Last month economist William Baumol died in the ages of 95. His death was universally mourned by folks the economics community, lots of whom shared the vista he had passed before buying a much-deserved Nobel Prize. Among us (Robert) had the truly great privilege of working together with him, befriending him, or being able to regularly witness his economic wisdom, even just in his old age.
Of Baumol’s many contributions to economics, the most famous is cost disease, which explains why 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 notion of Baumol’s which is equally relevant today knowning 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 the incorrect form of work.
In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the amount of entrepreneurial ambition in the country is essentially fixed after a while, knowning that what determines a nation’s entrepreneurial output could be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Many people think of Entrepreneurship Books Online beeing 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 these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the old for the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, by the different sort of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to make regulatory moats, secure public spending because of their own benefit, or bend specific rules with their will, in the act stifling competition to make advantage because of their firms. Economists know this as rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably here and always play some substantial role. But there are many of roles among which the entrepreneur’s efforts can be reallocated, and a few of the roles tend not to keep to the constructive and innovative script which is conventionally caused by the face. Indeed, sometimes the entrepreneur could even lead a parasitical existence which is actually damaging on the economy. The way the entrepreneur acts at a with time and place depends heavily around the rules with the game-the reward structure within the economy-that get lucky and prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a change in the mix of entrepreneurial effort between the two sorts of entrepreneurship would be to blame – specifically, a decline in productive entrepreneurship along with a coincident rise in unproductive entrepreneurship. But is this what’s actually happening within the U.S.?
Well, for starters, we yet others have documented a pervasive decline in the pace of recent firm formation throughout the last three decades as well as an acceleration because decline since 2000. Actually, we learned that by 2009 the pace of economic closures exceeded the pace of economic births for the first time within the three-decades-plus reputation our data. This decline in startup formation has happened in each state and nearly all metropolitan areas, along with each broad industrial sector, including advanced. We are seeing a slowdown in activity of high-growth firms, the relatively few businesses that account for the lion’s share of net job gains. All this points to a slowdown within the development of productive entrepreneurship.
Think about the opposite form of entrepreneurship? Should we also visit a rise in unproductive entrepreneurship, as Baumol theorized?
We don’t possess a smoking gun to ensure this hypothesis, but there surely is smoke, plus it will come in two forms: rising profits, particularly those earned through the largest businesses in the economy, and suggestive evidence a rise in efforts to shape the rules with the game. This pattern is like rise of monetary 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 rising, particularly since 2000, and were a central aspect in increasing wage inequality observed during this period. Similarly, a small grouping of economists from MIT, Harvard, and Zurich learned that industries where top firms’ business had most increased had experienced the greatest declines within the share of capital planning to workers.
Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income offered to labor, capital, and “profits.” (Normally, capital and income is included together in a broad, residual “returns to shareholders” category.) He learned that the proportion of capital earned by workers has become falling, as others have pointed out, but additionally how the share earned by capital has, too. Indeed, both have been declining as the share of capital planning to “markups,” or rents, has become increasing.
In reality, the presence of economic rents by itself doesn’t establish that there’s been a rise in unproductive entrepreneurship. To the to be true, there has to be be evidence a rise in rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules with the game in the market.
James Bessen of Boston University presents suggestive evidence that rent-seeking behavior has become increasing. In a 2016 paper Bessen signifies that, since 2000, “political factors” account for an amazing area of the rise 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 are finding that businesses that have executives with relationships to key policy makers have abnormally high stock returns.
To put it briefly, Baumol was in advance of his time in warning that economies can suffer not only coming from a cost disease but additionally by reviewing the entrepreneurial counterpart – a change in the rules that shifts the distribution of entrepreneurial effort from activity which enables the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings have started to pass. If the U.S. will probably tackle its many problems, we will need to find approaches to encourage would-be entrepreneurs to start innovative, productive businesses, instead of dedicating their efforts to co-opting government so that you can secure economic advantage.
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