Good Capitalism, Bad Capitalism, and the Economic Reform Feature Service

There are roughly 26 million registered firms in the United States. Only six million of them have employees and less than 650,000 firms employ more than 20 people. A scant 18,000 firms employ more than 500 people. Small firms in the U.S. are often touted as the engine of economic growth and job creation – in the U.S. they produce 69 percent of new jobs. Firms less than five years old were responsible for nearly all net job creation from 1980-2005. Today, somewhere between 30 -40 percent of U.S. GDP comes from firms that did not exist in 1980. Small firms don’t always stay small; between 1982 and 2006, about 40 firms a year were knocked out of the Fortune 500, replaced by fast-growing younger firms. 

Small firms exist outside the U.S. – such as the 93 percent of India’s workforce is in the informal sector, where they’re primarily self- or family-employed on a farm or other family business. In Cairo (Egypt), CIPE and the Federation of Economic Development Associations are working to help the smallest and perhaps most ubiquitous of entrepreneurs bring their voice into public debate: street vendors. Although small firms certainly exist everywhere, they aren’t everywhere able to play the same vital role they play in the U.S., and they certainly don’t everywhere grow to replace large companies on a regular basis.

The role of small firms in an economy is at the heart of the latest Economic Reform Feature Service article, “Good Capitalism, Bad Capitalism: What is a market economy and how can it deliver?” by Robert E. Litan, Ph.D. Out of the roughly 188 countries that officially recognize the right to private property, very few of them emphasize the role of small firms or entrepreneurs. The important role of entrepreneurs and institutions that protect and encourage them are hallmarks of entrepreneurial capitalism, one of the four typologies of capitalism Litan offers to analyze the differences between those 188 capitalist economies.

Besides entrepreneurial capitalism, there’s big-firm capitalism, where large organizations dominate including corporations and unions; state-guided capitalism, where the state heavily influences investment such as in a few key developing economies including Singapore; and oligarchic capitalism, where a small group of elites made up of political leaders and private-sector cronies prioritizes centralized power rather than widespread, sustainable economic growth. Elements of all four can exist in any capitalist economy; the prevalence of one or another, Litan argues, is the key determinant between widespread growth, economic sclerosis, or rampant inequality. Most small firms in the world struggle under oligarchic economies, unable to provide the level of vibrancy and renewal as they do in the U.S.

Inspired by Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity, co-written by Litan, William Baumol, and Carl Schramm, the article argues for renewed emphasis on the role of entrepreneurs and small firms in the economy, especially after the 2008-9 financial crisis and recession. Nearly half the Fortune 500 started during a bear market or recession. The turmoil has opened up vital questions that should bring greater attention to the role that smaller firms – you might call them ‘Main Street Firms’ -  have always played in leading the way out of crisis, as well as oligarchy.

Article-at-a-glance:

  • The traditional approach to studying economic growth overlooks the importance of individuals and individual firms.
  • Market economies are not monolithic – there are four different types of capitalism (oligarchic, state-guided, big-firm, and entrepreneurial), each with different features and implications for growth.
  • Entrepreneurial capitalism is the most effective driver of economic growth because it provides opportunities for new firms to innovate and create new markets.

Download the full article in PDF or watch Robert E. Litan presenting the remarks from which it was composed.

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