

In particular, we argue that the "better capitalism" the United States needs now more than ever is one that fosters continuous entrepreneurial revolution—the economic equivalent of what Thomas Jefferson called for when he famously uttered, "Every generation needs a new [political] revolution." Whether or not that statement is appropriate for governing, it could not be more relevant today as an economic proposition. For countries at the technological frontier like the United States, sustained rapid growth is only possible through the continued commercialization of new, disruptive—and, yes, revolutionary—technologies, products, and services.

We are not sufficiently clairvoyant to predict what those technologies will be. Futurists in the past have missed the mark, and no doubt their heirs today will be equally unsuccessful. Nonetheless, it is does not take much imagination to believe that eventually some form of computer chip will be in almost everything we buy, enabling many household and business chores to be carried out by robots rather than humans. Cars at some point may not need drivers, but instead will be carried along expressways with computer guidance. New therapies, devices, and medicines will extend average life spans, with good quality of life, by decades. And so on. Just as entrepreneurs have shaped the lives most readers enjoy today, they will shape the tomorrows of the billions of people living now and born into the future.

Of more immediate interest, sustained and continuous entrepreneurial revolutions of the kinds just listed also are what America needs to meet five large challenges that confront it in the wake of the financial crisis and subsequent recession:

• Generating a faster recovery in jobs and incomes that is now needed more than ever;

• Eliminating a deficit of imagination about what our country and its economy could look like if our entrepreneurial spirit could be more effectively harnessed, consistently;

• Restoring faith in our political system;

• Averting a potential fiscal crisis that could produce an even deeper and more lasting financial crisis than the one that began in 2008 (and has continued to show aftershocks in subsequent years);

• Maintaining U.S. economic power in an age where it may matter more than military force (but where force is required, stronger growth will make it easier to finance); and

In outlining our views on these topics in the balance of this chapter and throughout the rest of this book, we are cautiously optimistic. Time and again, Americans have faced enormous challenges and overcome them, so those who bet against the United States coming back strong after the Great Recession do so at their peril. At the same time, we also recognize the huge nature of these challenges. Those who say America is "in decline"—as a Time cover story by the journalist Fareed Zakaria argued in March 2011—or who fear the inexorable rise of the Chinese or Indian economies, or both, have plenty of arguments on their side. It will take successive entrepreneurial revolutions in the United States in many spheres of life to prove the pessimists wrong. Our main purpose in writing this book is to outline how those revolutions can be spawned, maintained, and put to use in lifting living sandards for all Americans at a faster rate over a sustained period than conventional wisdom now thinks possible.


Excerpted from BETTER CAPITALISM by Robert E. Litan Carl J. Schramm Copyright © 2012 by Robert E. Litan and Carl J. Schramm. Excerpted by permission of Yale UNIVERSITY PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents


1 Toward Better Capitalism....................1
2 Toward a New Understanding of the Economy: An Entrepreneurial Synthesis....................35
3 Toward a More Entrepreneurial Economy....................56
4 Unleashing America's Academic Entrepreneurs....................85
5 Importing Entrepreneurs....................108
6 Improving Entrepreneurial Finance....................124
7 Toward Sustainable Growth....................149
8 Averting Future Economic Crises....................171
9 Entrepreneurship and the Opportunity Society....................201
10 Conclusion: The Political Economy of Growth....................227
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