Entrepreneurship critical for economy

A recent study has confirmed the importance of entrepreneurship in creating economic growth and improvement in the standard of living for Americans.

In their book, "Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity," William J. Baumol, Robert E. Litan and Carl J. Schramm have compared the different kinds of capitalism we observe in the world.

They first look at "state-guided capitalism," in which the government gives major direction to the market by supporting some industries. Japan's heavy regulation of industry is an example of this type of capitalism.

The study finds that government attempts to pick and then support winning industries is sometimes driven by politics rather than good economics. They also find that thousands of individuals making decisions about what to produce and where to invest do much better than a few bureaucrats buried in a government office. As a result, state-guided capitalism tends to result in slower economic growth, with recessions that last longer and consumers who experience lower standards of living.

The second type of capitalism Baumol, Litan and Schramm call "oligarchic capitalism." Russia is a clear example of this. It refers to capitalism in which most of the wealth and power rests with a few individuals and families with strong ties to government officials.

This is the worst type. New entrants with higher-quality/lower-priced products are blocked by government rules and regulations. Consumers are generally offered few choices and products of poor quality.

The third type of capitalism to which the authors refer is what they call "big-firm capitalism," in which giant firms carry out all the major economic activities. This type is the most efficient in delivering many products and services.

For example, Honda and Toyota need to be large to handle the large research and development costs required to manufacture new and better automobiles. Pharmaceutical companies need to be large to afford the huge costs to develop and test new drugs. It even makes sense that Microsoft is huge because of "network effects" — that is, it is more efficient if most people use the same software due to the ease of communicating with other people.