Last month economist William Baumol died on the ages of 95. His death was universally mourned by members of the economics community, lots of whom shared the vista which he had passed before finding a much-deserved Nobel Prize. Certainly one of us (Robert) had the fantastic 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 most famous is cost disease, which is why high-productivity industries raise costs and so prices in low-productivity industries. The insight is very relevant now, as business activities 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 and that could help explain America’s productivity slump. Baumol’s writing raises the possibility that U.S. productivity is low because would-be entrepreneurs are dedicated to the wrong form of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the level of entrepreneurial ambition inside a country is essentially fixed after a while, and that what determines a nation’s entrepreneurial output may be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
A lot of people think of Buy Entrepreneurship Books as the “productive” kind, as Baumol known it, the place that the firms that founders launch commercialize something new or better, benefiting society and themselves in the act. A sizable body of research establishes that these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the existing and only the new, are critical for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by a completely different form 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 to their will, in the act stifling competition to make advantage for their firms. Economists refer to this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be around try to play some substantial role. But there are a number of roles among that this entrepreneur’s efforts may be reallocated, and several of people roles tend not to keep to the constructive and innovative script that is certainly conventionally related to the face. Indeed, occasionally the entrepreneur might even lead a parasitical existence that is certainly actually damaging towards the economy. How the entrepreneur acts at a given time and put depends heavily for the rules of the game-the reward structure within the economy-that happen to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a modification of the amalgamation of entrepreneurial effort backward and forward types of entrepreneurship is always to blame – specifically, a decline in productive entrepreneurship and a coincident increase in unproductive entrepreneurship. But are these claims what’s actually happening within the U.S.?
Well, for starters, we yet others have documented a pervasive decline in the rate of new firm formation during the last three decades as well as an acceleration for the reason that decline since 2000. The truth is, we learned that by 2009 the rate of economic closures exceeded the rate of economic births for the first time within the three-decades-plus good our data. This decline in startup formation has took place each state and the majority of towns, along with each broad industrial sector, including modern day. There has also been a slowdown in activity of high-growth firms, the relatively very few firms that take into account the lion’s share of net job gains. All this points to a slowdown within the growth of productive entrepreneurship.
Why don’t you consider the opposite form of entrepreneurship? Do we also view a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to ensure this hypothesis, but there is surely smoke, and it comes in two forms: rising profits, specially those earned by the largest businesses in the economy, and suggestive evidence more efforts to shape the policies of the game. This pattern is like rise of monetary rents and rent-seeking behavior.
For instance, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote an important 2016 paper that argued that economic rents are rising, particularly since 2000, and were a main aspect in increasing wage inequality observed during this time. Similarly, a small grouping 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 planning to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income provided to labor, capital, and “profits.” (Normally, capital and profits are included together a single broad, residual “returns to shareholders” category.) He learned that the share of capital earned by workers has become falling, as others have stated, but additionally the share earned by capital has, too. Indeed, both have been declining even though the share of capital planning to “markups,” or rents, has become increasing.
In reality, the existence of economic rents by itself doesn’t establish that there’s been more unproductive entrepreneurship. With the really was, there needs to be be evidence more rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules of the game inside a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has become increasing. In a 2016 paper Bessen shows that, since 2000, “political factors” take into account a substantial part of the rise in corporate profits. Such a thing happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang of the University of Illinois have found that firms that have executives with relationships to key policy makers have abnormally high stock returns.
To put it briefly, Baumol could have been before his amount of time in warning that economies can suffer not just from the cost disease but additionally by reviewing the entrepreneurial counterpart – a modification of the policies that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there’s strong suggestive evidence that Baumol’s warnings have learned to pass. In the event the U.S. is going to tackle its many problems, we intend to have to find ways to encourage would-be entrepreneurs to get started on innovative, productive businesses, instead of dedicating their efforts to co-opting government so that you can secure economic advantage.
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