Last week economist William Baumol passed on in the ages of 95. His death was universally mourned by members of the economics community, a lot of whom shared the scene which he had passed before receiving a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly amazing privilege of dealing with him, befriending him, and being able to regularly witness his economic wisdom, even in his old age.
Of Baumol’s many contributions to economics, the best is cost disease, which explains why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is especially relevant now, as economic activity 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 weighed down U.S. productivity growth overall.
But there’s a lesser-known thought of Baumol’s that is equally relevant today understanding that 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 the wrong type of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the a higher level entrepreneurial ambition in a country it’s essentially fixed as time passes, understanding that what determines a nation’s entrepreneurial output may be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Many people consider Cheap Entrepreneurship Books beeing the “productive” kind, as Baumol known it, where the businesses that founders launch commercialize a new challenge or better, benefiting society and themselves in the act. A substantial body of research establishes the “Schumpeterian” entrepreneurs, the ones that are “creatively destroying” the existing for the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by a different kind of entrepreneur: the “unproductive” ones, who exploit special relationships with all the government to create regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the act stifling competition to generate advantage for their firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be along with us and try to play some substantial role. But there are a variety of roles among that your entrepreneur’s efforts may be reallocated, plus some of people roles tend not to keep to the constructive and innovative script that is conventionally due to that individual. Indeed, at times the entrepreneur might lead a parasitical existence that is actually damaging for the economy. What sort of entrepreneur acts with a given time and set depends heavily for the rules in the game-the reward structure inside the economy-that get lucky and prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a change in a combination of entrepreneurial effort between the two kinds of entrepreneurship is always to blame – specifically, a decline in productive entrepreneurship plus a coincident boost in unproductive entrepreneurship. But are these claims what’s actually happening inside the U.S.?
Well, for starters, we yet others have documented a pervasive decline in the interest rate of recent firm formation over the past three decades as well as an acceleration in this decline since 2000. The truth is, we found that by 2009 the interest rate of business closures exceeded the interest rate of business births for the first time inside the three-decades-plus good reputation for our data. This decline in startup formation has occurred in each state and virtually all locations, along with each broad industrial sector, including advanced. There has also 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. Doing this exactly what to a slowdown inside the expansion of productive entrepreneurship.
Why don’t you consider the opposite type of entrepreneurship? Will we also visit a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to substantiate this hypothesis, but there surely is smoke, and yes it will come in two forms: rising profits, in particular those earned from the largest businesses throughout the market, and suggestive proof of a rise in efforts to shape the policies in the game. This pattern is consistent with the rise of monetary rents and rent-seeking behavior.
For example, Jason Furman and Peter Orszag, both former economic advisers to The president, wrote a disciplined 2016 paper that argued that economic rents are rising, particularly since 2000, and were a main element in increasing wage inequality observed in those times. Similarly, a group of economists from MIT, Harvard, and Zurich found that industries where top firms’ business had most increased had experienced the biggest declines inside the share of greenbacks likely to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income offered to labor, capital, and “profits.” (Normally, capital and earnings are included together in one broad, residual “returns to shareholders” category.) He found that the proportion of greenbacks earned by workers may be falling, as others have stated, but also how the share earned by capital has, too. Indeed, have been declining as the share of greenbacks likely to “markups,” or rents, may be increasing.
In reality, the presence of economic rents on its own doesn’t establish that there’s been a rise in unproductive entrepreneurship. For that actually was, there has to be be proof of a rise in rent-seeking – that is, concerted efforts to stifle competition by influencing the reward structure or rules in the game in a market.
James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior may be increasing. In the 2016 paper Bessen shows that, since 2000, “political factors” account for a considerable area of the increase 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 businesses that have executives with close ties to key policy makers have abnormally high stock returns.
In short, Baumol was in advance of his time in warning that economies can suffer not merely coming from a cost disease but also from the entrepreneurial counterpart – a change in the policies that shifts the distribution of entrepreneurial effort from activity that assists the economy toward activity that hurts it. Unfortunately, there is certainly strong suggestive evidence that Baumol’s warnings have learned to pass. In the event the U.S. will almost certainly tackle its many problems, we intend to have to find methods to encourage would-be entrepreneurs to get started on innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government so that you can secure economic advantage.
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