Last week economist William Baumol passed away in the day of 95. His death was universally mourned by members of the economics community, a lot of whom shared the view which he had passed before finding a much-deserved Nobel Prize. One among us (Robert) had the fantastic privilege of working with him, befriending him, or being able to regularly witness his economic wisdom, during his retirement years.
Of Baumol’s many contributions to economics, the most common is cost disease, which is the reason high-productivity industries raise costs and so prices in low-productivity industries. The insight is especially relevant now, as business activities has shifted into low-productivity services like health 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 idea of Baumol’s which is equally relevant today knowning that may help explain America’s productivity slump. Baumol’s writing adds to the possibility that U.S. productivity is low because would-be entrepreneurs are dedicated to the incorrect type of work.
Within a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the a higher level entrepreneurial ambition in the country is basically fixed with time, knowning that what determines a nation’s entrepreneurial output will be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most of the people think of Entrepreneurship Books Online as the “productive” kind, as Baumol referred to it, the location where the firms that founders launch commercialize something new or better, benefiting society and themselves in the process. A substantial body of research establishes these “Schumpeterian” entrepreneurs, those who are “creatively destroying” that old for the modern, are critical for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by way of a completely different sort of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to construct regulatory moats, secure public spending for own benefit, or bend specific rules to their will, in the process stifling competition to produce advantage for firms. Economists refer to this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be here try to play some substantial role. But there are a variety of roles among that the entrepreneur’s efforts can be reallocated, and several of these roles usually do not stick to the constructive and innovative script which is conventionally due to see your face. Indeed, occasionally the entrepreneur could even lead a parasitical existence which is actually damaging towards the economy. What sort of entrepreneur acts at a given time and place depends heavily about the rules in the game-the reward structure in the economy-that occur 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 a combination of entrepreneurial effort between the two forms of entrepreneurship is usually to blame – specifically, a decline in productive entrepreneurship along with a coincident increase in unproductive entrepreneurship. But are these claims what’s actually happening in the U.S.?
Well, first of all, we while others have documented a pervasive decline in the speed of new firm formation during the last 30 years as well as an acceleration in this decline since 2000. In fact, we found that by 2009 the speed of economic closures exceeded the speed of economic births the very first time in the three-decades-plus history of our data. This decline in startup formation has happened each state and virtually all locations, as well as in each broad industrial sector, including high tech. We are seeing a slowdown in activity of high-growth firms, the relatively small number of firms that take into account the lion’s share of net job gains. This exactly what to a slowdown in the development of productive entrepreneurship.
How about one other type of entrepreneurship? Do we also visit a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to verify this hypothesis, but there is smoke, also it also comes in two forms: rising profits, especially those earned from the largest businesses for the overall design, and suggestive proof more efforts to shape the principles in the game. This pattern is like rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote a disciplined 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 period. Similarly, a small grouping of economists from MIT, Harvard, and Zurich found that industries where top firms’ share of the market had most increased had experienced the largest declines in the share of capital likely 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 profits are included together in a broad, residual “returns to shareholders” category.) He found that the share of capital earned by workers may be falling, as others have described, and also that the share earned by capital has, too. Indeed, both have been declining even though the share of capital likely to “markups,” or rents, may be increasing.
In reality, the use of economic rents on it’s own doesn’t establish that there’s been more unproductive entrepreneurship. With the to be true, there should be be proof more rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules in the game in the market.
James Bessen of Boston University presents suggestive evidence that rent-seeking behavior may be increasing. Within a 2016 paper Bessen signifies that, since 2000, “political factors” take into account an amazing part of the surge in corporate profits. This happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang in the University of Illinois have discovered that firms that have executives with relationships to key policy makers have abnormally high stock returns.
To put it briefly, Baumol was in front of his period in warning that economies can suffer not merely from your cost disease and also looking at the entrepreneurial counterpart – a modification of the principles that shifts the distribution of entrepreneurial effort from activity that helps the economy toward activity that hurts it. Unfortunately, there’s strong suggestive evidence that Baumol’s warnings began to pass. If the U.S. will almost certainly tackle its many problems, we are going to need to find methods 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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