Last week economist William Baumol passed away on the ages of 95. His death was universally mourned by folks the economics community, a lot of whom shared the scene which he had passed before buying a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly amazing privilege of utilizing him, befriending him, and being able to regularly witness his economic wisdom, even in his retirement years.
Of Baumol’s many contributions to economics, the most famous is cost disease, which is why high-productivity industries raise costs and thus prices in low-productivity industries. The insight is especially 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 concept of Baumol’s which is equally relevant today knowning that might 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 an unacceptable type of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this a higher level entrepreneurial ambition inside a country is basically fixed after a while, 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.
A lot of people think of Entrepreneurship Books beeing the “productive” kind, as Baumol described it, in which the firms that founders launch commercialize something new or better, benefiting society and themselves in the operation. A considerable body of research establishes that these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the previous and only the modern, are critical for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, with a completely different form of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to make regulatory moats, secure public spending for his or her own benefit, or bend specific rules with their will, in the operation stifling competition to create advantage for his or her firms. Economists know this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs are always with us and always play some substantial role. But there are a selection of roles among which the entrepreneur’s efforts could be reallocated, and some of those roles don’t follow the constructive and innovative script which is conventionally attributed to the face. Indeed, sometimes the entrepreneur may even lead a parasitical existence which is actually damaging towards the economy. How a entrepreneur acts with a with time make depends heavily about the rules with 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 the mix of entrepreneurial effort backward and forward kinds of entrepreneurship would be to blame – specifically, a decline in productive entrepreneurship as well as a coincident surge in unproductive entrepreneurship. But is what’s actually happening inside the U.S.?
Well, first of all, we and others have documented a pervasive decline in the rate of new firm formation over the past thirty years plus an acceleration in this decline since 2000. The truth is, we discovered that by 2009 the rate of economic closures exceeded the rate of economic births for the first time inside the three-decades-plus good reputation for our data. This decline in startup formation has happened each state and almost all towns, plus each broad industrial sector, including hi-tech. There has also been a slowdown in activity of high-growth firms, the relatively few companies that take into account the lion’s share of net job gains. This points to a slowdown inside the development of productive entrepreneurship.
How about the opposite type of entrepreneurship? Do we also see a surge in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to confirm this hypothesis, but there is surely smoke, plus it is available in two forms: rising profits, specially those earned with the largest businesses in the economy, and suggestive proof of a rise in efforts to shape the guidelines with the game. This pattern is in conjuction with the rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote an important 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a main factor in increasing wage inequality observed during this period. Similarly, several economists from MIT, Harvard, and Zurich discovered that industries where top firms’ business had most increased had experienced the largest declines inside the share of greenbacks gonna 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 income is included together in one broad, residual “returns to shareholders” category.) He discovered that the share of greenbacks earned by workers may be falling, as others have talked about, but also that this share earned by capital has, too. Indeed, have been declining even though the share of greenbacks gonna “markups,” or rents, may be increasing.
To be clear, the existence of economic rents alone doesn’t establish that there’s been a rise in unproductive entrepreneurship. To the to be true, there has to be be proof of a rise in rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules with the game inside a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior may be increasing. In a 2016 paper Bessen implies that, since 2000, “political factors” take into account a substantial part of the boost in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang with the University of Illinois are finding that firms that have executives with partners to key policy makers have abnormally high stock returns.
In a nutshell, Baumol was ahead of his in time warning that economies can suffer not merely coming from a cost disease but also by reviewing the entrepreneurial counterpart – a change in the guidelines that shifts the distribution of entrepreneurial effort from activity which enables the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings have learned to pass. In the event the U.S. will tackle its many problems, we will 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 to be able to secure economic advantage.
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