Last month economist William Baumol died with the age of 95. His death was universally mourned by individuals the economics community, most of whom shared the view which he had passed before finding a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly great privilege of working together with him, befriending him, and being able to regularly witness his economic wisdom, even in his final years.
Of Baumol’s many contributions to economics, the most common is cost disease, which is why high-productivity industries raise costs and thus prices in low-productivity industries. The insight is especially relevant now, as economic activity has shifted into low-productivity services like healthcare 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 which is equally relevant today and that could 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 a bad sort of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this degree of entrepreneurial ambition within a country is basically fixed with 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.
Many people imagine Cheap Entrepreneurship Books as the “productive” kind, as Baumol known as it, the place that the companies that founders launch commercialize something totally new or better, benefiting society and themselves in the process. A sizable body of research establishes the “Schumpeterian” entrepreneurs, the ones that are “creatively destroying” the existing and only the newest, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by the unique type of entrepreneur: the “unproductive” ones, who exploit special relationships with all the government to make regulatory moats, secure public spending for own benefit, or bend specific rules for their will, in the process stifling competition to create advantage for firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably along with us and always play some substantial role. But there are a variety of roles among that your entrepreneur’s efforts may be reallocated, and several of those roles usually do not continue with the constructive and innovative script which is conventionally attributed to the face. Indeed, occasionally the entrepreneur may even lead a parasitical existence which is actually damaging towards the economy. How a entrepreneur acts at the with time and put depends heavily around the rules of the game-the reward structure within the economy-that occur to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t at fault 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 loss of productive entrepreneurship and a coincident boost in unproductive entrepreneurship. But is this what’s actually happening within the U.S.?
Well, to begin with, we and others have documented a pervasive loss of the pace of new firm formation throughout the last 3 decades and an acceleration for the reason that decline since 2000. Actually, we found that by 2009 the pace of commercial closures exceeded the pace of commercial births initially within the three-decades-plus good our data. This loss of startup formation has occurred in each state and virtually all urban centers, 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 firms that are the cause of the lion’s share of net job gains. All this suggests a slowdown within the expansion of productive entrepreneurship.
What about the other sort of entrepreneurship? Will we also go to a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to substantiate this hypothesis, but there is surely smoke, and it also comes in two forms: rising profits, particularly those earned by the largest businesses throughout the market, and suggestive proof of more efforts to shape the policies of the game. This pattern is consistent with the rise of monetary rents and rent-seeking behavior.
As an 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 on the rise, particularly since 2000, and were a central element in increasing wage inequality observed in those times. Similarly, a small grouping of economists from MIT, Harvard, and Zurich found that industries where top firms’ business had most increased had experienced the most important declines within the share of income planning to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income offered to labor, capital, and “profits.” (Normally, capital and income is included together in a single broad, residual “returns to shareholders” category.) He found that the share of income earned by workers may be falling, as others have talked about, but additionally that this share earned by capital has, too. Indeed, have been declining as the share of income planning to “markups,” or rents, may be increasing.
In reality, the presence of economic rents by itself doesn’t establish that there’s been more unproductive entrepreneurship. To the to be true, there should be be proof of more rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules of the game within a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior may be increasing. In a 2016 paper Bessen signifies that, since 2000, “political factors” are the cause of a considerable 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 found that companies that have executives with relationships to key policy makers have abnormally high stock returns.
To put it briefly, Baumol was ahead of his period in warning that economies can suffer not merely from your cost disease but additionally from the entrepreneurial counterpart – a change in the policies that shifts the distribution of entrepreneurial effort from activity that assists the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings have learned to pass. When the U.S. will tackle its many problems, we’re going to need to find methods to encourage would-be entrepreneurs to get started on innovative, productive businesses, rather than dedicating their efforts to co-opting government to be able to secure economic advantage.
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