Identity crisis for American capitalism

Steven Pearlstein
Columnist May 26, 2012

Beneath all the folderol about job creation and destruction at Bain Capital or President Obama’s alleged war against success and free enterprise, there’s actually a legitimate debate to be had about what kind of capitalism we want in the United States.

It turns out that capitalism, like ice cream, comes in many flavors. These different capitalisms can be combined, in the same way chocolate and coffee produce mocha. There are also all sorts of mix-ins and swirls that add to the variety. And while there is a natural instinct to arrange these different forms of capitalism along a left-right axis, that is hardly the most interesting way to think about them.

Steven Pearlstein is a business and economics columnist who writes about local, national and international topics. View Archive

The first kind of modern capitalism was of the robber baron variety. As the name suggests, this was a period when the economy fell increasingly under the control of a handful of clever entrepreneurs and financiers who ruthlessly used their economic power to enhance their political power, and vice versa. It was an era generally characterized by rapid technological progress, big booms and big busts with widening disparities in income and wealth.

Following the Great Depression, robber baron capitalism gave way to a golden era of “corporate” or “managerial” capitalism, during which growth and innovation were driven by large national and international firms run by trained executives. Competition tended to be gentlemanly and the power of big business was held in check by the federal government (big government) and unions (big labor). Business cycles tended to be relatively tame, and the gap between rich and poor shrank as more Americans joined the middle class. It all seemed to work pretty well until government and labor unions began to squeeze the competitive vitality out of the U.S. economy.

Outside the United States, most other countries had long since embraced some form of “state capitalism,” in which government played an even bigger role, not just as regulator but in many instances as owner of major corporations, many of which were government monopolies. State capitalism worked particularly well for countries recovering from the destruction of World War II, or those like Japan and Korea making the transition from developing economies to developed. But by the 1990s, state capitalism had often given way to crony capitalism — and over-regulated labor and product and financial markets became barriers to innovation and productivity growth.

Back in the United States, state capitalism never really caught on, but there were three new models vying to replace the old corporate capitalism.

“Entrepreneurial capitalism” took seed along Boston’s Route 128, in Silicon Valley outside of San Francisco and before long in places like Seattle, Austin, Boulder and North Carolina’s Research Triangle. While drawing its inspiration from tech companies started in garages by young geeks, entrepreneurial capitalism soon become much more than that. In industry after industry — airlines, package delivery, long distance telephones, restaurants, grocery stores, for-profit education, pharmaceuticals — upstart companies used new products and new business models to upend long-established corporate incumbents.

The mythology surrounding entrepreneurial capitalism is that it creates great wealth for risk-taking entrepreneurs, great numbers of new jobs and great numbers of new products that dramatically enhance the quality of life and the productivity of the rest of the economy. But as the economist Joseph Schumpeter understood, there is an irreducible amount of destruction that comes along with all that creativity—destruction of existing companies, jobs, wealth and in a few instances, communities. While Americans admire and celebrate entrepreneurial success, we tend to forget and ignore the losers from this dynamic process.

Although today it sounds rather quaint, “worker capitalism” was something of a fad in the 1980s. In its purest form, worker capitalism meant employee-owned firms that were either bought from a retiring entrepreneur or brought out of bankruptcy by workers looking to save their jobs. The same spirit, however, was taken up by an even larger number of public and private companies whose executives subscribed to enlightened management strategies such as profit-sharing, employee empowerment, high performance work teams, open-book management, continuous process improvement. Whatever the name, all involved pushing responsibility and accountability to front line workers, on the theory that it was their hard work, commitment and ingenuity that made for successful companies.

Coming from the opposite direction, however, was “shareholder capitalism,” which was based on the theory that workers were largely interchangeable and expendable and that companies should be managed solely to maximize short-term profits and share prices for owners and investors. In many ways, shareholder capitalism was an effort to overcome the self-interested complacency of managerial capitalism that, in the view of many, had allowed the American economy to fall behind Germany, Japan and the other Asian “tigers.”

The driving force behind shareholder capitalism came not from Wall Street’s traditional investors but from upstart financiers known as “corporate raiders” who were the first to use a new financing mechanism, the “junk bond,” to launch hostile takeovers of under-performing public companies.

Although corporate executives decried the trend, the threat of having their companies bought out from under them led to a fundamental shift in corporate management in which the interests of customers and employees have been subordinated to the interests of shareholders. To reinforce this new orientation, top executives were loaded up with stock and stock options that would better align their own economic fortunes with those of other shareholders.

From there, it was only a short hop and a skip to capitalism’s newest incarnation, “financial capitalism,” where the focus has shifted from running companies to simply buying and selling them for profit. More and more of the country’s capital and talent was diverted toward trading and financial engineering, with more and more of the economy’s profits and the nation’s income captured by a relatively small number of investment bankers and the managers of hedge funds and private-equity funds.

What should be obvious from all this is that our notions about American capitalism – what it is and what it ought to be—are constantly changing.

Given that he made his fortune in private equity, it is not surprising that what Mitt Romney now offers the country is a mix of shareholder and financial capitalism. Romney rejects the managerial capitalism of his auto executive father, considers all forms of state capitalism to be illegitimate and dismisses worker capitalism as naïve and unsustainable. And while he is not the robber baron capitalist the Obama campaign would have you believe, neither is he the entrepreneurial capitalist he pretends to be. For Romney, it is not the desire to create great products or enduring employment that really animates the entrepreneurial spirit, but the prospect of making a big score by going public or selling out to Bain Capital. In Romney capitalism, it is the financier who ultimately makes the successful entrepreneur, not the other way around.

Obama, too, would like to wrap himself in the flag of entrepreneurial capitalism, but not in the dislocation it sometimes causes or the “anything goes” regulatory and tax regime that entrepreneurs crave. Ultimately, the president is drawn to the equality and stability of managerial capitalism, perhaps with a swirl of worker capitalism and the occasional sprinkle of state capitalism mixed in. He views shareholder capitalism as morally cramped and financial capitalism as both economically and socially destructive.

We would all surely welcome an intelligent presidential debate on what kind of capitalism we want to have. Only please spare us the self-serving nonsense about who created or destroyed how many jobs. In almost any form of capitalism, running the government is not the same as running the economy, and neither is like running Bain Capital.

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