Carl Schramm

Robert Litan
William Baumol

Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity

An analogy to military arms races is instructive. In medieval times, every king seemingly was forced into an arms race in which the ante was constantly raised, with innovation relentlessly raising costs. Stone castles replaced wooden castles and were not only more costly to build but far more costly to besiege. Gunpowder and artillery in the mid-fourteenth century increased the cost of fortification. The sociopolitical innovations that led the kings to become less dependent on vassals to man their armies forced them to pay their military often purely mercenary troops, which added significantly to royal expenses. The predictable consequence of this military Red Queen game was that the kings were almost always seriously short of funds. For whenever they did manage to scrape up enough to proceed on military enterprises with little financial hindrance, this merely invited ratcheting of the arms race up yet another notch, so by the inherent character of the 'gamer' any amount that seemed sufficient on one day was sure to be woefully inadequate in the next.

Thus monarchs found themselves perpetually underfinanced, heavily in debt and unable to find willing lenders, and reduced to distasteful expedients) to beg for a bit here, wheedle or extort a bit there. Indeed, much of medieval history is a story of battles—not the supposedly glorious clashes of arms) but battles between the kings and the subjects from whom the monarchs hoped to draw their funding. As some historians have put it, they were 'pauper kings.'

Fortunately, there is a happy and peaceful ending to this (truthful) parable about military Red Queen games. One consequence of the unceasing chase for money was that kings desperate for funds were forced into recognizing the rights of the individual. This process began in England and spread to the United States and eventually to much of Europe. To be sure, the process was a gradual one. Rights first were granted to the magnates (the fewer than ten earls and less than one hundred barons in England at the time of the birth of parliament), and then to towns and the commons (the upper middle class, the knights, the landowners, and the wealthier town residents). Furthermore, some kings found it necessary to turn to commerce rather than funding themselves with taxes and wartime booty. This made commercial activity—indeed entrepreneurial activity—respectable for members of the English nobility.

All of this helped lay the foundations for the future free-market economy and its remarkable productivity and record of growth. Indeed, the evolution of the rule of law—which predated the evolution of democratically chosen representatives—arguably was the single most important contribution to the birth of entrepreneurial capitalism.