A Tale of Two Capitalisms: Perilous Misperceptions About Capitalism, Entrepreneurship, Government, and Inequality

Abstract

This paper examines two widely held perceptions about capitalism, challenging the popular view that capitalism is a villainous perpetuator and government a saintly corrector of cronyism and inequality. This characterization is largely driven by misperceptions. Capitalism is viewed as a system that favors the elite at the expense of everyone else (crony capitalism), rather than one that promotes economic liberty and opportunity for all (free market capitalism). The state is meanwhile viewed as a benevolent and omniscient corrector of market failures and provider of public goods (romantic view of politics), rather than a political system operated by agents whose actions may reflect their own self-interest and not the welfare of the general public (public choice view). These misperceptions result in not only a distorted understanding of the institutional structure that underlies capitalism and the mechanism in which income is distributed, but also lead to perilous reform prescriptions that undermine free market capitalism and generate unintended consequences that act to reduce individual and societal well-being.

A theory is outlined that links an economy’s institutional environment to the type of capitalism, entrepreneurship, and inequality to emerge in society. Institutions that constrain the discretionary authority of government incentivize productive entrepreneurship and facilitate free market capitalism, giving rise to a natural or market determined income distribution and opportunity for economic mobility. Institutions that do not sufficiently constrain the authority of government incentivize unproductive entrepreneurship and facilitate the development of crony capitalism, resulting in structural inequality and little opportunity for economic mobility. Empirical evidence suggests that, in the long-run, sound monetary institutions and legal institutions that protect private property rights and uphold the rule of law are associated with free market capitalism, greater living standards and a more egalitarian distribution of income. The practical implications of this research for the future of capitalism are discussed.

Keywords: capitalism, cronysim, free markets, economic freedom, inequality, economic mobility, entrepreneurship, institutions

JEL Classification: D30, D63, P16, P14, O17