A few weeks ago economist William Baumol perished in the age of 95. His death was universally mourned by members of the economics community, most of whom shared the view he had passed before finding a much-deserved Nobel Prize. Among us (Robert) had the great privilege of working with him, befriending him, or being able to regularly witness his economic wisdom, even in his final years.
Of Baumol’s many contributions to economics, the most famous is cost disease, which is why 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 health care 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 notion of Baumol’s that is equally relevant today and that may help explain America’s productivity slump. Baumol’s writing improves the possibility that U.S. productivity is low because would-be entrepreneurs are focused on the wrong form of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the amount of entrepreneurial ambition within a country is basically fixed over time, and that what determines a nation’s entrepreneurial output will be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
A lot of people think about Entrepreneurship Books Online being the “productive” kind, as Baumol referred to it, in which the companies that founders launch commercialize something new or better, benefiting society and themselves in the process. A substantial body of research establishes the “Schumpeterian” entrepreneurs, those that are “creatively destroying” the existing and only the new, are crucial for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by way of a different form of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to make regulatory moats, secure public spending for his or her own benefit, or bend specific rules for their will, in the process stifling competition to produce advantage for his or her firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will always be with us and always play some substantial role. But there are a variety of roles among that the entrepreneur’s efforts may be reallocated, and a few of those roles tend not to continue with the constructive and innovative script that is conventionally related to that individual. Indeed, at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy. What sort of entrepreneur acts at the given time and place depends heavily on the rules from the game-the reward structure in the economy-that get lucky and prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, a general change in the amalgamation of entrepreneurial effort backward and forward sorts of entrepreneurship is always to blame – specifically, a loss of productive entrepreneurship and a coincident increase in unproductive entrepreneurship. But is that this what’s actually happening in the U.S.?
Well, first of all, we while others have documented a pervasive loss of the rate of new firm formation during the last 30 years as well as an acceleration in this decline since 2000. In reality, we learned that by 2009 the rate of business closures exceeded the rate of business births the very first time in the three-decades-plus history of our data. This loss of startup formation has took place each state and virtually all locations, and in each broad industrial sector, including modern day. There has also been a slowdown in activity of high-growth firms, the relatively small number of businesses that take into account the lion’s share of net job gains. All this points to a slowdown in the growth of productive entrepreneurship.
Why don’t you consider another form of entrepreneurship? Do we also view a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t possess a smoking gun to confirm this hypothesis, but there is smoke, and yes it comes in two forms: rising profits, specially those earned by the largest businesses for the overall design, and suggestive proof more efforts to shape the principles from 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 President barack obama, wrote a disciplined 2016 paper that argued that economic rents are rising, particularly since 2000, and were a central element in increasing wage inequality observed during this time. Similarly, a gaggle of economists from MIT, Harvard, and Zurich learned that industries where top firms’ share of the market had most increased had experienced the most important declines in the share of capital going to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income distributed to labor, capital, and “profits.” (Normally, capital and earnings are included together in one broad, residual “returns to shareholders” category.) He learned that the share of capital earned by workers has been falling, as others have stated, and also that the share earned by capital has, too. Indeed, both have been declining while the share of capital going to “markups,” or rents, has been increasing.
To be clear, a good economic rents alone doesn’t establish that there’s been more unproductive entrepreneurship. For your actually was, there needs to be be proof more rent-seeking – that is, concerted efforts to stifle competition by influencing the reward structure or rules from the game within a market.
James Bessen of Boston University provides suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen signifies that, since 2000, “political factors” take into account a considerable the main boost in corporate profits. This happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang from the University of Illinois have realized that companies that have executives with partners to key policy makers have abnormally high stock returns.
In short, Baumol might have been in front of his amount of time in warning that economies can suffer not only from the cost disease and also looking at the entrepreneurial counterpart – a general change in the principles that shifts the distribution of entrepreneurial effort from activity which enables the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings began to pass. If your U.S. is going to tackle its many problems, we will must find solutions to encourage would-be entrepreneurs to start out innovative, productive businesses, as opposed to dedicating their efforts to co-opting government as a way to secure economic advantage.
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