Recently economist William Baumol passed away on the ages of 95. His death was universally mourned by members of the economics community, a lot of whom shared the scene which he had passed before getting a much-deserved Nobel Prize. One among us (Robert) had the truly great privilege of working together with him, befriending him, and being able to regularly witness his economic wisdom, during his retirement years.
Of Baumol’s many contributions to economics, the favourite is cost disease, which is why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is very 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 thought of Baumol’s that is certainly equally relevant today which could help explain America’s productivity slump. Baumol’s writing raises the possibility that U.S. productivity is low because would-be entrepreneurs are centered on the incorrect sort of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the amount of entrepreneurial ambition within a country is essentially fixed over 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.
Many people consider Entrepreneurship Books being the “productive” kind, as Baumol known it, where the companies which founders launch commercialize something new or better, benefiting society and themselves in the act. A considerable body of research establishes the “Schumpeterian” entrepreneurs, those who are “creatively destroying” that old in favor of the newest, are critical for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, by way of a unique type of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to create regulatory moats, secure public spending because of their own benefit, or bend specific rules to their will, in the act stifling competition to create advantage because of their firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be with us and try to play some substantial role. But there are a selection of roles among that the entrepreneur’s efforts may be reallocated, plus some of these roles tend not to keep to the constructive and innovative script that is certainly conventionally due to see your face. Indeed, from time to time the entrepreneur could even lead a parasitical existence that is certainly actually damaging on the economy. How the entrepreneur acts in a given time and set depends heavily about 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 at fault for periods of slow economic growth; rather, changing your a combination of entrepreneurial effort between the two kinds of entrepreneurship would be to blame – specifically, a decline in productive entrepreneurship plus a coincident boost in unproductive entrepreneurship. But is that this what’s actually happening in the U.S.?
Well, to begin with, we among others have documented a pervasive decline in the interest rate of the latest firm formation throughout the last 3 decades as well as an acceleration in that decline since 2000. The truth is, we found that by 2009 the interest rate of commercial closures exceeded the interest rate of commercial births the very first time in the three-decades-plus reputation our data. This decline in startup formation has happened in each state and nearly all locations, plus each broad industrial sector, including modern day. There has been a slowdown in activity of high-growth firms, the relatively few companies that be the cause of the lion’s share of net job gains. This points to a slowdown in the increase of productive entrepreneurship.
Why don’t you consider the opposite sort of entrepreneurship? Will we also visit a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t have a very smoking gun to ensure this hypothesis, but there surely is smoke, and yes it comes in two forms: rising profits, specially those earned by the largest businesses in the economy, and suggestive proof of a boost in efforts to shape the principles from the game. This pattern is in conjuction with the rise of economic rents and rent-seeking behavior.
For instance, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an influential 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central take into account increasing wage inequality observed during this time. Similarly, a group of economists from MIT, Harvard, and Zurich found that industries where top firms’ business had most increased had experienced the largest declines in the share of greenbacks likely to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income given to labor, capital, and “profits.” (Normally, capital and profits are included together in a broad, residual “returns to shareholders” category.) He found that the proportion of greenbacks earned by workers has become falling, as others have talked about, but in addition the share earned by capital has, too. Indeed, have been declining even though the share of greenbacks likely to “markups,” or rents, has become increasing.
To be clear, a good economic rents on its own doesn’t establish that there’s been a boost in unproductive entrepreneurship. To the to be real, there needs to be be proof of a boost in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules from the game within a market.
James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior has become increasing. In a 2016 paper Bessen signifies that, since 2000, “political factors” be the cause of a considerable area of the 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 found that companies which have executives with partners to key policy makers have abnormally high stock returns.
Simply speaking, Baumol may have been in advance of his in time warning that economies can suffer not simply from the cost disease but in addition from the entrepreneurial counterpart – changing your the principles that shifts the distribution of entrepreneurial effort from activity that helps the economy toward activity that hurts it. Unfortunately, there is certainly strong suggestive evidence that Baumol’s warnings have started to pass. When the U.S. is going to tackle its many problems, we will have to find methods to encourage would-be entrepreneurs to begin innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government as a way to secure economic advantage.
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