Recently economist William Baumol perished on the day of 95. His death was universally mourned by individuals the economics community, a lot of whom shared the view that he had passed before buying a much-deserved Nobel Prize. One 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 in his final years.
Of Baumol’s many contributions to economics, the best is cost disease, which is the reason high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is very relevant now, as business activities has shifted into low-productivity services like healthcare 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 is equally relevant today which might help explain America’s productivity slump. Baumol’s writing adds to the possibility that U.S. productivity is low because would-be entrepreneurs are devoted to an unacceptable form of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the amount of entrepreneurial ambition within a country is actually fixed as time passes, which what determines a nation’s entrepreneurial output will be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
A lot of people consider Entrepreneurship Books Online as the “productive” kind, as Baumol referred to it, the place that the companies which founders launch commercialize something new or better, benefiting society and themselves along the way. A big body of research establishes that these “Schumpeterian” entrepreneurs, people who are “creatively destroying” the previous in support of the modern, are crucial for breakthrough innovations and rapid advances in productivity and standards of life.
Baumol was worried, however, by way of a completely different form of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to make regulatory moats, secure public spending for his or her own benefit, or bend specific rules to their will, along the way stifling competition to generate advantage for his or her 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 number of roles among which the entrepreneur’s efforts could be reallocated, and a few of people roles usually do not keep to the constructive and innovative script that is conventionally attributed to the face. Indeed, at times the entrepreneur might even lead a parasitical existence that is actually damaging to the economy. How the entrepreneur acts at the moment make depends heavily on the rules in the game-the reward structure in 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, changing your the mix of entrepreneurial effort between the two sorts of entrepreneurship would be to blame – specifically, a decline in productive entrepreneurship as well as a coincident surge in unproductive entrepreneurship. But is what’s actually happening in the U.S.?
Well, for starters, we yet others have documented a pervasive decline in the rate of the latest firm formation throughout the last three decades with an acceleration because decline since 2000. In fact, we found out that by 2009 the rate of business closures exceeded the rate of business births the first time in the three-decades-plus good our data. This decline in startup formation has took place each state and nearly all towns, and in each broad industrial sector, including high tech. We are seeing a slowdown in activity of high-growth firms, the relatively small number of firms that account for the lion’s share of net job gains. All of this items to a slowdown in the development of productive entrepreneurship.
How about the opposite form of entrepreneurship? Do we also visit a surge in unproductive entrepreneurship, as Baumol theorized?
We don’t use a smoking gun to verify this hypothesis, but there is smoke, also it is available in two forms: rising profits, especially those earned with the largest businesses for the overall design, and suggestive proof of more efforts to shape the guidelines in the game. This pattern is consistent with the rise of monetary rents and rent-seeking behavior.
By way of example, Jason Furman and Peter Orszag, both former economic advisers to The president, wrote a disciplined 2016 paper that argued that economic rents are on the rise, particularly since 2000, and were a central take into account increasing wage inequality observed during this period. Similarly, a group of economists from MIT, Harvard, and Zurich found out that industries where top firms’ share of the market had most increased had experienced the biggest declines in the share of income planning 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 found out that the proportion of income earned by workers continues to be falling, as others have described, but also how the share earned by capital has, too. Indeed, have been declining while the share of income planning to “markups,” or rents, continues to be increasing.
In reality, the existence of economic rents by itself doesn’t establish that there’s been more unproductive entrepreneurship. For your really was, there has to be be proof of more rent-seeking – that is, concerted efforts to stifle competition by influencing the reward structure or rules in the game within a market.
James Bessen of Boston University provides suggestive evidence that rent-seeking behavior continues to be increasing. In the 2016 paper Bessen signifies that, since 2000, “political factors” account for an important part of the increase in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang in the University of Illinois have discovered that companies which have executives with close ties to key policy makers have abnormally high stock returns.
In a nutshell, Baumol may have been in front of his amount of time in warning that economies can suffer not only from a cost disease but also from the entrepreneurial counterpart – changing your the guidelines that shifts the distribution of entrepreneurial effort from activity that can help the economy toward activity that hurts it. Unfortunately, there exists strong suggestive evidence that Baumol’s warnings have learned to pass. If your U.S. will tackle its many problems, we intend to need to find approaches 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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