A few weeks ago economist William Baumol passed away with the day of 95. His death was universally mourned by folks the economics community, many of whom shared the vista he had passed before getting a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly great privilege of utilizing him, befriending him, and being able to regularly witness his economic wisdom, even just in his final years.
Of Baumol’s many contributions to economics, the most famous is cost disease, so in retrospect high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is especially relevant now, as business activities has shifted into low-productivity services like medical and education, where price increases are devouring public and household budgets, and whose continued low productivity has overwhelmed U.S. productivity growth overall.
But there’s a lesser-known thought of Baumol’s that is certainly equally relevant today knowning that could help explain America’s productivity slump. Baumol’s writing raises the possibility that U.S. productivity is low because would-be entrepreneurs are dedicated to the wrong kind of work.
Within a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this level of entrepreneurial ambition in the country is actually fixed over time, knowning 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 Kogan Page Entrepreneurship Books as the “productive” kind, as Baumol described it, where the firms that founders launch commercialize something totally new or better, benefiting society and themselves in the process. A sizable body of research establishes why these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the previous for the newest, are critical for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, with a unique form of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to create regulatory moats, secure public spending for his or her own benefit, or bend specific rules on their will, in the process stifling competition to produce advantage for his or her firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably with us try to play some substantial role. But there are many of roles among that the entrepreneur’s efforts can be reallocated, and several of the roles tend not to stick to the constructive and innovative script that is certainly conventionally due to that individual. Indeed, at times the entrepreneur could even lead a parasitical existence that is certainly actually damaging for the economy. How a entrepreneur acts at the given time and place depends heavily on the rules of the game-the reward structure in the economy-that occur to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, a change in this mixture of entrepreneurial effort between the two types of entrepreneurship is usually to blame – specifically, a decline in productive entrepreneurship plus a coincident rise in unproductive entrepreneurship. But is this what’s actually happening in the U.S.?
Well, first of all, we yet others have documented a pervasive decline in the speed of recent firm formation over the past thirty years as well as an acceleration in that decline since 2000. Actually, we found that by 2009 the speed of business closures exceeded the speed of business births for the first time in the three-decades-plus history of our data. This decline in startup formation has occurred in each state and nearly all urban centers, plus each broad industrial sector, including hi-tech. We are seeing a slowdown in activity of high-growth firms, the relatively few businesses that be the cause of the lion’s share of net job gains. Doing this items to a slowdown in the expansion of productive entrepreneurship.
Why don’t you consider the opposite kind of entrepreneurship? Do we also visit a rise in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to verify this hypothesis, but there is smoke, and yes it is available in two forms: rising profits, specially those earned through the largest businesses throughout the economy, and suggestive evidence of a rise in efforts to shape the guidelines of the game. This pattern is like rise of economic rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an influential 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a main factor in increasing wage inequality observed during this time. Similarly, a group of economists from MIT, Harvard, and Zurich found that industries where top firms’ share of the market had most increased had experienced the most important declines in the share of income likely to 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 earnings are included together in a single broad, residual “returns to shareholders” category.) He found that the proportion of income earned by workers may be falling, as others have described, and also that this share earned by capital has, too. Indeed, both have been declining even though the share of income likely to “markups,” or rents, may be increasing.
In reality, a good economic rents on it’s own doesn’t establish that there’s been a rise in unproductive entrepreneurship. For your actually was, there has to be be evidence of a rise in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules of the game in the market.
James Bessen of Boston University presents suggestive evidence that rent-seeking behavior may be increasing. Within a 2016 paper Bessen demonstrates that, since 2000, “political factors” be the cause of an important part of the increase in corporate profits. Such a thing happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang of the University of Illinois have realized that firms that have executives with close ties to key policy makers have abnormally high stock returns.
To put it briefly, Baumol could have been before his time in warning that economies can suffer not merely from the cost disease and also from the entrepreneurial counterpart – a change in the guidelines that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there’s strong suggestive evidence that Baumol’s warnings have learned to pass. When the U.S. will probably tackle its many problems, we are going to must find solutions to encourage would-be entrepreneurs to begin innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government to be able to secure economic advantage.
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