What’s at stake: An interesting debate about the trade-off between innovation and redistribution has sparked over the (admittedly wonky) paper by Daron Acemoglu, James Robinson and Thierry Verdier in which the authors argue that the "cuddly" capitalism of Europe could not sustain high levels of growth in the absence of the "cutthroat" capitalism of America. Entrepreneurs in those ruthless economic models bear more risks – and thus move the technology frontier faster. While still in Working Paper format and written for an academic audience, the paper was picked up by several bloggers who criticized the premises, the methodology and the conclusions.
Are more redistributive European countries free-riding on the US?
Dylan Mattews writes on the Wonk Blog that many left-leaning folks look admiringly to Scandinavia as a region that has managed to make true social democracy work. Acemoglu and al. argue, however, that their economic growth is only possible because Scandinavian companies can piggyback on, or copy, innovations that originate in the U.S. If the U.S. adopted a Scandinavian-style government, those innovations wouldn’t occur as fast, and both America and Scandinavia would do worse.
Daron Acemoglu and James Robinson provide some background to the paper in their blogs “Why Nations Fail”. There is a line of work in political science, sometimes referred to as the “Varieties of Capitalism” literature. The main idea is that there are many different ways of organizing a capitalist economy, perhaps with two polar cases being a Coordinated Market Economy (CME), which captures certain salient features of Scandinavian countries, and a Liberal Market Economy (LME), proxying for a US style economy. This literature suggests that both of these institutional/organizational arrangements can lead to high incomes and similar growth rates, in particular, because LMEs generate radical innovations, particularly in sectors such as software development, biotechnology and semiconductors, while CMEs are good at incremental innovation in sectors such as machine tools, consumer durables and specialized transport equipment; as part of this institutional arrangements, they also provide more social insurance and generate less inequality. Because their economic outcomes are similar but CMEs provide better social insurance to their citizens, if an LME could turn itself into a CME, this would be associated with a significant gain in welfare.
Daron Acemoglu and James Robinson writes that the main idea of their paper is to observe that international linkages are absent from this picture, and to suggest that the institutional choice of that society is not entirely independent of the choices of others. The surprising result is this: in equilibrium those under cutthroat capitalism cannot switch to cuddly capitalisms because of the interdependences in the world economy: when others are doing cuddly, it’s a best response to do cutthroat because the cutthroat country is contributing disproportionately to the world technology frontier and a switch from cutthroat to cuddly would slow down world growth.
Patent-count and the US lead in innovation
Matthew Yglesias writes that one thing many people have seized on is that at a key stage in their argument they rely on a patent-count as an index of innovation, and note that this is ridiculous. And it is ridiculous (for starters two of Sweden's biggest firms, Ikea and H&M, operate in the design sector and are ineligible for intellectual property protections). But the problem is that it's not just ridiculous, it's a standard procedure in the field.
Daron Acemoglu and James Robinson write that Yglesias is right in pointing out that patents only capture some specific types of innovation and many important breakthroughs in productivity will not show up there. But this is not an excuse for ignoring the wealth of data on patents, especially given that the economics literature has shown how patents correlate with growth both at the aggregate and firm level.
Financial incentives and innovation
Mark Thoma argues that there must be diminishing returns to incentives. If we take away $50 million in taxes leaving someone the prospect of earning "only" $100 million in net profit, would the person really decide to give up the project? Would someone really decide it isn't worth it to only earn $100 million and work less or give it up altogether? Or is it the case that by the time you get to that much income, a marginal increase of decrease in profit has almost no effect on incentives? And for those in the game simply to see who can accumulate the most, so long as the rules are the same for all, incentives won't change either.
Lane Kenworthy suggests reasons to doubt that modest inequality and generous cushions are significant obstacles to innovation. Despite low inequality and high government spending in the 1960s and 70s, there was plenty of innovation over that period in the US. Second, the Nordic countries, with their low-income inequality and generous safety nets, currently are among the world’s most innovative countries.
Dimitros Diamantaras picks up an interesting example from a commenter to the post by Mark Thoma. One of the most important innovations of the last two decades or so has been the development of Linux, on which run most of the web servers in the world, as well as the many, many phones and other devices that run Android. But Linux came out of the “cuddly” capitalism of Scandinavia (and indeed, from a then 21-year old student who opened it up to the world not in order to get rich but to learn and because he loved to tinker with operating system software).
Social insurance and innovation
Mark Thoma argues that an enhanced safety net — a backup if things go wrong — can give people the security they need to take a chance on pursuing an innovative idea that might die otherwise, or opening a small business. So it may be that an expanded social safety net encourages innovation.
Noah Smith writes that the authors assume that the only cost of entrepreneurship is effort. “We assume that workers can simultaneously work as entrepreneurs (so that there is no occupational choice). This implies that each individual receives wage income in addition to income from entrepreneurship”. In other words, the authors have assumed away much of the risk of entrepreneurship! A failed entrepreneur gets paid exactly the same wage income as a worker who doesn't try to be an entrepreneur at all! This automatic wage income reduces the risk of entrepreneurship substantially, and makes social insurance much less necessary for reducing risk.
Daron Acemoglu and James Robinson write that current inequality is likely way beyond what would be necessary to provide the right sort of incentives to entrepreneurs since it has at least in part political roots and causes severe challenges to the (already dwindling) inclusivity of American institutions. Second and equally importantly, the mechanism in their paper clearly refers to inequality among entrepreneurs, whereas a lot of the inequality in the United States is among workers. It should be obvious that providing a safety net at the bottom of the distribution will not be a major factor in innovation decisions.