Last week economist William Baumol died at the ages of 95. His death was universally mourned by individuals the economics community, most of whom shared the scene that they had passed before buying a much-deserved Nobel Prize. Certainly one of us (Robert) had the fantastic 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 thus prices in low-productivity industries. The insight is very relevant now, as economic activity has shifted into low-productivity services like medical care 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 notion of Baumol’s that is equally relevant today understanding 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 dedicated to a bad sort of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the level of entrepreneurial ambition within a country is actually fixed after a while, understanding that what determines a nation’s entrepreneurial output could be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most of the people imagine Entrepreneurship Books being the “productive” kind, as Baumol referred to it, where the businesses that founders launch commercialize a new challenge or better, benefiting society and themselves in the process. A substantial body of research establishes why these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the old for the new, are critical for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, by way of a different type of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to make regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the process stifling competition to produce advantage for their firms. Economists label 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 number of roles among that this entrepreneur’s efforts could be reallocated, and several of people roles tend not to continue with the constructive and innovative script that is conventionally related to that person. Indeed, occasionally the entrepreneur might even lead a parasitical existence that is actually damaging towards the economy. What sort of entrepreneur acts with a given time and place depends heavily about the rules from the game-the reward structure in the economy-that occur to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, changing your the mix of entrepreneurial effort between the two kinds of entrepreneurship is usually to blame – specifically, a loss of productive entrepreneurship as well as 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 loss of the pace of recent firm formation throughout the last 3 decades and an acceleration in this decline since 2000. Actually, we learned that by 2009 the pace of economic closures exceeded the pace of economic births the first time in the three-decades-plus history of our data. This loss of startup formation has occurred in each state and almost all urban centers, as well as in each broad industrial sector, including high tech. There has 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 in the development of productive entrepreneurship.
Think about the opposite sort of entrepreneurship? Do we also view a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to substantiate this hypothesis, but there is smoke, also it will come in two forms: rising profits, especially those earned with the largest businesses for the overall design, and suggestive proof of more efforts to shape the principles from the game. This pattern is like rise of monetary rents and rent-seeking behavior.
For example, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote an influential 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a main take into account increasing wage inequality observed during this time. Similarly, a gaggle of economists from MIT, Harvard, and Zurich learned that industries where top firms’ share of the market had most increased had experienced the most important declines in the share of capital gonna workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income distributed to labor, capital, and “profits.” (Normally, capital and profits are included together a single broad, residual “returns to shareholders” category.) He learned that the proportion of capital earned by workers has been falling, as others have stated, but in addition how the share earned by capital has, too. Indeed, both have been declining as the share of capital gonna “markups,” or rents, has been increasing.
To be clear, the use of economic rents alone doesn’t establish that there’s been more unproductive entrepreneurship. For that to be real, there needs to be be proof of more rent-seeking – that is, concerted efforts to stifle competition by influencing the reward structure or rules from the game within a market.
James Bessen of Boston University provides suggestive evidence that rent-seeking behavior has been increasing. In a 2016 paper Bessen shows that, since 2000, “political factors” account for an amazing part 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 realized that businesses that have executives with close ties to key policy makers have abnormally high stock returns.
In short, Baumol could have been in advance of his in time warning that economies can suffer not only from a cost disease but in addition by reviewing the entrepreneurial counterpart – changing your the principles 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 began to pass. In the event the U.S. will almost certainly tackle its many problems, we are going to must find ways to encourage would-be entrepreneurs to start innovative, productive businesses, as opposed to dedicating their efforts to co-opting government as a way to secure economic advantage.
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