Faster and Fairer

The American Dream vs. the Gospel of Wealth: The Fight for a Productive Middle-Class Economy by Norton Garfinkle (Yale University Press, 230 pages, $22.00) Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity by William J. Baumol, Robert E. Litan, and Carl J. Schramm (Yale University Press, 321 pages, $30.00)

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As the Bush administration implodes, the chances that a Democrat will be the next occupant of the White House are looking better every day. But what difference would that make to the economic well-being of most Americans? What economic policies would a new administration be likely to follow? More to the point, what are the chances that a change at the political helm would provide any new vision or coherent new direction for the economy?

No one can honestly answer these questions yet, but two new books offer some thoughtful insights on what would enable the American economy to grow faster and fairer. Their authors are economists, open to evidence rather than wedded to dogma, and they share many fundamental prescriptions, if somewhat different priorities.

The more slender, and avowedly partisan, volume is Norton Garfinkle's The American Dream vs. the Gospel of Wealth. The book is part of a series on the "Future of American Democracy," which under Garfinkle's editorship is examining the challenges facing the American political system today. A major concern addressed in the series is that democracy cannot survive without keeping alive the promise of economic opportunity for everyone. If the mass of average Americans come to believe that the system is rigged against them, or that the odds of attaining the dream of a decent standard of living are hopeless, their allegiance to liberty and constitutional government will inevitably unravel.

Garfinkle's principal contribution here is his spirited demolition of the fairy tale of supply-side economics. Whether promulgated by Ronald Reagan, Newt Gingrich, or George W. Bush, the theory that wealth accumulated by the rich automatically trickles down to the benefit of all is so much snake oil (or "voodoo economics," as our current leader's father so trenchantly put it). According to Garfinkle, the modern debate between supply-side and demand-side economists is the contemporary version of the dispute between the Gospel of Wealth of the Gilded Age and the promise of the American dream as Lincoln and the two Roosevelts saw it. For example, in response to a sagging economy, the tax cuts advocated by the two sides are diametrically opposed: The right claims that tax cuts for the wealthy stimulate greater business investment, thus producing increased employment and growth, while liberals and progressives argue that by putting money directly into the hands of the majority of consumers, tax cuts for middle- and low-income earners will do more to stimulate production, job growth, and investment.

Fortunately, these are propositions that can be empirically tested. Looking at the period from 1951 to 2004, Garfinkle finds that of the 18 years with the lowest top marginal tax rate, only seven were also among the 18 years with the highest real growth of business investment. Moreover, six of those seven high-growth years occurred from 1994 to 1999, immediately after the Clinton administration increased the top marginal tax rate. In contrast, growth in business investment was typically in the low to middle range in the years of the supply-side tax cuts. Garfinkle finds no correlation between low marginal tax rates and employment or real gains in the gross domestic product.

What he does find is historical evidence favoring the core assumption of the demand-side model: "High real growth in consumption is strongly associated with high performance of the most important economic growth variables" -- that is, business investment, employment, and an increase in real GDP.

Although Garfinkle makes a strong case for the productive role of government, he doesn't address many other key determinants of growth. This is the strength of Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity, the work of three leading mainstream economists. Shifting the focus to economic structures, William J. Baumol, Robert E. Litan, and Carl J. Schramm offer a wide-ranging analysis of the effects of different institutions and cultural patterns. They point out that there is no such thing as "capitalism" pure and simple, a clearly defined and manifestly superior economic system. No one knows for sure what explains the great difference in growth among nations, the authors argue, and it is time for some fresh thinking on the subject. The so-called Washington Consensus of the 1990s, which led American policy-makers to instruct other nations on the right economic policies, has evaporated.

In their own effort, the authors describe four different forms of capitalism, variously leading to stagnation and prosperity. The two bad forms are state-guided and oligarchic capitalism. Under the state-guided systems prevalent in many countries of Southeast Asia, governments try to guide the market and steer funds into favored sectors. Under oligarchic capitalism -- common in much of Latin America, the former Soviet Union, Africa, and most of the Arab world -- the bulk of wealth and power belongs to a narrow elite, and the main function of economic policy is patronage rather than growth.

Good capitalism, as Baumol and his colleagues have it, also comes in two forms: "big-firm capitalism," found in Continental Europe, Japan, South Korea, and pockets of the U.S. economy, and entrepreneurial capitalism, found in the Anglo-American world, where large numbers of independent economic actors have an incentive to innovate in a dynamic, unplanned fashion. The ideal system, in the authors' view, contains a mix of entrepreneurial enterprises and large, established firms that can turn technical innovations into reliable, user-friendly mass products -- a description that fits the United States during the prosperous, fast-growing years of the 1990s.

At bottom, according to Baumol and his colleagues, the engine of growth is innovation, and smart policy-makers will do what it takes to encourage entrepreneurs to take risks. Along with the need to make it easy to start new businesses and get out of businesses that fail (here the recent tightening of the bankruptcy laws might have negative unintended consequences), the authors argue that it is crucial to allow entrepreneurs to enjoy handsome rewards if they succeed. That imperative entails accepting some economic inequality. There is a logic to rewarding Richard Branson that doesn't apply to rewarding the CEO of, say, General Motors.

Even if fortunes are made, the lion's share of the gains of innovation still spill over to the rest of society, just as innovations in one country eventually benefit others. And to make sure that the broader public does benefit from entrepreneurial capitalism, Baumol and his co-authors advocate safety nets that shield some of the victims of disruptive change, if only to prevent a backlash against free-trade policies, direct foreign investment, and the like.

Good Capitalism, Bad Capitalism ends on a warning note that even the most successful entrepreneurial economies, such as the United States, can grow complacent and degenerate into something less attractive. The authors are big fans of the late economist Mancur Olson, who argued that especially in democratic countries, special-interest lobbies will produce "rent-seeking" policies that benefit particular groups at the expense of the general welfare. The oil, drug, and health-insurance industries immediately come to mind.

Things may even be worse than that, though. The book doesn't even mention the destructive economic effects of ideologically motivated policies, such as the ban on stem-cell research, which is driving innovation overseas. And what of the economic effects of the Iraq War and misguided antiterrorism policies, from the squandering of federal expenditures to the decline in the number of talented foreigners studying in the United States?

Both of these books are clear that wise government spending for such purposes as Social Security, health insurance, the GI Bill, education, and basic scientific research can help expand the economy. None of these economists see any empirical support for the conservative claim that less government and a lower overall tax burden (taxes as a percentage of GDP) translate into higher GDP growth. The American economy has actually grown faster in the era of "big government" than it did in earlier eras.

These economists remind us that economies that are both fast-growing and fair benefit us all. The two aims of growth and equality don't have to be in conflict, and the message for a new administration is clear: Don't ask Americans to sacrifice one for the other. A stronger safety net, public investments in programs that lead to greater productivity, and big rewards for those who contribute to growth in extraordinary ways -- these all have to be part of the mix. But the next administration will also need the guts to stand up to the special interests that are making parts of the American economy look like a kleptocracy. As Lincoln said, government should "clear the path" for the common man. A tall order, but a necessary one.

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