On the parallels between science and the free market

Edmund Phelps -- recent winner of the Nobel Prize in economics -- defends the moral rightness and the economic wisdom of the capitalist system in this essay in the WSJ:

There are two economic systems in the West. Several nations--including the U.S., Canada and the U.K.--have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, as in pharmaceuticals, much comes from start-ups, particularly the most novel innovations. This is free enterprise, a k a capitalism.

The other system--in Western Continental Europe--though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners." The system's institutions include big employer confederations, big unions and monopolistic banks. Since World War II, a great deal of liberalization has taken place. But new corporatist institutions have sprung up: Co-determination (cogestion, or Mitbestimmung) has brought "worker councils" (Betriebsrat); and in Germany, a union representative sits on the investment committee of corporations. The system operates to discourage changes such as relocations and the entry of new firms, and its performance depends on established companies in cooperation with local and national banks. What it lacks in flexibility it tries to compensate for with technological sophistication. So different is this system that it has its own name: the "social market economy" in Germany, "social democracy" in France and "concertazione" in Italy.

The American and Continental systems are not operationally equivalent, contrary to some neoclassical views. Let me use the word "dynamism" to mean the fertility of the economy in coming up with innovative ideas believed to be technologically feasible and profitable--in short, the economy's talent at commercially successful innovating. In this terminology, the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.

Wasn't the Continental system designed to stifle dynamism? When building the massive structures of corporatism in interwar Italy, theoreticians explained that their new system would be more dynamic than capitalism--maybe not more fertile in little ideas, such as might come to petit-bourgeois entrepreneurs, but certainly in big ideas. Not having to fear fluid market conditions, an entrenched company could afford to develop radical innovation. And with industrial confederations and state mediation available, such companies could arrange to avoid costly duplication of their investments. The state and its instruments, the big banks, could intervene to settle conflicts about the economy's direction. Thus the corporatist economy was expected to usher in a new futurismo that was famously symbolized by Severini's paintings of fast trains. (What was important was that the train was rushing forward, not that it ran on time.)

Friedrich Hayek, in the late 1930s and early '40s, began the modern theory of how a capitalist system, if pure enough, would possess the greatest dynamism--not socialism and not corporatism. First, virtually everyone right down to the humblest employees has "know-how," some of what Michael Polanyi called "personal knowledge" and some merely private knowledge, and out of that an idea may come that few others would have. In its openness to the ideas of all or most participants, the capitalist economy tends to generate a plethora of new ideas.

Second, the pluralism of experience that the financiers bring to bear in their decisions gives a wide range of entrepreneurial ideas a chance of insightful evaluation. And, importantly, the financier and the entrepreneur do not need the approval of the state or of social partners. Nor are they accountable later on to such social bodies if the project goes badly, not even to the financier's investors. So projects can be undertaken that would be too opaque and uncertain for the state or social partners to endorse. Lastly, the pluralism of knowledge and experience that managers and consumers bring to bear in deciding which innovations to try, and which to adopt, is crucial in giving a good chance to the most promising innovations launched. Where the Continental system convenes experts to set a product standard before any version is launched, capitalism gives market access to all versions.

He goes on to defend the moral rightness of capitalism even when income is not distributed as equally as we would like. Basically he argues that other systems deprive the entreperneur -- the engine in his view of economic growth -- of his liberty.

Yet the tone here is wrong. As Kant also said, persons are not to be made instruments for the gain of others. Suppose the wage of the lowest- paid workers was foreseen to be reduced over the entire future by innovations conceived by entrepreneurs. Are those whose dream is to find personal development through a career as an entrepreneur not to be permitted to pursue their dream? To respond, we have to go outside Rawls's classical model, in which work is all about money. In an economy in which entrepreneurs are forbidden to pursue their self-realization, they have the bottom scores in self-realization--no matter if they take paying jobs instead--and that counts whether or not they were born the "least advantaged." So even if their activities did come at the expense of the lowest-paid workers, Rawlsian justice in this extended sense requires that entrepreneurs be accorded enough opportunity to raise their self-realization score up to the level of the lowest-paid workers--and higher, of course, if workers are not damaged by support for entrepreneurship. In this case, too, then, the introduction of entrepreneurial dynamism serves to raise Rawls's bottom scores.

Actual capitalism departs from well-functioning capitalism--monopolies too big to break up, undetected cartels, regulatory failures and political corruption. Capitalism in its innovations plants the seeds of its own encrustation with entrenched power. These departures weigh heavily on the rewards earned, particularly the wages of the least advantaged, and give a bad name to capitalism. But I must insist: It would be a non sequitur to give up on private entrepreneurs and financiers as the wellspring of dynamism merely because the fruits of their dynamism would likely be less than they could be in a less imperfect system. I conclude that capitalism is justified--normally by the expectable benefits to the lowest-paid workers but, failing that, by the injustice of depriving entrepreneurial types (as well as other creative people) of opportunities for their self-expression. (Emphasis mine.)

I have always been struck by the parallels between the free market and the scientific enterprise -- yet I am puzzled that so few scientists embrace free markets.

Let me put it this way. What would happen if the government decided what scientific questions we should pursue by fiat? Most scientists would tell you that new discoveries would be stifled because the scientists could not pursue those questions that they find most interesting. Bureaucrats would not be as educated in all the areas the scientists were studying, nor could the enterprise benefit from the plurality of techniques employed in the absence of central planning. Science -- it would appear -- benefits from a form of entreperneurial competition.

Yet, most scientists -- at least the ones I have met -- are not whole-hearted proponents of free markets. Most scientists I have met have a strong socialist bent. Why they fail to see how what is beneficial to the process of science would not be desirable for the rest of society is a source of continuing puzzlement to me.

I think that it might be in part because we think that we understand the world so much better than other people. Scientists are good at making hypotheses and constructing elaborate models. It is tempting to apply this skill to Utopian visions and then claim -- just as we do in grants -- that those visions are destined to work. In many cases, we tend to forget when our own models turned out to be horribly incomplete.

Scientific enterprise would be perfectly amenable to central planning if we knew what the answers would be in advance. Unfortunately, we don't. Similarly, state planning of the economy would be lovely if we knew what technologies would turn out to be important and where resources should be allocated years into the future. Unfortunately, we don't. Because we do not operate in a world filled with ideal information, Phelps argues that society benefits from the dynamism and creative destruction of the free market. I would argue that the same premise applies to the scientific enterprise -- and that scientists should recognize the parallel.

If you are interested, by the way, Tyler Cowen has a thorough summary of Dr. Phelps' work.

Hat-tip: Virginia Postrel.