A few weeks ago economist William Baumol passed away on the ages of 95. His death was universally mourned by folks the economics community, most of whom shared the vista which he had passed before buying a much-deserved Nobel Prize. Among us (Robert) had the truly amazing privilege of working together with him, befriending him, and being able to regularly witness his economic wisdom, even during his later years.
Of Baumol’s many contributions to economics, the best is cost disease, which is the reason high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is particularly 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 overwhelmed U.S. productivity growth overall.
But there’s a lesser-known thought of Baumol’s that is certainly equally relevant today understanding that can help explain America’s productivity slump. Baumol’s writing enhances the possibility that U.S. productivity is low because would-be entrepreneurs are devoted to the incorrect type of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the amount of entrepreneurial ambition in the country is actually fixed after a while, 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 people imagine Kogan Page Entrepreneurship Books as the “productive” kind, as Baumol known it, in which the businesses that founders launch commercialize a new challenge or better, benefiting society and themselves along the way. A big body of research establishes that these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the old and only the modern, are critical for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, with a different type of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to create regulatory moats, secure public spending for their own benefit, or bend specific rules with their will, along the way stifling competition to produce advantage for their firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are always here and constantly play some substantial role. But there are a variety of roles among that the entrepreneur’s efforts may be reallocated, plus some of those roles usually do not keep to the constructive and innovative script that is certainly conventionally due to that individual. Indeed, sometimes the entrepreneur could even lead a parasitical existence that is certainly actually damaging to the economy. How a entrepreneur acts in a given time make depends heavily about 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, a change in this mixture of entrepreneurial effort between the two forms of entrepreneurship is usually to blame – specifically, a decline in productive entrepreneurship plus a coincident rise in unproductive entrepreneurship. But are these claims what’s actually happening inside the U.S.?
Well, to begin with, we and others have documented a pervasive decline in the interest rate of recent firm formation during the last thirty years as well as an acceleration in that decline since 2000. In fact, we learned that by 2009 the interest rate of business closures exceeded the interest rate of business births for the first time inside the three-decades-plus history of our data. This decline in startup formation has happened each state and nearly all urban centers, plus each broad industrial sector, including high tech. There has been a slowdown in activity of high-growth firms, the relatively very few firms that be the cause of the lion’s share of net job gains. This points to a slowdown inside the growth of productive entrepreneurship.
What about the other type of entrepreneurship? Will we also see a rise in unproductive entrepreneurship, as Baumol theorized?
We don’t possess a smoking gun to confirm this hypothesis, but there surely is smoke, plus it is available in two forms: rising profits, especially those earned through the largest businesses throughout the economy, and suggestive proof of an increase in efforts to shape the rules from the game. This pattern is in conjuction with the rise of monetary rents and rent-seeking behavior.
For 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 main aspect in increasing wage inequality observed during this 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 biggest declines inside the share of greenbacks 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 earnings are included together in a broad, residual “returns to shareholders” category.) He learned that the share of greenbacks earned by workers has been falling, as others have pointed out, but in addition how the share earned by capital has, too. Indeed, both have been declining while the share of greenbacks likely to “markups,” or rents, has been increasing.
In reality, the use of economic rents by itself doesn’t establish that there’s been an increase in unproductive entrepreneurship. For your really was, there should be be proof of an increase 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 offers suggestive evidence that rent-seeking behavior has been increasing. In a 2016 paper Bessen demonstrates that, since 2000, “political factors” be the cause of a substantial the main surge in corporate profits. This happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang from the University of Illinois have discovered that businesses that have executives with relationships to key policy makers have abnormally high stock returns.
In short, Baumol might have been in advance of his amount of time in warning that economies can suffer not merely from a cost disease but in addition by reviewing the entrepreneurial counterpart – a change in the rules 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 learned to pass. When the U.S. will tackle its many problems, we’re going to must find approaches to encourage would-be entrepreneurs to start innovative, productive businesses, rather than dedicating their efforts to co-opting government so that you can secure economic advantage.
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