Last month economist William Baumol passed away in the chronilogical age of 95. His death was universally mourned by people in the economics community, lots of whom shared the scene which he had passed before receiving a much-deserved Nobel Prize. One among us (Robert) had the great privilege of working with him, befriending him, and being able to regularly witness his economic wisdom, even during his old age.
Of Baumol’s many contributions to economics, the best is cost disease, which is why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is particularly 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 weighed down U.S. productivity growth overall.
But there’s a lesser-known concept of Baumol’s that is certainly equally relevant today knowning 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 focused on the incorrect kind of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the amount of entrepreneurial ambition in a country is basically fixed over time, knowning 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 people think about Buy Entrepreneurship Books as the “productive” kind, as Baumol known as it, in which the businesses that founders launch commercialize new things or better, benefiting society and themselves in the process. A big body of research establishes these “Schumpeterian” entrepreneurs, people who are “creatively destroying” that old in support of the brand new, are critical for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by a unique kind 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 with their will, in the process stifling competition to generate advantage for firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will always be along with us and constantly play some substantial role. But there are a selection of roles among which the entrepreneur’s efforts might be reallocated, and several of these roles usually do not stick to the constructive and innovative script that is certainly conventionally due to that person. Indeed, sometimes the entrepreneur may even lead a parasitical existence that is certainly actually damaging to the economy. How the entrepreneur acts in a given time and set depends heavily about the rules in the game-the reward structure within the economy-that happen to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t at fault for periods of slow economic growth; rather, a modification of this mixture of entrepreneurial effort between the two types of entrepreneurship would be to blame – specifically, a loss of productive entrepreneurship and a coincident boost in unproductive entrepreneurship. But is what’s actually happening within the U.S.?
Well, for starters, we while others have documented a pervasive loss of the rate of new firm formation over the last three decades as well as an acceleration in this decline since 2000. In fact, we learned that by 2009 the rate of commercial closures exceeded the rate of commercial births for the first time within the three-decades-plus reputation our data. This loss of startup formation has happened in each state and virtually all urban centers, as well as in each broad industrial sector, including advanced. We are seeing a slowdown in activity of high-growth firms, the relatively very few businesses that be the cause of the lion’s share of net job gains. All of this exactly what to a slowdown within the increase of productive entrepreneurship.
Why don’t you consider the opposite kind of entrepreneurship? Can we also view 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 it will come in two forms: rising profits, especially those earned through the largest businesses in the economy, and suggestive evidence of a boost in efforts to shape the policies in 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 influential 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central aspect in increasing wage inequality observed in those times. Similarly, a group of economists from MIT, Harvard, and Zurich learned that industries where top firms’ business had most increased had experienced the largest declines within the share of capital going to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income distributed to labor, capital, and “profits.” (Normally, capital and income is included together in a broad, residual “returns to shareholders” category.) He learned that the share of capital earned by workers has been falling, as others have talked about, but additionally the share earned by capital has, too. Indeed, have been declining as the share of capital going to “markups,” or rents, has been increasing.
To be clear, the presence of economic rents on it’s own doesn’t establish that there’s been a boost in unproductive entrepreneurship. For that actually was, there should be be evidence of a boost in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules in the game in a market.
James Bessen of Boston University provides suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen shows that, since 2000, “political factors” be the cause of a considerable the main boost in corporate profits. This takes place through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang in the University of Illinois are finding that businesses that have executives with close ties to key policy makers have abnormally high stock returns.
To put it briefly, Baumol might have been in front of his period in warning that economies can suffer not only coming from a cost disease but additionally from the entrepreneurial counterpart – a modification of the policies 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. If your U.S. will tackle its many problems, we are going to need to find approaches to encourage would-be entrepreneurs to get started on innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government to be able to secure economic advantage.
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