Innovative Business Ideas

Capitalism rethought

02 December 2014


Edwin Sim explores a new capitalism perspective.

Capitalism is being blamed by many as the culprit for middle-class stagnation and rising income inequality.

In “Redefining Capitalism”, Eric Beinhocker, executive director of the Institute for New Economic Thinking at the Oxford Martin School, University of Oxford and Nick Hanauer said that most people have misunderstood how and why it worked so well.

“….the conventional economic theories we have relied upon for the past century have misled us about the workings of capitalism.”

To improve the current capitalist system, the authors said we must replace old theories that have dominated our thinking.

Neoclassical economics – dominant paradigm

Neoclassical economics, they said has painted a narrow and mechanistic view of capitalism, because it focuses on the role of markets and prices in the efficient allocation of society’s resources.

These concepts determined that rational, self-interested firms maximize profits while rational, self-interested consumers maximize their “utility”.

At the same, peoples’ actions drove supply to equal demand, set prices and cleared markets so that resources are allocated in a socially optimal way.

Many of these neoclassical economic assumptions, however have begun to unravel.

Real humans don’t always act rationally

Behavioral economists have accumulated data that showed real humans don’t always act rationally.

“Experimental economists have raised awkward questions about the very existence of utility; and that is problematic because it has long been the device economists use to show that markets maximize social welfare.”

At the same time, empirical economists have identified anomalies suggesting that financial markets aren’t always efficient.

“And the macroeconomic models built on neoclassical ideas performed very poorly during the financial crisis.”

Real economy – complex, dynamic, open and nonlinear system

According to the authors, many economists today view the economy as a constantly evolving, interacting network of highly diverse households, firms, banks, regulators, and other agents.

“….more in common with an ecosystem than with the mechanistic systems the neoclassicists modeled their theory on.

These new economic perceptions, they said have fundamental implications for how people think about the nature of capitalism and prosperity.

“It suggests that markets are evolutionary systems that each day carry out millions of simultaneous experiments on ways to make our lives better.”

Capitalism’s essential role – creation

Capitalism today, they said should be viewed as a product-creation vehicle that advances humanity.

Life isn’t better today because mankind has been able to allocate resources more efficiently.

“…. it is better because we have life-saving antibiotics, indoor plumbing, motorized transport, access to vast amounts of information, and an enormous number of technical and social innovations that have become available to much (if not yet all) of the world’s population.”

Capitalism’s greatest quality, comes from its ability to create incentives for solving human problems and making those solutions widely available.

“And it is solutions to human problems that define prosperity, not money.”

Prosperity redefined

Most people, the authors said intuitively believe that the more money people have, the more prosperous a society must be.

However, prosperity in human societies can’t be properly understood by looking just at monetary measures, such as income or wealth.

“Prosperity in a society is the accumulation of solutions to human problems.”

Ultimately, a society’s wealth is measured by the range of human problems it has solved and how it has made those solutions available to its people.

Genius of capitalism

Capitalism’s greatest strength, the authors said is because its an unmatched evolutionary system for finding solutions.

“Finding new solutions to human problems is rarely easy or obvious — if it was, they would have already been found.”

Capitalism provides incentives for millions of problem-solving experiments to occur every day, provides competition to select the best solutions, and provides incentives and mechanisms for scaling up and making the best solutions available.

At the same time, it scales down or eliminates less successful ones.

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