A few weeks ago economist William Baumol passed away on the age of 95. His death was universally mourned by individuals the economics community, a lot of whom shared the scene that they had passed before getting a much-deserved Nobel Prize. Among us (Robert) had the fantastic privilege of working together with him, befriending him, or being able to regularly witness his economic wisdom, even during his old age.
Of Baumol’s many contributions to economics, the most common is cost disease, which explains why high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is especially relevant now, as economic activity 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 weighed down U.S. productivity growth overall.
But there’s a lesser-known notion of Baumol’s that is equally relevant today which might help explain America’s productivity slump. Baumol’s writing raises the possibility that U.S. productivity is low because would-be entrepreneurs are focused on a bad type of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the amount of entrepreneurial ambition within a country is actually fixed with time, which what determines a nation’s entrepreneurial output could be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most people consider Buy Entrepreneurship Books being the “productive” kind, as Baumol referred to it, the place that the companies which founders launch commercialize new things or better, benefiting society and themselves in the operation. A considerable body of research establishes why these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the previous in favor of the new, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by the unique sort of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to construct regulatory moats, secure public spending for own benefit, or bend specific rules on their will, in the operation stifling competition to make advantage for firms. Economists refer to this as 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 this entrepreneur’s efforts could be reallocated, plus some of those roles usually do not follow the constructive and innovative script that is conventionally due to that person. Indeed, at times the entrepreneur might lead a parasitical existence that is actually damaging to the economy. What sort of entrepreneur acts in a given time and set depends heavily about the rules from the game-the reward structure in the economy-that occur to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a change in a combination of entrepreneurial effort backward and forward sorts of entrepreneurship is always to blame – specifically, a decline in productive entrepreneurship along with a coincident surge 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 interest rate of recent firm formation over the last three decades as well as an acceleration for the reason that decline since 2000. The truth is, we found out that by 2009 the interest rate of commercial closures exceeded the interest rate of commercial births initially in the three-decades-plus good reputation for our data. This decline in startup formation has happened in each state and nearly all locations, plus each broad industrial sector, including advanced. We are seeing a slowdown in activity of high-growth firms, the relatively small number of businesses that account for the lion’s share of net job gains. All this exactly what to a slowdown in the growth of productive entrepreneurship.
Why don’t you consider the other type of entrepreneurship? Should we also view a surge in unproductive entrepreneurship, as Baumol theorized?
We don’t possess a smoking gun to verify this hypothesis, but there is smoke, and it comes in two forms: rising profits, specially those earned through the largest businesses throughout the economy, and suggestive proof of more efforts to shape the rules from the game. This pattern is consistent with the rise of economic rents and rent-seeking behavior.
As an example, Jason Furman and Peter Orszag, both former economic advisers to The president, wrote an important 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 period. Similarly, a group of economists from MIT, Harvard, and Zurich found out that industries where top firms’ share of the market had most increased had experienced the greatest declines in the share of capital likely to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income given to labor, capital, and “profits.” (Normally, capital and profits are included together in a single broad, residual “returns to shareholders” category.) He found out that the share of capital earned by workers continues to be falling, as others have described, and also how the share earned by capital has, too. Indeed, both have been declining whilst the share of capital likely to “markups,” or rents, continues to be increasing.
To be clear, the presence of economic rents by itself doesn’t establish that there’s been more unproductive entrepreneurship. To the to be real, there must be be proof of 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 offers suggestive evidence that rent-seeking behavior continues to be increasing. Inside a 2016 paper Bessen implies that, since 2000, “political factors” account for a substantial the main rise in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang from the University of Illinois have realized that companies which have executives with partners to key policy makers have abnormally high stock returns.
Simply speaking, Baumol was ahead 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 change in the rules that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there is certainly strong suggestive evidence that Baumol’s warnings have come to pass. If your U.S. is going to tackle its many problems, we are going to have to find solutions to encourage would-be entrepreneurs to get started on innovative, productive businesses, rather than dedicating their efforts to co-opting government in order to secure economic advantage.
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