October 10, 2006 11:38AM

Nobel Winner Phelps on Dynamism, Enterpreneurship, and Justice

This year's newly minted Nobel Prize winner in economics, Columbia University's Edmund Phelps, has a wonderful essay on the difference between the American economic model and the various forms of European social democracy in today's Wall Street Journal.

Phelps says the difference is the exceptional "dynamism" of the American free enterprise system:

[T]he free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.

Drawing on Hayek and Polanyi's ideas about "personal knowledge" and entrepreneurship, Phelps explains how greater dynamism encourages a greater degree of innovation. Under capitalism, Phelps writes,

the financier and the entrepreneur do not need the approval of the state or of social partners. Nor are they accountable later on to such social bodies if the project goes badly, not even to the financier's investors. So projects can be undertaken that would be too opaque and uncertain for the state or social partners to endorse.

Consequently, the U.S. has a remarkable record of innovation that much of the rest of the world, including the European social democracies, relies upon to maintain their own standards of living. This is a crucial point to hammer home when American statist liberals point to what they see as the success of the Western European institutions: the viability of European social democracy depends in part on the ability to, as Phelps puts it, "sail in the slipstream" of American innovation.

But the most fascinating part of Phelps' essay is his attempt to justify capitalism in terms of John Rawls' political philosophy. As one of a handful of classical liberals who think that Rawls identified something close to the correct method of political justification, I found Phelps' appeal to Rawls darn interesting, even if he does slightly misinterpret him.

Like Rawls and Amartya Sen, Phelps denies that material resources alone are sufficient for well-being, and, again like Rawls and Sen, he leans heavily on the importance of self-realization through the exercise of our intellectual and creative capacities. Phelps notes that a higher degree of economic volatility is a pretty straightfoward consequence of a dynamic system in which enterpreneurs are free to shake things up without having to get buy-in from the state and all the veto-happy "stakeholders." But if dynamism buys us higher productivity and higher incomes across the distribution, volatility will turn out to be a far cry from economic insecurity or precariousness. (Jacob Hacker, listen up.) And, Phelps thinks, more importantly, once we've passed a threshold of economic sufficiency, the concern for more profound matters such as self-realization becomes paramount. Capitalist dynamism offers greater opportunities for self-realization through challenge and the engagement of our higher capacities. And this is so not only for the enterpreneurs who are shaking things up, but for workers inside firms who are faced with the constant, stimulating challenge of creatively adjusting when things get shaken.

Instituting a high level of dynamism, so that the economy is fired by the new ideas of entrepreneurs, serves to transform the workplace--in the firms developing an innovation and also in the firms dealing with the innovations. The challenges that arise in developing a new idea and in gaining its acceptance in the marketplace provide the workforce with high levels of mental stimulation, problem-solving, employee-engagement and, thus, personal growth.

Now, Rawls's standard for a just set of institutions is that it be the best feasible alternative in terms of the welfare of the "least advantaged." In Rawls's philosophy, advantage is understood in terms of "primary goods," the necessary basic means to any meaningful and fulfilling human life. In addition to material goods, Rawls adds our moral rights, the availability of opportunites, and "the social bases of self-respect." In justifying his theory, Rawls leans heavily on the the importance of "the Aristotelian Principle" that other things equal, we are better off if we engage our distinctively human capacities at a higher level. So it is not technically true that, as Phelps writes:

In the classic case to which Rawls devoted his attention, the lowest score is always that of workers with the lowest wage, whom he called the "least advantaged"...

The lowest score is always that of those who have the least primary goods, whatever those might be. But Phelps is right that most discussion of Rawls proceeds as if was talking about the distribution of money. So it turns out that Phelps' self-realization-based argument for dynamically entrepreneurial capitalism is truer to Rawls than Phelps seems to think.

In an economy in which entrepreneurs are forbidden to pursue their self-realization, they have the bottom scores in self-realization--no matter if they take paying jobs instead--and that counts whether or not they were born the "least advantaged." So even if their activities did come at the expense of the lowest-paid workers, Rawlsian justice in this extended sense requires that entrepreneurs be accorded enough opportunity to raise their self-realization score up to the level of the lowest-paid workers--and higher, of course, if workers are not damaged by support for entrepreneurship. In this case, too, then, the introduction of entrepreneurial dynamism serves to raise Rawls's bottom scores.

If Ayn Rand and John Rawls had a love child, isn't this what he'd say?