Recently economist William Baumol passed on with the day of 95. His death was universally mourned by individuals the economics community, most of whom shared the scene which he had passed before finding a much-deserved Nobel Prize. 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 just in his later years.
Of Baumol’s many contributions to economics, the favourite is cost disease, which explains why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is specially 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 certainly equally relevant today and 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 centered on an unacceptable form of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the level of entrepreneurial ambition within a country is essentially fixed after a while, and that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Many people imagine Entrepreneurship Books as the “productive” kind, as Baumol known as it, where the companies which founders launch commercialize something totally new or better, benefiting society and themselves in the process. A considerable body of research establishes the “Schumpeterian” entrepreneurs, the ones that are “creatively destroying” the old in support of the modern, are critical for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, by a unique form of entrepreneur: the “unproductive” ones, who exploit special relationships with all the government to develop regulatory moats, secure public spending for his or her own benefit, or bend specific rules for their will, in the process stifling competition to generate advantage for his or her firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are always around and try to play some substantial role. But there are a selection of roles among that this entrepreneur’s efforts can be reallocated, and some of people roles usually do not follow the constructive and innovative script that is certainly conventionally attributed to the face. Indeed, occasionally the entrepreneur could even lead a parasitical existence that is certainly actually damaging to the economy. How a entrepreneur acts at a with time and put depends heavily around the rules with 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 the amalgamation of entrepreneurial effort forwards and backwards types of entrepreneurship is always to blame – specifically, a decline in productive entrepreneurship and a coincident surge in unproductive entrepreneurship. But is what’s actually happening in the U.S.?
Well, first of all, we and others have documented a pervasive decline in the pace of the latest firm formation over the last thirty years with an acceleration for the reason that decline since 2000. Actually, we learned that by 2009 the pace of economic closures exceeded the pace of economic births the very first time in the three-decades-plus good reputation for our data. This decline in startup formation has happened in each state and almost all towns, and in each broad industrial sector, including hi-tech. There has been a slowdown in activity of high-growth firms, the relatively very few companies that take into account the lion’s share of net job gains. Doing this items to a slowdown in the increase of productive entrepreneurship.
Why don’t you consider the other form of entrepreneurship? Will we also view a surge in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to confirm this hypothesis, but there surely is smoke, also it is available in two forms: rising profits, in particular those earned from the largest businesses throughout the market, and suggestive proof a boost in efforts to shape the principles with the game. This pattern is similar to the rise of monetary rents and rent-seeking behavior.
For instance, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote a disciplined 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central element in increasing wage inequality observed in those times. Similarly, a small grouping of economists from MIT, Harvard, and Zurich learned that industries where top firms’ business had most increased had experienced the most important declines in the share of income 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 profits are included together in a broad, residual “returns to shareholders” category.) He learned that the share of income earned by workers has been falling, as others have described, and also the share earned by capital has, too. Indeed, both have been declining whilst the share of income gonna “markups,” or rents, has been increasing.
To be clear, a good economic rents alone doesn’t establish that there’s been a boost in unproductive entrepreneurship. With the to be true, there should be be proof a boost in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules with the game within a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen demonstrates that, since 2000, “political factors” take into account a considerable section of the rise in corporate profits. This happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang with the University of Illinois are finding that companies which have executives with close ties to key policy makers have abnormally high stock returns.
In a nutshell, Baumol was before his in time warning that economies can suffer not simply coming from a cost disease and also by reviewing the entrepreneurial counterpart – a modification of the principles that shifts the distribution of entrepreneurial effort from activity that assists the economy toward activity that hurts it. Unfortunately, there’s strong suggestive evidence that Baumol’s warnings have come to pass. In the event the U.S. will tackle its many problems, we’re going to have to find solutions to encourage would-be entrepreneurs to start out innovative, productive businesses, rather than dedicating their efforts to co-opting government so that you can secure economic advantage.
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