A few weeks ago economist William Baumol passed on in the age of 95. His death was universally mourned by people in the economics community, most of whom shared the view which he had passed before finding a much-deserved Nobel Prize. One among us (Robert) had the fantastic privilege of utilizing 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 famous is cost disease, which is why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is specially 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 weighed down U.S. productivity growth overall.
But there’s a lesser-known thought of Baumol’s that’s equally relevant today which 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 an unacceptable kind of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this level of entrepreneurial ambition in the country it’s essentially fixed over time, which what determines a nation’s entrepreneurial output may be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most of the people think about Entrepreneurship Books Online as the “productive” kind, as Baumol known it, in which the companies which founders launch commercialize something totally new or better, benefiting society and themselves in the act. A big body of research establishes these “Schumpeterian” entrepreneurs, those who are “creatively destroying” the existing and only the newest, are crucial for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by way of a completely different form of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to construct regulatory moats, secure public spending for own benefit, or bend specific rules on their will, in the act stifling competition to generate advantage for firms. Economists know this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs will always be here and try to play some substantial role. But there are a variety of roles among that the entrepreneur’s efforts may be reallocated, and several of the roles usually do not continue with the constructive and innovative script that’s conventionally due to see your face. Indeed, occasionally the entrepreneur could even lead a parasitical existence that’s actually damaging for the economy. How the entrepreneur acts in a with time and put depends heavily on the rules from the game-the reward structure inside the economy-that happen to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t at fault for periods of slow economic growth; rather, a change in this mixture of entrepreneurial effort forwards and backwards forms of entrepreneurship is to blame – specifically, a loss of productive entrepreneurship along with a coincident boost in unproductive entrepreneurship. But is what’s actually happening inside the U.S.?
Well, first of all, we while others have documented a pervasive loss of the rate of new firm formation over the past three decades plus an acceleration in this decline since 2000. In fact, we learned that by 2009 the rate of commercial closures exceeded the rate of commercial births initially inside the three-decades-plus history of our data. This loss of startup formation has happened each state and virtually all metropolitan areas, along with each broad industrial sector, including advanced. There has also been a slowdown in activity of high-growth firms, the relatively few firms that take into account the lion’s share of net job gains. This exactly what to a slowdown inside the expansion of productive entrepreneurship.
What about the opposite kind of entrepreneurship? Should we also see a boost in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to confirm this hypothesis, but there is surely smoke, and yes it also comes in two forms: rising profits, especially those earned from the largest businesses throughout the economy, and suggestive evidence more efforts to shape the rules from the game. This pattern is similar to the rise of economic rents and rent-seeking behavior.
For instance, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an important 2016 paper that argued that economic rents are rising, particularly since 2000, and were a main aspect in increasing wage inequality observed during this time period. Similarly, several economists from MIT, Harvard, and Zurich learned that industries where top firms’ share of the market had most increased had experienced the most important declines inside the share of income likely to 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 earnings are included together in a single broad, residual “returns to shareholders” category.) He learned that the proportion of income earned by workers continues to be falling, as others have stated, but additionally that this share earned by capital has, too. Indeed, have been declining even though the share of income likely to “markups,” or rents, continues to be increasing.
To be clear, the use of economic rents alone doesn’t establish that there’s been more unproductive entrepreneurship. For that to be true, there should be be evidence more rent-seeking – that’s, concerted efforts to stifle competition by influencing the reward structure or rules from the game in the market.
James Bessen of Boston University presents suggestive evidence that rent-seeking behavior continues to be increasing. Inside a 2016 paper Bessen signifies that, since 2000, “political factors” take into account an amazing the main increase in corporate profits. Such a thing happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang from the University of Illinois have discovered that companies which have executives with close ties to key policy makers have abnormally high stock returns.
To put it briefly, Baumol may have been in advance of his time in warning that economies can suffer not just from your cost disease but additionally by reviewing the entrepreneurial counterpart – a change in the rules that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings have started to pass. When the U.S. is going to tackle its many problems, we are going to have to find ways to encourage would-be entrepreneurs to start out innovative, productive businesses, instead of dedicating their efforts to co-opting government as a way to secure economic advantage.
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