Last week economist William Baumol perished on the age of 95. His death was universally mourned by members of the economics community, many of whom shared the view he had passed before getting a much-deserved Nobel Prize. One of us (Robert) had the truly amazing 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, 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 that is equally relevant today understanding that could help explain America’s productivity slump. Baumol’s writing improves 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 that this a higher level entrepreneurial ambition in a country is actually fixed after a while, understanding that what determines a nation’s entrepreneurial output will be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Many people think of Buy Entrepreneurship Books being the “productive” kind, as Baumol known as it, the location where the businesses that founders launch commercialize something totally new or better, benefiting society and themselves along the way. A substantial body of research establishes these “Schumpeterian” entrepreneurs, those who are “creatively destroying” the old in favor of the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by a different form of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to construct regulatory moats, secure public spending for his or her own benefit, or bend specific rules with their will, along the way stifling competition to make advantage for his or her firms. Economists know this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs are always with us and constantly play some substantial role. But there are many of roles among which the entrepreneur’s efforts may be reallocated, and some of those roles tend not to keep to the constructive and innovative script that is conventionally related to see your face. Indeed, from time to time the entrepreneur might even lead a parasitical existence that is actually damaging for the economy. How the entrepreneur acts with a given time and put depends heavily on the rules in the game-the reward structure in 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 general change in a combination of entrepreneurial effort backward and forward forms of entrepreneurship is usually to blame – specifically, a loss of productive entrepreneurship along with a coincident boost in unproductive entrepreneurship. But is this what’s actually happening in the U.S.?
Well, first off, we yet others have documented a pervasive loss of the speed of the latest firm formation over the past 3 decades plus an acceleration because decline since 2000. In fact, we discovered that by 2009 the speed of business closures exceeded the speed of business births for the first time in the three-decades-plus history of our data. This loss of startup formation has occurred in each state and nearly all urban centers, as well as in each broad industrial sector, including advanced. There has also been a slowdown in activity of high-growth firms, the relatively few companies that account for the lion’s share of net job gains. Doing this points to a slowdown in the development of productive entrepreneurship.
How about another kind of entrepreneurship? Do we also visit a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t have a smoking gun to substantiate this hypothesis, but there is surely smoke, plus it will come in two forms: rising profits, in particular those earned with the largest businesses in the economy, and suggestive proof of an increase in efforts to shape the guidelines in the game. This pattern is similar to the rise of economic rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to The president, 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 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 in the share of capital planning to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share 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 discovered that the share of capital earned by workers continues to be falling, as others have pointed out, but also that this share earned by capital has, too. Indeed, both have been declining while the share of capital planning to “markups,” or rents, continues to be increasing.
In reality, a good economic rents on it’s own doesn’t establish that there’s been an increase in unproductive entrepreneurship. To the really was, there has to be be proof of an increase 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 continues to be increasing. Inside a 2016 paper Bessen demonstrates that, since 2000, “political factors” account for an amazing section of the surge in corporate profits. Such a thing happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang in the University of Illinois have found that businesses that have executives with close ties to key policy makers have abnormally high stock returns.
In a nutshell, Baumol might have been ahead of his time in warning that economies can suffer not only coming from a cost disease but also from its entrepreneurial counterpart – a general change in the guidelines that shifts the distribution of entrepreneurial effort from activity that assists the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings have started to pass. If your U.S. is going to tackle its many problems, we are going to need to find ways to encourage would-be entrepreneurs to get started on innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government to be able to secure economic advantage.
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