Last month economist William Baumol passed on in the day of 95. His death was universally mourned by individuals the economics community, many of whom shared the scene that he had passed before finding a much-deserved Nobel Prize. Among us (Robert) had the truly great privilege of utilizing him, befriending him, or being able to regularly witness his economic wisdom, even in his retirement years.
Of Baumol’s many contributions to economics, the most common is cost disease, so in retrospect high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is especially relevant now, as business activities has shifted into low-productivity services like medical 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 thought of Baumol’s which is equally relevant today and that can 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 a bad kind of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the level of entrepreneurial ambition in the country is actually fixed after a while, and 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 consider Kogan Page Entrepreneurship Books as being 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 sizable body of research establishes the “Schumpeterian” entrepreneurs, people who are “creatively destroying” the existing in favor of the modern, are critical for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by way of 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 for their will, in the act stifling competition to generate advantage for their firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will always be around and constantly play some substantial role. But there are a number of roles among that this entrepreneur’s efforts could be reallocated, and several of those roles tend not to continue with the constructive and innovative script which is conventionally caused by the face. Indeed, sometimes the entrepreneur could even lead a parasitical existence which is actually damaging to the economy. How the entrepreneur acts at a moment make depends heavily about the rules from the game-the reward structure in the economy-that occur to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a general change in the amalgamation 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 is this what’s actually happening in the U.S.?
Well, first off, we among others have documented a pervasive decline in the rate of new firm formation during the last three decades as well as an acceleration in that decline since 2000. Actually, we discovered that by 2009 the rate of commercial closures exceeded the rate of commercial births the first time in the three-decades-plus reputation our data. This decline in startup formation has occurred in each state and nearly all metropolitan areas, plus each broad industrial sector, including hi-tech. We are seeing a slowdown in activity of high-growth firms, the relatively very few companies that account for the lion’s share of net job gains. All this items to a slowdown in the expansion of productive entrepreneurship.
What about the opposite kind of entrepreneurship? Do we also visit a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to substantiate this hypothesis, but there is smoke, and it also comes in two forms: rising profits, specially those earned with the largest businesses for the overall design, and suggestive evidence more efforts to shape the guidelines from the game. This pattern is in conjuction with the rise of economic rents and rent-seeking behavior.
For example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an important 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 period. Similarly, several economists from MIT, Harvard, and Zurich discovered that industries where top firms’ share of the market had most increased had experienced the greatest declines in the share of greenbacks gonna 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 a single broad, residual “returns to shareholders” category.) He discovered that the proportion of greenbacks earned by workers may be falling, as others have talked about, but additionally the share earned by capital has, too. Indeed, both have been declining whilst the share of greenbacks gonna “markups,” or rents, may be increasing.
To be clear, the existence of economic rents by itself doesn’t establish that there’s been more unproductive entrepreneurship. To the actually was, there should be be evidence more rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules from the game in the market.
James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior may be increasing. Inside a 2016 paper Bessen shows that, since 2000, “political factors” account for an important area of the increase in corporate profits. This happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang from the University of Illinois have realized that businesses that have executives with close ties to key policy makers have abnormally high stock returns.
Simply speaking, Baumol might have been in front of his amount of time in warning that economies can suffer not only coming from a cost disease but additionally from its entrepreneurial counterpart – a general 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 began to pass. When the U.S. is going to tackle its many problems, we’re going to need to find approaches to encourage would-be entrepreneurs to begin innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government in order to secure economic advantage.
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