Cutthroat vs. Cuddly Capitalism

From Lane Kenworthy:

Daron Acemoglu, James Robinson, and Thierry Verdier have a new paper that asks “Can’t We All Be More Like Scandinavians?” Their answer is no. The answer follows from a model they develop in which

  1. Countries choose between two types of capitalism. “Cutthroat” capitalism provides large financial rewards to successful entrepreneurship. This yields high income inequality, but it stimulates lots of entrepreneurial effort and hence is conducive to innovation. “Cuddly” capitalism features less financial payoff to entrepreneurs and more generous cushions against risk. This yields modest income inequality but less innovation.
  2. Because of the difference in innovation, economic growth initially is faster in cutthroat-capitalism nations. But technological advance spills over from cutthroat nations to cuddly ones, so growth rates then equalize. Over the long run, GDP per capita is higher in cutthroat-capitalism nations (due to the initial burst) while economic growth rates are similar across the two types.
  3. Average well-being may be higher in cuddly countries because the more egalitarian distribution of economic output more than compensates for the lower level of output.
  4. Nevertheless, it would be bad for all countries if cutthroat-capitalism nations switched to cuddly capitalism. That would reduce innovation in the (formerly) cutthroat nations, which would reduce economic growth in all nations.
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  • Sher

    Hmm, when I think of Sweden,I think of innovation…IKEA, H&M, to just name a couple

  • I prefer crony capitalism. Solyndra.

  • Jacob the Wrestler

    The profits from innovation may be high in Somalia but I see no rush to move there. I am about ready to move from this country due to the high levels of corporate throat-cutting. When profit becomes society’s ultimate measure of goodness (as in the current attacks on the post office), goodness will not result.

    And as someone who has done his fair share of innovation and entrepreneurialism, profit was not my goal. It’s similar to music: if you go into it strictly for profit, you’re much more likely to fail than if you have a passion, a drive, a will that goes beyond mere dollars.

    I really don’t like doing business with someone who is only in it for the money; suppose taking advantage of me becomes the most profitable choice for that business? On the other hand, I have a conservative uncle who firmly believes that greed is the most powerful human emotion and has no problem with it.

  • Klasie Kraalogies

    Completely wrong. Why is it that folks on this continent rarely look at Ordoliberalism, the economic model of post-war Germany, which encouraged both growth and innovation, but not at the cost of human decency??

    The economics of Roepke, Bohm and others are not only more realistic than Keynesianism, but also more moral and responsible than the Austrian School, especially in the more extreme form that many read those fellows today.

    An overview of Ordoliberal Economics:

  • phil_style

    “Cuddly” capitalism features less financial payoff to entrepreneurs and more generous cushions against risk. This yields modest income inequality but less innovation

    – not necessarily..
    The cushion against risk (i.e. against failure) allows people without large personal asset backing to actually take the risk in the first place.

    Given that start-up funding is, in many cases, provided by family and social networks (and is not a completely rational decision made by a central funding agency or banks); a “cuddly” environment enables a greater number of “entrepreneurs” to take the start up risk. In a “cut throat” environment success might produce higher individual return for the entrepreneur, thus making the securing of bank loans more easy, but running an economy on the cut-throat model assumes that all investment into start-ups is detached (i.e. not provided within the social network) from the entrepreneur.

    The question is, which is better overall for the economy?

  • NateW

    Even as I type this on my 32GB iPad with wifi and 4G capability I can’t help but wonder if “innovation” should really be the benchmark for societal health. I often long for the simplicity and intimate community relationships within less “innovative” societies.

  • Patrick

    I think their conclusions are valid. Although we’re hardly “cut throat”. We’re far from that. Otherwise we wouldn’t have our state picking and choosing corporations for subsidy, we wouldn’t have such deficits due to various social spending obligations, etc.

    We were cut throat I’d say before the modern era. Now closer to the El Duce model now.

    As goofy as he looks to us now, his economic views are what we use( we and every state on earth except outright socialist and Marxist states). El Duce preceded and exceeded Keynes a lot in how to utilize the state in private economics to enhance the state w/o confiscating private wealth i.e. Lenin. Corporatism is the name for it today, back then it was called fascism as it did not have the political overtones that word does now.

  • Marshall

    GDP per capita is a valid measure of average well-being??? I don’t think so. And I don’t believe that a high level of innovation is an unqualified good for society, either.

  • Tom F.

    I can believe that there are trade-offs inherent in each system. And I can believe that one trade-off is between income inequality and innovation .

    I am not concerned about income inequality itself. So in that trade-off, give me the high inequality and the high innovation.

    What I don’t understand is why a social safety net is understood to reduce innovation, or why a social safety net is assumed to be equated with less income inequality. (If the authors include safety nets in “cutthroat” capitalism, than why is it so “cutthroat”? “Cutthroat” implies that the winners win at the grave expense of the losers.) The goal of a social safety net, in my opinion, is not to reduce inequality. It is to protect people from economic devastation. Yes, a “greater gap between successful and unsuccessful entrepreneurs” does seem likely to spur innovation. But is the threat of economic ruin crucial to spurring that innovation? Why? In situations where complete economic ruin is a possibility, one would think that this would make people more cautious about risky investment and entrepreneurship, not less.

    Consider the case of the expansion of a family owned business. This often requires loans, perhaps borrowing against the value of a home or against the current worth of the business. Now, if a person knows that they will be literally out-on-the-street if the expansion fails, it would seem that they would be less likely to take that sort of risk.

    Now, others might rightly point out that all taxes must be higher to provide for this safety net, and so the rewards for the person successfully expanding this business are likely to be less. But all this means is that there has to be a trade-off between maximizing the reward to the successful entrepreneur and minimizing the personal risk to them.

    The key point is that there is no easy way to find out what the exact right mix is of keeping taxes low and keeping risk low. I think there is a buried premise in the argument, that “cushy” capitalism can only be bad for innovation, which is something that seems unproven, given that the social safety net may have some positive effect on risk-taking, by lessening the risk to the individual’s basic economic security.

    On the other hand, European social safety nets do seem to want to prevent people from falling below lower middle class, and American safety nets are more focused on preventing the poor from becoming completely destitute. If we are simply comparing these two different forms of safety nets, than perhaps I can agree with the author’s arguments to a greater degree. You would definitely get less risk-taking “bang-for-your-buck” setting the economic “floor” at European levels rather than at American levels.

    But in the light of the current political conversation in the US, where even minimal safety net sort of things like food stamps are being questioned, its hard not to read an article about “cutthroat” capitalism and wonder if they don’t mean a kind of capitalism where these sort of basic safety net items are up for grabs.

  • phil_style

    @Tom F “And I can believe that one trade-off is between income inequality and innovation”

    You’re right. The trade-offs are invented.
    People innovate for reasons more than simply long-term financial payout.
    It’s madness to ninth that an innovator is able to calculate so perfectly the likely return on their work over a long period AND would come to the conclusion that the tax burden on their profits would render the work less profitable than not innovating AND that this person would be simplemindedly innovating on a coast-benefit basis.

    The assumptions made about human behavior in the formulation of this supposed trade-of are borderline ridiculous.

  • Tom F.

    I mean, I always like when people agree with me, but I think we might actually disagree. 🙂

    I said I do think that there could be a trade-off between inequality and innovation. I don’t think there is a trade-off between social safety nets and innovation, at least not an uncomplicated one.

    It does seem that throughout history, the most innovative peoples have had considerable income disparity. And the most equitable countries have zeroed out their innovation.

    But even if we disagree on this particular point, it sounds as though we might end up in the same place, which is to question this article’s assumptions about human behavior.

  • “Cuddly” capitalism features less financial payoff to entrepreneurs and more generous cushions against risk.

    phil_style hit on one of the problems with this assumption. IF all things were equal, and every entrepreneur had equal access to investment capital, then this might hold truer. As it is, however, the picture becomes seriously muddled in a capitalistic country such as ours, with problematic lack of regulation in the financial markets. The entrepreneurs who become funded are those who have more connections and money to begin with, generally speaking, or if they don’t, they have a spit-in-your-face determination against all odds (and few of us have that over lengthy periods of time). If their innovation garners enough attention with success, over time, to mitigate the lack of connections, they may have a better opportunity, but that doesn’t mean that a shark won’t still try to take their hard work and shaft the entrepreneur.

    phil and Tom F’s interactions also point to the paucity of the rationale that innovators and entrepreneurs do so strictly for profit motives. I think we have the apostle Paul’s “compulsion” to proclaim the gospel as a counter-example! 😉

    Also, Marshall hits on a very real problem w/ this sort of economic analysis. An assumption that GDP (or GNP) per capita are valid measures of “average well-being” is ridiculous. My cousin explains why in this article, and he wrote basically so that his points would be understood by non-economists. I have the charts which were omitted from the piece, if anyone is interested enough. ( )

    Then, there are our government’s failures to regulate derivatives markets well (cf., the money poured into Congressional campaigns by financial market insiders) These markets have become the means for insiders to shirk risk onto the vulnerable, the ignorant, and smaller investors. So, the way in which our financial markets distort the outcome can be explained thus:
    * an entrepreneur with a really lousy idea gets really good funding
    * because
    * (his/her pals) the investors are able to fund the lousy idea, even if they KNOW it’s a lousy idea, and then shift the risk from their investment onto others via an arcane financial instrument that isn’t well-understood by the new holder of the risk
    * and thus both the entrepreneur may skate well on his lousy idea for long enough to come up w/ the next lousy idea, and the investors gain by having palmed off the risk, and the creator(s) of the derivative gain by the fees associated w/ its creation.
    * the loser is the poor sod (or municipality, or pension fund, or country…) who bought the risk.

    The “speculative” (NB the authors’ choice of word!!) econometric model tried to account for risk, via the “moral hazard” on the part of the entrepreneurs, but failed – AFAICS, at my first glance over the paper – to account for shifting the hazard away from the entrepreneurs & venture capital funders via financial markets. For those who aren’t familiar w/ these mechanisms, we can consider how the winners in the economic downturn continued winning in the markets’ fall, while the mortgagees, CDS holders and the taxpayers were big, big losers. The bubble and Enron in the early 2000’s were smaller examples.

    Even for non-economists, it’s easy to spot the preceding bias in the word choices of the authors.

  • Lane Kenworthy’s assumptions in this sentence are staggeringly flawed & obtuse, btw: An indicator of financial incentives for entrepreneurs is the top 1%’s share of household income. An indicator of the extent of cushions against risk is government expenditures’ share of GDP.

  • DRT

    I feel it is useful for people to have a good idea of what the term “risk” really means. When you get right down to it, risk is variability. In the world of financial investments a risky asset can go way up or way down. In the world of motorcycle riders Evel Knievel generally experiences higher variability when he rides than most people.

    Add to that the concept that reducing variability has a cost associated with it, then we have a situation where the trade off is usually a cost benefit analysis of risk and variability.

    Also recognize that variability has both a downside and upside component to it. People who have money, or have nothing to lose, mitigate the downside risk by their situation. So they are likely more inclined to take risk.

    But most don’t have that luxury, they are somewhere in the middle where they would be willing to have decreased variability (also expressed as uncertainty) on both extremes.

    Further add, that genius is not only given to those with natural downside risk buffers, and it seems obvious to me that there is much bigger potential for a group of people to encourage innovation (and I include things like art, simplicity, and not just advancements in technology here) if risk was buffered.