Capitalism has two powerful things going for it. First, it has been shown to be incredibly effective in leading to economic growth. …Second, capitalism tends to be self-correcting. When the free market does fail, the market itself steps in to correct the problem. …But that doesn’t mean markets always work to self-correct structural problems. The snag, as Adam Smith first identified in The Wealth of Nations, is that free markets require certain conditions in order to function—among them, well-defined property rights, enforceable contracts, non-collusion between parties, and complete knowledge that puts everyone on a level playing field. And while some of these conditions are self-fulfilling in markets, some are not.
Take accounting standards, for example. While it’s essential from a standpoint of complete knowledge to have everyone calculating their financials in a comparable and consistent manner, there is no profit motive for a private institution to produce accounting standards. Some public intervention is necessary—and that public intervention manifests itself as institutions operate not through a competitive market process, but through a democratic political process.
Therein lies the rub. Once the market is open to politics, then that market can be corrupted. …If you happen to engage in a political process that structures institutions that underlie capitalism, what are your obligations?
Authors: Karthik Ramanna, Michael Blanding, Rebecca M. Henderson
Source: Harvard Business School (HBS) Working Knowledge
Subjects: Capitalism, Economics
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