Edmund Phelps's "Mass Flourishing" could easily be retitled "Contra-Corporatism," for at its heart this fine book is an attack on that increasingly common "third way" between capitalism and socialism. Mr. Phelps cogently argues that America's current economic woes reflect a reduction in the innovative dynamism that generates economic success and personal satisfaction. He places little hope in the Democratic Party, which "voices a new corporatism well beyond Franklin Roosevelt's New Deal or Lyndon Johnson's Great Society," or in Republicans in the thrall of "traditional values," who see "the good economy as mercantile capitalism plus social protection and social insurance." He instead yearns for legislative solons who "could usefully ask of every bill and regulatory directive: How would it impact the dynamism of our economy?"
Mass Flourishing

By Edmund Phelps
Princeton, 378 pages, $29.95



Enlarge Image


Edmund Phelps, winner of the 2006 Nobel Prize for economics.




The first third of Mr. Phelps's book concerns the advent of modern capitalism—the rise of an economy that depends not upon the solid, easily understandable ground of natural resources but upon the constant convulsions of knowledge breakthroughs. The Industrial Revolution is the watershed event, when "for the first time in history," as the economist Robert Lucas put it, "the living standards of the masses of ordinary people have begun to undergo sustained growth." Mr. Phelps distinguishes this "modern capitalism" from pre-1800 "mercantile capitalism," in which merchants completed aggressively but industrial activity was limited and output per worker stagnated.
The author ably summarizes the long literature debating why the modern dynamic economy began where and when it did (England, around 1800). He sees some truth in a traditional view, associated with Walt Rostow, that emphasizes economic conditions: There needed to be sufficient agricultural prosperity to allow savings, as well as sufficient population density, transportation linkages and trade to provide the markets that justify large-scale production. But Mr. Phelps is also an institutionalist, arguing along the lines of Douglass North that economic freedoms enabled innovation. He emphasizes both the protection of businesses from expropriation—"the legal right to accumulate the income earned from a new successful product"—and the freedom of consumers "to adopt a novel product, to judge whether it best meets a need, and to learn how to use it."
The book eloquently discusses the culture of innovation, which can refer to both an entrepreneurial mind-set and the cultural achievements during an age of change. He sees modern capitalism as profoundly humanist, imbued with "a spirit that views the prospect of unanticipated consequences that may come with voyaging into the unknown as a valued part of experience and not a drawback." The dismal science becomes a little brighter when Mr. Phelps draws the connections between the economic ferment of the industrial age and the art of Beethoven, Verdi and Rodin.
The middle third of "Mass Flourishing" discusses the enemies of the modern economy: socialism and corporatism. Despite the extraordinary successes of the 19th century, the imperfections of the industrial age led many to dream of alternatives that might deliver a fairer and more efficient society. One strand of thinking led toward socialism and direct public control of the means of production. A second strand led toward corporatism, a hybrid approach that combines private ownership with heavy labor representation and some management by the public sector.
Even if the critics of free capitalism are right that markets are imperfect and that economic freedom doesn't guarantee equality, any interventionist alternative must weigh the failures of the market against the failures of the public sector. Mr. Phelps is right that, even if public management of coal mines and railroads were able to rival the private sector in short-run efficiency, "a socialist economy could not realize its potential for innovation," since entrepreneurs, financiers and inventors would not be free to compete and succeed with new ideas. The demise of the Soviet Union discredited the socialist chimera in much of the Western world. But the threat of corporatism continues, and Mr. Phelps's case against it is what makes his book so valuable.
In Mr. Phelps's telling, corporatism emerged in Mussolini's Italy in 1925, as a middle path between free-market capitalism and socialism. The corporatist approach was that government-sponsored unions would negotiate with a federation of Italy's companies, all under the watchful eye of the state. Full employment could be maintained by fiat and the mess of a market economy replaced by well-choreographed negotiation. Corporatism particularly appealed to militaristic regimes that dreaded disorder: Hitler was a corporatist; so were Franco and Salazar. Corporatism came to France when "German soldiers marched into Paris in 1940."
America's most obvious peacetime foray into corporatism came during the Great Depression, with the National Recovery Administration, whose administrator, retired Gen. Hugh Johnson, tried to set prices, mandate minimum wages and maximum workweeks and save America from "the murderous doctrine of savage and wolfish competition and rugged individualism." From their graves, America's Founders reached out and saved the country from this enormous overreach of executive authority when the Supreme Court unanimously invalidated the NRA's mandatory codes.
While the obvious corporatism of the NRA's Blue Eagle vanished, Mr. Phelps persuasively argues that "a new kind of corporatism has developed in recent decades," in which "the state is less a guide choosing the heading than a pilot paid by the passengers to take them where they ask." In this new corporatism, the state protects both organized labor and politically connected companies. and the state has acquired a "panoply of new roles," from regulations "aimed at shielding companies or workforces from competition" to lawsuits that "add to the diversion of income from earners to those receiving compensation or indemnification." It is as if "every person in a society is a signatory to an implicit contract" in which "no person may be harmed by others without receiving compensation." But protection against all conceivable harm also means protection against almost all change—and this is the death knell of dynamism and innovation.
The final third of Mr. Phelps's book concerns the America's long-run deterioration in productivity growth, job creation and business births. The author blames a cast of villains—corporate chieftains who emphasize only the short run, mutual funds that acquire too little specialized knowledge about individual corporations and a "congressional-banking complex." He takes aim at both greed—because "wealth seeking competes with innovation seeking"—and well-meaning policies that have "encroached on dynamism" by putting "pressure on companies to allow employees to work at home." One doesn't need to agree with all of Mr. Phelps's arguments to enjoy his idiosyncratically insightful take on American society and cheer his full-throated argument that the enemies of innovation hurt not only economic growth but also the great human joy that comes from creativity.
But what is to be done? The author wants governments that are "aware of the importance of the role played by dynamism in a modern-capitalist economy," and he disparages both current political camps. He has a number of thoughtful ideas about financial-sector reform. He is no libertarian and even proposes a "national bank specializing in extending credit or equity capital to start-up firms"—not my favorite idea.
My largest quibble with "Mass Flourishing" is its lack of emphasis on human capital—the role of education and the gradual accumulation of skills. One could argue that good institutions, and even democracy itself, rest on the bedrock of education. Education is crucial for widespread innovation, especially in a world that is far more technologically complex than 18th-century England. If we would follow Mr. Phelps's instructions to embrace an innovation agenda, we must reduce our government's tendency to over-regulate change and increase public support for educational reform. Ultimately, innovation is about empowering smart people and then getting out of their way.
—Mr. Glaeser is an economics professor at Harvard University and a senior fellow at the Manhattan Institute.