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19 Dec 2006Working Paper Summaries

The Political Economy of Capitalism

by Bruce R. Scott
Capitalism is often defined as an economic system where private actors are allowed to own and control the use of property according to their own interests, and where the invisible hand of the pricing mechanism coordinates supply and demand in markets in a way that is automatically in the best interests of society. Government, in this perspective, is often described as responsible for peace, justice, and tolerable taxes. Bruce Scott argues in this chapter that for a capitalist system to evolve in an effective developmental sense through time, it must have two hands, not one: an invisible hand that is implicit in the pricing mechanism, and a visible hand that is explicitly managed by government through a legislature and a bureaucracy. Inevitably the actions of the visible hand imply a strategy, no matter how implicit, shortsighted, or incoherent that strategy may be. Key concepts include:
  • Government has two quite different roles to play in a capitalist economy, as an administrator of an ongoing system and as an innovator.
  • Political leaders have prime responsibility for mobilizing the power to promote changes to the system.
  • Capitalism has two hands, first the familiar if invisible hand of price mechanisms that coordinate economic actors within current frameworks, and second the visible hand of government, where it is both an administrator and an innovator.
  • The visible hand of the state must be able to intervene in order to modernize market frameworks in a timely way, while at the same time administering and enforcing existing rights and responsibilities as a complement to the invisible hand.

Author Abstract

Capitalism is often defined as an economic system where private actors are allowed to own and control the use of property in accord with their own interests, and where the invisible hand of the pricing mechanism coordinates supply and demand in markets in a way that is automatically in the best interests of society. Government, in this perspective, is often described as responsible for peace, justice, and tolerable taxes.

This paper defines capitalism as a system of indirect governance for economic relationships, where all markets exist within institutional frameworks that are provided by political authorities, i.e., governments. In this second perspective capitalism is a three level system much like any organized sports. Markets occupy the first level, where the competition takes place; the institutional foundations (e.g., rules, referees, infrastructure) that underpin those markets are the second; and the political authority that administers the system is the third (e.g., the NFL, NBA or FIFA). While markets do indeed coordinate supply and demand with the help of the invisible hand in a short term, quasi-static perspective, government coordinates the modernization of market frameworks in accord with changing circumstances, including changing perceptions of societal costs and benefits. In this broader perspective government has two distinct roles, one to administer the existing institutional frameworks, including the provision of infrastructure and the administration of laws and regulations, and the second to mobilize political power to bring about modernization of those frameworks as circumstances and/or societal priorities change.

For a capitalist system to evolve in an effective developmental sense through time, it must have two hands and not one: an invisible hand that is implicit in the pricing mechanism and a visible hand that is explicitly managed by government through a legislature and a bureaucracy. Inevitably the actions of the visible hand imply a strategy, no matter how implicit, short sighted or incoherent that strategy may be.

This working paper is a draft of Chapter 2 of a manuscript titled Capitalism, Democracy and Development.

Paper Information

  • Full Working Paper Text
  • Working Paper Publication Date: December 2006
  • HBS Working Paper Number: 07-037
  • Faculty Unit(s):
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