Last week economist William Baumol died on the chronilogical age of 95. His death was universally mourned by members of the economics community, most of whom shared the vista that they had passed before buying a much-deserved Nobel Prize. One of us (Robert) had the fantastic privilege of utilizing him, befriending him, and being able to regularly witness his economic wisdom, even 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 medical 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 which may help explain America’s productivity slump. Baumol’s writing improves the possibility that U.S. productivity is low because would-be entrepreneurs are centered on an unacceptable sort of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the degree of entrepreneurial ambition in a country it’s essentially fixed after a while, which 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 think of Cheap Entrepreneurship Books as being the “productive” kind, as Baumol referred to it, where the businesses that founders launch commercialize something totally new or better, benefiting society and themselves in the operation. A big body of research establishes these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the old in support of the newest, are critical for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by the very different type of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to make regulatory moats, secure public spending for their own benefit, or bend specific rules with their will, in the operation stifling competition to generate advantage for their firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will always be along with us try to play some substantial role. But there are a selection of roles among that your entrepreneur’s efforts might be reallocated, plus some of people roles don’t continue with the constructive and innovative script that is certainly conventionally caused by the face. Indeed, sometimes the entrepreneur may even lead a parasitical existence that is certainly actually damaging to the economy. What sort of entrepreneur acts at a given time make depends heavily for the rules from the game-the reward structure in the economy-that eventually prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, a general change in the amalgamation of entrepreneurial effort backward and forward types of entrepreneurship is to blame – specifically, a decline in productive entrepreneurship as well as a coincident surge in unproductive entrepreneurship. But is this what’s actually happening in the U.S.?
Well, to begin with, we while others have documented a pervasive decline in the interest rate of latest firm formation during the last 3 decades plus an acceleration because decline since 2000. Actually, we learned that by 2009 the interest rate of commercial closures exceeded the interest rate of commercial births the first time in the three-decades-plus history of our data. This decline in startup formation has happened in each state and nearly all urban centers, along with each broad industrial sector, including advanced. There has been a slowdown in activity of high-growth firms, the relatively very few businesses that account for the lion’s share of net job gains. All this points to a slowdown in the expansion of productive entrepreneurship.
How about the opposite sort of entrepreneurship? Do we also visit a surge in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to verify this hypothesis, but there is smoke, and yes it will come in two forms: rising profits, in particular those earned through the largest businesses in the economy, and suggestive evidence of more efforts to shape the principles from the game. This pattern is in conjuction with the rise of economic rents and rent-seeking behavior.
For example, Jason Furman and Peter Orszag, both former economic advisers to President Obama, wrote a disciplined 2016 paper that argued that economic rents are rising, particularly since 2000, and were a central element in increasing wage inequality observed in those times. 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 biggest declines in the share of income going 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 earnings are included together a single broad, residual “returns to shareholders” category.) He learned that the proportion of income earned by workers has been falling, as others have talked about, and also that the share earned by capital has, too. Indeed, both have been declining as the share of income going to “markups,” or rents, has been increasing.
In reality, a good economic rents on its own doesn’t establish that there’s been more unproductive entrepreneurship. With the really was, there should be be evidence of more rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules from the game in a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has been increasing. Inside a 2016 paper Bessen shows that, since 2000, “political factors” account for an amazing section of the rise 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 realized that businesses that have executives with relationships to key policy makers have abnormally high stock returns.
In short, Baumol may have been in advance of his time in warning that economies can suffer not just from your cost disease and also from the entrepreneurial counterpart – a general change in the principles that shifts the distribution of entrepreneurial effort from activity that assists the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings began to pass. If your U.S. will probably tackle its many problems, we’re going to must find ways to encourage would-be entrepreneurs to get started on innovative, productive businesses, rather than dedicating their efforts to co-opting government so that you can secure economic advantage.
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