Bootstrap capitalism or complex reform?

A sizable segment of America, many of whom are investors, now look for guidance to Rush Limbaugh, a highly-successful broadcaster and talk show host. For Limbaugh and his followers, the way out of any financial crisis or economic problem is individualism, private ownership, free markets, and capitalism in its purest form. For them, capitalism and markets solve all problems.

One view of reform

Economist Joseph Schumpeter is someone Limbaugh and his followers probably don't know a great deal about. Like Marx, Schumpeter argued that capitalism's demise is inevitable. But unlike Marx, Schumpeter theorized that capitalism's end would stem not from revolution or even agitation, but from a peaceful, domestic majority that forms and votes for reforms. The reformers create a social safety net and social welfare state that removes capitalism's harshness -- and in the process eliminates the incentives that both drive entrepreneurship and that form the foundation for the capitalist structure. Paraphrasing T.S. Eliot, for Schumpeter, capitalism will end not with a bang but with a whimper.

For Schumpeter, the free enterprise system's ability to increase wealth, living standards, spur innovation and resourcefulness are real and noble, but they are also, unfortunately, long-term. Meanwhile, long-term benefits have little clout in a short-term world: the free enterprise system's flaws of instability, inequality, and unemployment, although short-term, Schumpeter said, are the things that citizens would focus on, and over time, they would trigger the rise of the reformers, and the end of the free enterprise system. Schumpeter also believed that advocates of democracy would slowly chip-away at the free enterprise system's anti-democratic qualities.

An alternate view of reform

Although one disagrees with Schumpeter only at one's theoretical and analytical peril, that's the view from here. But that's not due to Schumpeter's description of free enterprise, but regarding the possibilities of reform. Schumpeter said reform would not change the fate of the free enterprise system. In fact, Schumpeter sees the reforms evolving capitalism to the point where it is no longer capitalism. I disagree. The American system has shown a remarkable ability to undergo large economic, social, and political change, and still retain its free enterprise structure. History has demonstrated that there's room in the American system for a safety net – and the timetable of that net indicates it is expanding, in cycles, starting from its first, limited form, to a social safety with substantive impact today. Is the American system capable of tolerating a broad, European social welfare state? The resources are certainly there; it may take the culture and political will one or two more cycles to catch up.

But what we do know is that reforms proposed and being codified into law today, as they were in the 1890s with its anti-trust laws, and during the 1930s under FDR's New Deal, and in the 1970s with its environmental regulation, will create a more sustainable, fairer, and safer free enterprise system, while still retaining the system's many benefits.

American reform kind of cuts off Schumpeter's short-term flaws at the pass, and I believe the rise and election of President Obama and the congressional Democrats are part of this reform process. The American reforms implicitly recognize Schumpeter's critique of capitalism, then solve the puzzle in a different way, by leaving more than enough capitalism to survive and thrive. (It's kind of fitting, when you think about it, that a 'can-do, fix-it America' would think of the reforms what would perpetuate the free enterprise system where other nations have failed.) Perhaps this is just my optimism breaking through, but a strong case can be made that Obama and the Democrats, like FDR and his New Deal coalition, are the safety valve that Schumpeter did not consider, or at least that Schumpeter did not believe would maintain the system. But reform has in the past in these United States, and there's every reason to believe that it will again.

Financial Editor Joseph Lazzaro is writing a book on the U.S. presidency and the U.S. economy.

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