Working Paper: The Dynamics of Capitalism

A new working paper explores the proliferation of capitalism, tracing it from its origins in the industrial revolution to modern times, and analyzing the dynamic effects of the economic system.

The paper, titled “The Dynamics of Capitalism,” focuses on the changes brought about by the emergence of industrial capitalism. Written by F.M. Scherer, professor of public policy and corporate management, emeritus, at Harvard Kennedy School, the paper discusses the immense economic growth that occurred at the beginning of capitalism, as well as the challenges brought about by the prolific economic system.

“The economic growth experienced during the two centuries since the Industrial Revolution borders on the miraculous,” wrote Scherer. “It truly was a revolution in productive power and standards of human welfare.”

Technological innovation was essential for the increased industrial productivity of capitalism, and new businesses focused on research and development in hopes of enhancing productivity and profits. As technology became more advanced and production more efficient, new dynamics arose, such as a decline in agricultural production and first a rise and then a decline in manufacturing activity. Since the 1970s, the distribution of income has also shifted sharply toward capitalists, managers, and the most skilled workers and away from working class individuals who previously enjoyed steadily rising income.

“The control of capital by private individuals or groups is the essence of capitalism,” wrote Scherer. “Capital is accumulated through investment, and changes over time in investment activity are the leading cause of economic fluctuations … the favorable expectations generated by an upswing may excite businessmen's ‘animal spirits,’” wrote Scherer, quoting John Maynard Keynes, “inducing more of an investment increase than the objective facts warrant. The upward movement or boom is amplified.”

Recessions and occasionally even depressions commonly follow:

“The fall in profits may be so sharp that borrowers -- both business firms and home mortgage holders -- default on their loans. And if there is widespread and synchronized default on loans, banks may become insolvent, the more so, the more highly they have leveraged their lending in the hope of higher returns on equity. Banks' difficulties in turn impair the flow of credit and turn what might have been a run-of-the-mill recession into a downward spiraling ‘panic.’”

Despite potential panics, capitalism remains a remarkable economic system, and the various dynamics present challenges for policymakers.

“[I]t is hard to conceive of a practical economic system exhibiting superior dynamic performance,” concludes Scherer, “notably, in the opportunity and incentive free markets provide to capitalistic entrepreneurs for technological innovation -- more efficient production processes, new products conferring superior consumer utility, and better methods of business organization -- which in turn has raised living standards by astonishing amounts. The problem for public policy is to secure the dynamic benefits of capitalism while minimizing its negative side effects.”

F.M. Scherer‘s research focuses primarily on industrial and transportation economics. He served as director of the Bureau of Economics at the Federal Trade Commission from 1974-1976 and received a PhD in business economics from Harvard University in 1963.