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«A Conversation with Will Baumol on Capitalism, Innovation and Growth Antonio Guarino1 and Maurizio Iacopetta2 1. Introduction William J. Baumol has ...»

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A Conversation with Will Baumol on

Capitalism, Innovation and Growth

Antonio Guarino1 and Maurizio Iacopetta2

1. Introduction

William J. Baumol has been one of the most influential economists in the last fifty

years. Pioneering work in the theory of money, foremost research in the theory of

competition, industrial organization and technological change, notable analyses in the

theory of externalities and environment, influential research in the theory of productivity

and growth are, perhaps, his best known contributions.

In his most recent book, “The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism,” Baumol reconsiders his analysis of industrial organization and technological change and makes one point: “Whatever the deficiencies of the free-market, it is certainly very good at one thing: the manufacture of economic growth.” Baumol attributes the unprecedented and unparalleled growth performance of capitalist economies to their ability to create and diffuse innovations and apply them to different purposes. The entire book is devoted to explain this ability, to capture the different mechanisms that make capitalism such a unique innovation and growth machine. In other words, for Baumol is not static efficiency what makes a big difference between capitalism and communism or capitalism and medieval societies: the great disparity is in dynamic efficiency, i.e., in the pace of technological change useful for industrial purposes. In this view, the fact that many actual capitalist economies are far from the model of perfect competition, for instance because of oligopolistic power or technological externalities (spillovers), is not necessarily negative for welfare. On the contrary, Baumol shows that oligopolistic rivalry and spillovers have substantial positive effects on the rate of innovation and growth.

On a methodological ground, the book is an invitation to economists to devote more effort to discuss the process of innovation and growth. The theory of value- Baumol argues - is by now well established and it is time to think more deeply about dynamic issues. For this purpose, in many points of the book Baumol goes back to the analysis of classical economists, Say, Marx and Schumpeter, the scholars who chose innovation and growth as the main topic of their research activity.

On August 8th, 2002 we have interviewed Baumol in his office in the Department of Economics at New York University. The interview lasted about one hour and a half.

We started our interview by discussing his new book and then moved to different topics, such as globalization, labor market, growth in underdeveloped countries, environment, education and heath systems, financial markets, history of economic thought and

methodology in economics. We have classified our questions in four groups:

1) Capitalism and innovation;

2) Economic growth;

–  –  –

3) Free market and government intervention;

4) Economic theory.

The tape of the entire interview is available from the authors on request.

2. The interview

2.1 On Capitalism and Innovation Guarino: I will start by asking you some questions about your new book, “The FreeMarket Innovation Machine: Analyzing the Growth Miracle of Capitalism.” In your book you refer to capitalism as the system that promotes innovation and growth most effectively. Which system in particular do you have in mind when you talk about “capitalism?” Can you say anything about the differences between the Anglo-Saxon system and, for example, the German or the Scandinavian? Which form of capitalist system is able to produce more innovation and growth?

Baumol: First, let me emphasize that in the book I am not arguing that capitalism is an ideal system in any sense. I am well aware of all the very serious problems, such as inequality, unemployment, environmental damage, that beset capitalist societies. My thesis is that capitalism is a special mechanism that is uniquely effective in accomplishing one thing: creating innovations, applying those innovations and using them to stimulate growth. The answer to your question is that there is not one mechanism that always best in all circumstances. There are historical and cultural differences that led to different forms of capitalism. The main point is that slightly different forms of capitalism will work equally well in different situations. So I am not suggesting that there is one rigid form that works best. Apparently, however -and this is not a result of my own research- the Common Law system is more effective in stimulating growth than the legal system based on the Code Napoleon, presumably because the Common Law is more effective in guaranteeing contracts and in providing a variety of legal protections that make it easier for entrepreneurs to gather and keep the fruits of what they have produced.

And a basic requirement of an effective capitalist economy is that the entrepreneurs can choose -with minimum interference from the State- how much they want to invest, which products they want to produce, and so on. And they have protection of their intellectual property both from other entrepreneurs and from government intervention or confiscation.

Iacopetta: According to a simple calculation that you suggest in the book, in the capitalist system the magnitude of spillovers is surprisingly high. Do you think that capitalist economies differ very much with respect to spillovers?

–  –  –

Japanese business innovators have taken steps themselves to obtain compensation for the spillover benefits, still imperfectly but to a greater degree than is done here. They are much more likely, for example to enter into technology trading agreements. They do it more quickly in Japan than they do it here in the US. The result is that in Japan obsolete products and processes disappear more quickly and, at the same time, the innovators are compensated because the agreements provide for compensation terms. Having said this, there still remain large spillovers for which innovators are not compensated. There is no question in my mind that if you could reduce those spillovers you would have more investment in innovations, but you would increase inequality in income and wealth. I am by no means convinced that it would be a good thing.

Guarino: What are the policy implications of your analysis of innovation? In other words, what can a government do to improve the free market’s management of innovations?

Baumol: The answer is that, to me, the implications for a bunch of advanced industrial countries (England, US, France, Italy, etc.) are not terribly significant because they are doing roughly the “right thing” from the point of view of creating innovations and stimulating growth. Governments should and do some things such as helping to finance basic research, whose returns are too uncertain to be attractive to private enterprise. The important lessons, however, are for places like South America and Africa. Not only are they failing to converge to the wealthiest countries, they are falling further and further behind. And I think the main lessons of the book are that the sorts of interference that governments have attempted in South America and in various African countries that seem to make sense are in fact the surest way to prevent innovation, growth and increase in per capita income. For me the extreme example is India, where, with the best of intentions, all sorts of inhibiting government intervention used to occur. An example is the severe restriction of computer usage in the insurance industry in order to preserve the jobs of clerks. You can understand why it was done. But the result was that India, that started up with a per capita income very similar to that of Taiwan in about 1950, fell further and further behind. Incidentally, what this implies for a country such as Italy is that restrictions on job mobility, restrictions that prevent employers from eliminating unneeded jobs - and one can understand why it is done, and one can sympathize with it in the long run are going to make life harder for the families of the very same people whose jobs are protected.

Guarino: Let me turn to a methodological problem. At the center of Economics textbooks there is the theory of value. I understand that you think that we should rewrite economic theory putting, innovation and not price at the center of our analysis. Some other economists who share your view on the importance of innovation have tried a different approach to Economics. You refrain from that. Why?

–  –  –

don’t you abandon neoclassical theory altogether?” The answer is that I think neoclassical theory is also very good, and very productive. In fact, I want both neoclassical and evolutionary theories. Neither of them is perfect. So even if we do more of one, we should be happy to keep the other. Moreover, a nice feature of my position on the desirability of greater emphasis on the role of innovation in our theory is that we can use neoclassical methods to go forward with innovation theory. I don’t think we need to invent a whole brand new set of methods. I do not think we need to leave the neoclassical analytical approach. What I am saying is that the topic needs to be added, not as a replacement but an addition.

Guarino: In several points in your book you quote Marx and Schumpeter. Many people, however, would consider your main thesis an apology of capitalism. I don’t consider it so but, still, don’t you think there is a bit of contradiction in this? It looks like your interpretation of Marx and Schumpeter is quite different from the traditional one.

Baumol: My comment is that actually Marx believed that capitalism from the point of view of innovation is a really extraordinary, effective instrument. What he believed is that eventually capitalism would have done its job and that at that point it would have to be replaced. But it does not mean that he would have disagreed with my conclusion about the effectiveness of capitalism as an innovation machine. As a matter of fact, he says that over and over again. He asserts, for example that relative to a feudal economy from the point of view of production growth there is just no comparison, as capitalism is so vastly superior a type of economy. His objections to capitalism are many. I also say that there are many criticisms that you can make of capitalism. But Marx, too, emphasized that it is a marvelously effective growth machine. Schumpeter, too, took this Marxian point of view saying that though capitalism has been a good growth machine, it was approaching the end of its life cycle. The evidence is that he was a little too early in offering his obituary of capitalism. But I do not see any fundamental difference between his idea of capitalism as an innovation machine and mine.

Guarino: But Schumpeter claimed that once R&D would have been routinized, capitalism would have declined.

Baumol: You are absolutely right. There, our views certainly differ. And yet there is a passage of Schumpeter that I quote where he says that the difference between price competition and innovation competition is the difference between a gentle push and breaking down of the door, which is essentially what I am saying.

Guarino: Maybe you are closer to the young Schumpeter of 1911… Baumol: Even a piece of “Capitalism, Socialism and Democracy” is close to my view. It is not clear what comes out of that last book.

–  –  –

sometimes impeded on the ground that they can hurt competition. How can we distinguish between “good” and “bad” cooperation among high-tech firms?

Baumol: It is an important question, but not one that I can answer in few minutes. It is a subject that I am working on at the moment. But let me offer an answer, which is excessively simple, to give you some ideas of how I am approaching the problem.

Cooperation on technology is fine as long as three things happen: first, there is no discussion of prices among the cooperating firms; second, there is no agreement on the amount to be spent on R&D; and third, if the firms license the innovation, the licenses should be made available to everybody on similar financial terms. I think if you have those three conditions, though you can still not be sure that no problems will arise, you can be reasonably confident that an innovation sharing consortium will promote competition rather than harming it.

Iacopetta: Some commentators argue that in high technology industries there should be no worry about market dominance since dominant positions do not last long. Therefore, the antitrust authorities should just leave the market work. What do you think?

Baumol: I think that there is some substance to that, and yet you have to keep your eyes open. Just to offer a caricature of the remaining perils to competition: suppose that Bill Gates were to hire a small army with machine guns to shoot anybody with labs working on software. That would be a way to preserve his dominance for a long time and antitrust authorities should surely do something about it! It’s true, in these markets, as long as there is no action of the dominant firm that prevents other firms from innovating, I would not worry about dominance. But there is still another issue and that is that in many of the high technology industries what is important for your success is having a lot of people using your innovative product – many people use Windows or Word because that enables them to communicate with many others who use the same software. And this means that entry becomes very difficult because the entrant has to be able to catch a large share of the market almost instantly, so even an entrant with a better product would not be able to get very far against a firm that already has many customers. There are many historical examples where this has happened. The ultimate answer is yes, there is some substance to the argument that in innovative fields dominance does not usually last too long, but that does not mean that we should ignore the possibility of problems or fail to constrain steps taken by a dominant firm to preserve its dominance by preventing innovative activity by others that threatens its future.

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