Last week economist William Baumol died on the day of 95. His death was universally mourned by members of the economics community, many of whom shared the scene he had passed before receiving a much-deserved Nobel Prize. One among 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 retirement years.
Of Baumol’s many contributions to economics, the most common 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 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 overwhelmed U.S. productivity growth overall.
But there’s a lesser-known idea of Baumol’s that is certainly equally relevant today understanding that might help explain America’s productivity slump. Baumol’s writing adds to the possibility that U.S. productivity is low because would-be entrepreneurs are devoted to an unacceptable type of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this degree of entrepreneurial ambition in the country is basically fixed with 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 Entrepreneurship Books as the “productive” kind, as Baumol described it, the place that the companies which founders launch commercialize a new challenge or better, benefiting society and themselves in the operation. A sizable body of research establishes these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the previous and only the new, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by the different form of entrepreneur: the “unproductive” ones, who exploit special relationships with all the government to develop regulatory moats, secure public spending because of their own benefit, or bend specific rules with their will, in the operation stifling competition to create advantage because of their firms. Economists refer to this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be with us and always play some substantial role. But there are many of roles among that the entrepreneur’s efforts might be reallocated, plus some of people roles usually do not follow the constructive and innovative script that is certainly conventionally due to see your face. Indeed, at times the entrepreneur might even lead a parasitical existence that is certainly actually damaging to the economy. What sort of entrepreneur acts in a unpredictable moment and set depends heavily for the rules from the game-the reward structure inside the economy-that get lucky and prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t at fault for periods of slow economic growth; rather, changing your this mixture of entrepreneurial effort forwards and backwards kinds of entrepreneurship is to blame – specifically, a loss of productive entrepreneurship plus a coincident increase in unproductive entrepreneurship. But is this what’s actually happening inside the U.S.?
Well, for starters, we yet others have documented a pervasive loss of the interest rate of the latest firm formation during the last thirty years as well as an acceleration for the reason that decline since 2000. In fact, we found that by 2009 the interest rate of business closures exceeded the interest rate of business births initially inside the three-decades-plus good reputation for our data. This loss of startup formation has happened in each state and almost all locations, plus each broad industrial sector, including high tech. There has also been 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. Doing this points to a slowdown inside the development of productive entrepreneurship.
Why don’t you consider the opposite type of entrepreneurship? Will we also visit a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to ensure this hypothesis, but there is surely smoke, plus it is available in two forms: rising profits, especially those earned with the largest businesses in the economy, and suggestive evidence of a rise in efforts to shape the rules from the game. This pattern is in conjuction with the rise of economic rents and rent-seeking behavior.
For example, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote an important 2016 paper that argued that economic rents are rising, particularly since 2000, and were a main take into account increasing wage inequality observed during this time period. Similarly, a group of economists from MIT, Harvard, and Zurich found that industries where top firms’ business had most increased had experienced the greatest declines inside the share of greenbacks likely to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income offered to labor, capital, and “profits.” (Normally, capital and earnings are included together in a broad, residual “returns to shareholders” category.) He found that the proportion of greenbacks earned by workers continues to be falling, as others have pointed out, but also that this share earned by capital has, too. Indeed, have been declining whilst the share of greenbacks likely to “markups,” or rents, continues to be increasing.
In reality, a good economic rents on its own doesn’t establish that there’s been a rise in unproductive entrepreneurship. For that to be true, there should be be evidence of a rise in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules from the game in the market.
James Bessen of Boston University provides suggestive evidence that rent-seeking behavior continues to be increasing. Inside a 2016 paper Bessen signifies that, since 2000, “political factors” account for an important the main increase in corporate profits. This takes place 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 relationships to key policy makers have abnormally high stock returns.
In a nutshell, Baumol could have been before his amount of time in warning that economies can suffer not simply coming from a cost disease but also from the entrepreneurial counterpart – changing your the rules 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 have learned to pass. If the U.S. will tackle its many problems, we are going to need to find approaches to encourage would-be entrepreneurs to start out innovative, productive businesses, instead of dedicating their efforts to co-opting government as a way to secure economic advantage.
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