Last week economist William Baumol passed on at the ages of 95. His death was universally mourned by individuals the economics community, most of whom shared the view that he had passed before receiving a much-deserved Nobel Prize. One of us (Robert) had the fantastic privilege of working with him, befriending him, or being able to regularly witness his economic wisdom, even during his later years.
Of Baumol’s many contributions to economics, the most common is cost disease, so in retrospect high-productivity industries raise costs and therefore 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 idea of Baumol’s which is equally relevant today knowning 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 incorrect form of work.
Within a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued the level of entrepreneurial ambition in the country is basically fixed as time passes, 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 consider Cheap Entrepreneurship Books as being the “productive” kind, as Baumol referred to it, where the businesses that founders launch commercialize new things or better, benefiting society and themselves in the act. A big body of research establishes why these “Schumpeterian” entrepreneurs, the ones that are “creatively destroying” the existing in favor of the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by the unique form of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to develop regulatory moats, secure public spending for his or her own benefit, or bend specific rules with their will, in the act stifling competition to make advantage for his or her firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably here and constantly play some substantial role. But there are a number of roles among that this entrepreneur’s efforts can be reallocated, and some of people roles tend not to follow the constructive and innovative script which is conventionally related to the face. Indeed, sometimes the entrepreneur might lead a parasitical existence which is actually damaging on the economy. How the entrepreneur acts in a with time make depends heavily for the rules of the game-the reward structure inside 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 this mixture of entrepreneurial effort backward and forward forms of entrepreneurship is usually to blame – specifically, a loss of productive entrepreneurship plus a coincident surge in unproductive entrepreneurship. But is that this what’s actually happening inside the U.S.?
Well, for starters, we and others have documented a pervasive loss of the interest rate of new firm formation over the past 30 years plus an acceleration for the reason that decline since 2000. In reality, we discovered that by 2009 the interest rate of commercial closures exceeded the interest rate of commercial births for the first time inside the three-decades-plus history of our data. This loss of startup formation has happened in each state and the majority of metropolitan areas, plus each broad industrial sector, including high tech. There has also been a slowdown in activity of high-growth firms, the relatively very few firms that account for the lion’s share of net job gains. All this suggests a slowdown inside the growth of productive entrepreneurship.
Why don’t you consider one 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 is surely smoke, and yes it is available in two forms: rising profits, particularly those earned with the largest businesses in the economy, and suggestive evidence of an increase in efforts to shape the rules of the game. This pattern is consistent with the rise of monetary rents and rent-seeking behavior.
As an example, 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 aspect in increasing wage inequality observed in those times. Similarly, a small grouping of economists from MIT, Harvard, and Zurich discovered that industries where top firms’ share of the market had most increased had experienced the greatest declines inside the share of greenbacks gonna workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income distributed to labor, capital, and “profits.” (Normally, capital and income is included together in a single broad, residual “returns to shareholders” category.) He discovered that the proportion of greenbacks earned by workers has become falling, as others have described, but in addition the share earned by capital has, too. Indeed, both have been declining even though the share of greenbacks gonna “markups,” or rents, has become increasing.
In reality, the presence of economic rents by itself doesn’t establish that there’s been an increase in unproductive entrepreneurship. For your actually was, there must be be evidence of an increase in rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules of the game in the market.
James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior has become increasing. Within a 2016 paper Bessen signifies that, since 2000, “political factors” account for an important part of the increase in corporate profits. This takes place through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang of the University of Illinois have found that businesses that have executives with partners to key policy makers have abnormally high stock returns.
In short, Baumol could have been in advance of his amount of time in warning that economies can suffer not simply from your cost disease but in addition from its entrepreneurial counterpart – a modification of the rules 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 began to pass. If your U.S. will probably tackle its many problems, we will must find approaches to encourage would-be entrepreneurs to begin innovative, productive businesses, instead of dedicating their efforts to co-opting government to be able to secure economic advantage.
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