Last month economist William Baumol died with the ages of 95. His death was universally mourned by members of the economics community, many of whom shared the scene that they had passed before finding a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly amazing privilege of working with him, befriending him, and being able to regularly witness his economic wisdom, even in his final years.
Of Baumol’s many contributions to economics, the most famous is cost disease, so in retrospect high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is specially relevant now, as economic activity has shifted into low-productivity services like medical 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 and that can 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.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the a higher level entrepreneurial ambition within a country is actually fixed after a while, and that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most people imagine Entrepreneurship Books beeing the “productive” kind, as Baumol described it, in which the companies which founders launch commercialize a new challenge or better, benefiting society and themselves in the operation. A substantial body of research establishes the “Schumpeterian” entrepreneurs, those that are “creatively destroying” that old and only the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by a different sort of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to create regulatory moats, secure public spending for their own benefit, or bend specific rules with their will, in the operation stifling competition to produce advantage for their firms. Economists refer to this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs will almost always be with us and try to play some substantial role. But there are a number of roles among that the entrepreneur’s efforts could be reallocated, and several of people roles don’t keep to the constructive and innovative script that’s conventionally related 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 at the unpredictable moment and set depends heavily on the rules with the game-the reward structure in 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 between the two kinds of entrepreneurship is to blame – specifically, a decline in productive entrepreneurship as well as a coincident increase in unproductive entrepreneurship. But is what’s actually happening in the U.S.?
Well, to begin with, we among others have documented a pervasive decline in the interest rate of recent firm formation over the past 30 years as well as an acceleration for the reason that decline since 2000. In reality, we found that by 2009 the interest rate of business closures exceeded the interest rate of business births the very first time in the three-decades-plus good our data. This decline in startup formation has took place each state and nearly all towns, along with each broad industrial sector, including advanced. There has also been a slowdown in activity of high-growth firms, the relatively small number of businesses that be the cause of the lion’s share of net job gains. This items to a slowdown in the growth of productive entrepreneurship.
How about the opposite form of entrepreneurship? Will we also go to a increase in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to confirm this hypothesis, but there is smoke, and yes it comes in two forms: rising profits, particularly those earned by the largest businesses for the overall design, and suggestive proof a rise in efforts to shape the principles with the game. This pattern is in conjuction with the rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote a disciplined 2016 paper that argued that economic rents are rising, particularly since 2000, and were a central factor in increasing wage inequality observed during this period. Similarly, several economists from MIT, Harvard, and Zurich found that industries where top firms’ share of the market had most increased had experienced the greatest declines in the share of greenbacks likely to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the share of industry income provided to labor, capital, and “profits.” (Normally, capital and income is included together a single broad, residual “returns to shareholders” category.) He found that the share of greenbacks earned by workers continues to be falling, as others have pointed out, but in addition that the share earned by capital has, too. Indeed, have been declining as the share of greenbacks likely to “markups,” or rents, continues to be increasing.
In reality, the presence of economic rents on it’s own doesn’t establish that there’s been a rise in unproductive entrepreneurship. To the actually was, there must be be proof a rise in rent-seeking – that’s, concerted efforts to stifle competition by influencing the reward structure or rules with the game within a market.
James Bessen of Boston University presents suggestive evidence that rent-seeking behavior continues to be increasing. In the 2016 paper Bessen implies that, since 2000, “political factors” be the cause of a substantial area of the surge in corporate profits. This takes place through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang with the University of Illinois have discovered that companies which have executives with relationships to key policy makers have abnormally high stock returns.
To put it briefly, Baumol may have been ahead of his period in warning that economies can suffer not simply from the cost disease but in addition from the entrepreneurial counterpart – a change in the principles that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there’s strong suggestive evidence that Baumol’s warnings have come to pass. When the U.S. will probably tackle its many problems, we intend to have to find solutions to encourage would-be entrepreneurs to start innovative, productive businesses, rather than dedicating their efforts to co-opting government in order to secure economic advantage.
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