A few weeks ago economist William Baumol died at the ages of 95. His death was universally mourned by people in the economics community, most of whom shared the scene that he had passed before receiving a much-deserved Nobel Prize. One of us (Robert) had the truly amazing privilege of dealing with him, befriending him, and being able to regularly witness his economic wisdom, even during his old age.
Of Baumol’s many contributions to economics, the best is cost disease, which is why high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is very 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 weighed down U.S. productivity growth overall.
But there’s a lesser-known thought of Baumol’s that’s equally relevant today understanding that might help explain America’s productivity slump. Baumol’s writing enhances the possibility that U.S. productivity is low because would-be entrepreneurs are focused on an unacceptable sort of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the a higher level entrepreneurial ambition in the country is essentially fixed over time, understanding that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most of the people think about Kogan Page Entrepreneurship Books as the “productive” kind, as Baumol referred to it, where the companies which founders launch commercialize new things or better, benefiting society and themselves in the process. A substantial body of research establishes these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the old in favor of the brand new, are critical for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by a very different kind of entrepreneur: the “unproductive” ones, who exploit special relationships with all the government to create regulatory moats, secure public spending for own benefit, or bend specific rules on their will, in the process stifling competition to produce advantage for firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be around and always play some substantial role. But there are a number of roles among that the entrepreneur’s efforts can be reallocated, plus some of the roles don’t stick to the constructive and innovative script that’s conventionally caused by that individual. Indeed, at times the entrepreneur could even lead a parasitical existence that’s actually damaging towards the economy. What sort of entrepreneur acts in a moment and set depends heavily for the rules from the game-the reward structure within the economy-that eventually prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a modification of the mix of entrepreneurial effort forwards and backwards sorts of entrepreneurship is to blame – specifically, a decline in productive entrepreneurship and a coincident rise in unproductive entrepreneurship. But are these claims what’s actually happening within the U.S.?
Well, to begin with, we yet others have documented a pervasive decline in the pace of latest firm formation throughout the last 30 years as well as an acceleration for the reason that decline since 2000. Actually, we learned that by 2009 the pace of commercial closures exceeded the pace of commercial births the very first time within the three-decades-plus good reputation for our data. This decline in startup formation has happened each state and virtually all locations, along with each broad industrial sector, including high tech. There has also been a slowdown in activity of high-growth firms, the relatively small number of companies that account for the lion’s share of net job gains. All this exactly what to a slowdown within the development of productive entrepreneurship.
Think about the other sort of entrepreneurship? Do we also view a rise in unproductive entrepreneurship, as Baumol theorized?
We don’t possess a smoking gun to confirm this hypothesis, but there is surely smoke, plus it is available in two forms: rising profits, in particular those earned through the largest businesses for the overall design, and suggestive proof of a boost in efforts to shape the rules from the game. This pattern is consistent with the rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to The president, wrote a disciplined 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central factor in increasing wage inequality observed during this time period. Similarly, a group of economists from MIT, Harvard, and Zurich learned that industries where top firms’ share of the market had most increased had experienced the largest declines within the share of capital gonna 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 one broad, residual “returns to shareholders” category.) He learned that the share of capital earned by workers has been falling, as others have pointed out, but also that the share earned by capital has, too. Indeed, both have been declining even though the share of capital gonna “markups,” or rents, has been increasing.
To be clear, a good economic rents on it’s own doesn’t establish that there’s been a boost in unproductive entrepreneurship. To the to be true, there must be be proof of a boost in rent-seeking – that’s, concerted efforts to stifle competition by influencing the reward structure or rules from the game in the market.
James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen signifies that, since 2000, “political factors” account for a considerable section of the surge 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 found that companies which have executives with close ties to key policy makers have abnormally high stock returns.
Simply speaking, Baumol was in advance of his amount of time in warning that economies can suffer not only from your cost disease but also looking at the entrepreneurial counterpart – a modification of the rules that shifts the distribution of entrepreneurial effort from activity that helps the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings have started to pass. If your U.S. will almost certainly tackle its many problems, we will need to find solutions to encourage would-be entrepreneurs to start innovative, productive businesses, instead of dedicating their efforts to co-opting government as a way to secure economic advantage.
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