A few weeks ago economist William Baumol perished at the age of 95. His death was universally mourned by individuals the economics community, many of whom shared the scene which he had passed before receiving a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly amazing privilege of working together with him, befriending him, or being able to regularly witness his economic wisdom, even just in his retirement years.
Of Baumol’s many contributions to economics, the favourite is cost disease, which is why high-productivity industries raise costs and thus prices in low-productivity industries. The insight is particularly relevant now, as business activities has shifted into low-productivity services like healthcare and education, where price increases are devouring public and household budgets, and whose continued low productivity has weighed down U.S. productivity growth overall.
But there’s a lesser-known concept of Baumol’s that is certainly equally relevant today and that might help explain America’s productivity slump. Baumol’s writing raises the possibility that U.S. productivity is low because would-be entrepreneurs are devoted to the wrong sort of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this a higher level entrepreneurial ambition in a country is actually fixed over time, and that what determines a nation’s entrepreneurial output may be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most people think about Entrepreneurship Books as the “productive” kind, as Baumol known as it, where the businesses that founders launch commercialize a new challenge or better, benefiting society and themselves in the process. A sizable body of research establishes that these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the existing in support of the brand new, are crucial for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, by way of a unique sort of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to develop regulatory moats, secure public spending because of their own benefit, or bend specific rules on their will, in the process stifling competition to create advantage because of their firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably along with us try to play some substantial role. But there are a number of roles among that this entrepreneur’s efforts might be reallocated, and some of these roles tend not to stick to the constructive and innovative script that is certainly conventionally related to the face. Indeed, at times the entrepreneur may even lead a parasitical existence that is certainly actually damaging towards the economy. The way the entrepreneur acts in a unpredictable moment and set depends heavily around the rules of the game-the reward structure within the economy-that eventually prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, changing your the mix of entrepreneurial effort backward and forward kinds of entrepreneurship is usually to blame – specifically, a decline in productive entrepreneurship and a coincident increase in unproductive entrepreneurship. But is that this what’s actually happening within the U.S.?
Well, for starters, we yet others have documented a pervasive decline in the interest rate of the latest firm formation throughout the last 30 years as well as an acceleration in this decline since 2000. In fact, we discovered that by 2009 the interest rate of business closures exceeded the interest rate of business births for the first time within the three-decades-plus good reputation for our data. This decline in startup formation has took place each state and virtually all locations, along with each broad industrial sector, including high tech. There has been a slowdown in activity of high-growth firms, the relatively small number of firms that are the cause of the lion’s share of net job gains. This points to a slowdown within the expansion of productive entrepreneurship.
How about the opposite sort of entrepreneurship? Can we also see a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to substantiate this hypothesis, but there surely is smoke, and it will come in two forms: rising profits, in particular those earned with the largest businesses throughout the economy, and suggestive proof a boost in efforts to shape the principles of the game. This pattern is in conjuction with the rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an important 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central aspect in increasing wage inequality observed during this time. Similarly, a group of economists from MIT, Harvard, and Zurich discovered that industries where top firms’ business had most increased had experienced the most important declines within the share of revenue gonna workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income provided to labor, capital, and “profits.” (Normally, capital and income is included together in a broad, residual “returns to shareholders” category.) He discovered that the proportion of revenue earned by workers has been falling, as others have stated, but additionally that this share earned by capital has, too. Indeed, have been declining even though the share of revenue gonna “markups,” or rents, has been increasing.
In reality, a good economic rents on its own doesn’t establish that there’s been a boost in unproductive entrepreneurship. With the actually was, there has to be be proof a boost in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules of the game in a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen shows that, since 2000, “political factors” are the cause of a considerable section of the increase in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang of the University of Illinois have found that businesses that have executives with relationships to key policy makers have abnormally high stock returns.
Simply speaking, Baumol could have been before his time in warning that economies can suffer not just from your cost disease but additionally by reviewing the entrepreneurial counterpart – changing your the principles that shifts the distribution of entrepreneurial effort from activity which enables the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings began to pass. When the U.S. will almost certainly tackle its many problems, we will must find solutions to encourage would-be entrepreneurs to begin innovative, productive businesses, instead of dedicating their efforts to co-opting government in order to secure economic advantage.
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