Recently economist William Baumol perished on the ages of 95. His death was universally mourned by individuals the economics community, lots of whom shared the view which he had passed before buying a much-deserved Nobel Prize. One of us (Robert) had the great privilege of utilizing him, befriending him, and being able to regularly witness his economic wisdom, during his retirement years.
Of Baumol’s many contributions to economics, the favourite is cost disease, which is the reason high-productivity industries raise costs and thus 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 idea of Baumol’s that’s equally relevant today understanding that can help explain America’s productivity slump. Baumol’s writing enhances the possibility that U.S. productivity is low because would-be entrepreneurs are dedicated to the wrong form of work.
Inside a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the degree of entrepreneurial ambition in a country is basically fixed as time passes, understanding that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
A lot of people imagine Entrepreneurship Books as the “productive” kind, as Baumol known it, in which the firms that founders launch commercialize something totally new or better, benefiting society and themselves along the way. A sizable body of research establishes why these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the old in support of the brand new, are critical for breakthrough innovations and rapid advances in productivity and standards of living.
Baumol was worried, however, by way of a different kind of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to construct regulatory moats, secure public spending for own benefit, or bend specific rules to their will, along the way stifling competition to make advantage for firms. Economists call this rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be with us and always play some substantial role. But there are a number of roles among that the entrepreneur’s efforts can be reallocated, and a few of the roles tend not to continue with the constructive and innovative script that’s conventionally caused by the face. Indeed, from time to time the entrepreneur might lead a parasitical existence that’s actually damaging on the economy. The way the entrepreneur acts at a with time make depends heavily on the rules in the game-the reward structure in the economy-that happen to prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a change in a combination of entrepreneurial effort between the two sorts of entrepreneurship is always to blame – specifically, a loss of productive entrepreneurship and a coincident boost in unproductive entrepreneurship. But are these claims what’s actually happening in the U.S.?
Well, to begin with, we among others have documented a pervasive loss of the rate of new firm formation throughout the last thirty years as well as an acceleration because decline since 2000. In reality, we discovered that by 2009 the rate of economic closures exceeded the rate of economic births the first time in the three-decades-plus good reputation for our data. This loss of startup formation has happened each state and the majority of towns, along with each broad industrial sector, including modern day. We are seeing a slowdown in activity of high-growth firms, the relatively small number of companies that account for the lion’s share of net job gains. This points to a slowdown in the growth of productive entrepreneurship.
What about one other form of entrepreneurship? Should we also visit a boost 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 also comes in two forms: rising profits, particularly those earned by the largest businesses throughout the market, and suggestive evidence 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.
For instance, Jason Furman and Peter Orszag, both former economic advisers to The president, wrote an important 2016 paper that argued that economic rents are on the rise, 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 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 distributed to labor, capital, and “profits.” (Normally, capital and income is included together in one broad, residual “returns to shareholders” category.) He discovered that the share of capital earned by workers has become falling, as others have talked about, but also how the share earned by capital has, too. Indeed, both have been declining while the share of capital planning to “markups,” or rents, has become increasing.
In reality, the existence of economic rents on its own doesn’t establish that there’s been an increase in unproductive entrepreneurship. With the to be real, there has to be be evidence of an increase in rent-seeking – that’s, concerted efforts to stifle competition by influencing the reward structure or rules in the game in a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has become increasing. Inside a 2016 paper Bessen signifies that, since 2000, “political factors” account for an important section of the surge in corporate profits. This takes place through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang in the University of Illinois have realized that firms that have executives with relationships 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 also from its entrepreneurial counterpart – a change in the guidelines that shifts the distribution of entrepreneurial effort from activity that helps the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings began to pass. If the U.S. will tackle its many problems, we will need to find methods to encourage would-be entrepreneurs to start innovative, productive businesses, instead of dedicating their efforts to co-opting government to be able to secure economic advantage.
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