Last month economist William Baumol perished at the ages of 95. His death was universally mourned by folks the economics community, a lot of whom shared the scene he had passed before getting a much-deserved Nobel Prize. One of us (Robert) had the fantastic privilege of utilizing 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, which is why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is very 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 that is certainly 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 focused on the incorrect type of work.
In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the a higher level entrepreneurial ambition inside a country is actually fixed as time passes, knowning that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.
Most of the people consider Entrepreneurship Books Online being the “productive” kind, as Baumol known it, in which the companies which founders launch commercialize new things or better, benefiting society and themselves along the way. A considerable body of research establishes these “Schumpeterian” entrepreneurs, those who are “creatively destroying” that old in support of the brand new, are crucial for breakthrough innovations and rapid advances in productivity and standards of just living.
Baumol was worried, however, with a completely different form of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to create regulatory moats, secure public spending for their own benefit, or bend specific rules for their will, along the way stifling competition to create advantage for their firms. Economists label this rent-seeking behavior. As Baumol wrote:
…entrepreneurs are invariably along with us and try to play some substantial role. But there are a selection of roles among that the entrepreneur’s efforts might be reallocated, and some of the roles do not keep to the constructive and innovative script that is certainly conventionally caused by that person. Indeed, at times the entrepreneur may even lead a parasitical existence that is certainly actually damaging on the economy. The way the entrepreneur acts with a moment make depends heavily about the rules in the game-the reward structure in the economy-that eventually prevail.
In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, changing your the mix of entrepreneurial effort between the two kinds of entrepreneurship is usually to blame – specifically, a loss of productive entrepreneurship and a coincident increase in unproductive entrepreneurship. But is that this what’s actually happening in the U.S.?
Well, first of all, we yet others have documented a pervasive loss of the rate of new firm formation throughout the last 3 decades plus an acceleration because decline since 2000. The truth is, we discovered that by 2009 the rate of commercial closures exceeded the rate of commercial births for the first time in the three-decades-plus good reputation for our data. This loss of startup formation has occurred in each state and almost all metropolitan areas, plus each broad industrial sector, including modern day. We are seeing a slowdown in activity of high-growth firms, the relatively few companies that are the cause of the lion’s share of net job gains. This items to a slowdown in the development of productive entrepreneurship.
Think about the other type of entrepreneurship? Can 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 surely smoke, and it will come in two forms: rising profits, specially those earned from the largest businesses throughout the market, and suggestive proof of a boost in efforts to shape the rules in the game. This pattern is in conjuction with the rise of economic rents and rent-seeking behavior.
For 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 main factor in increasing wage inequality observed during this time. Similarly, a group of economists from MIT, Harvard, and Zurich discovered that industries where top firms’ share of the market had most increased had experienced the most important declines in the share of greenbacks gonna 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 income is included together in one broad, residual “returns to shareholders” category.) He discovered that the proportion of greenbacks earned by workers may be falling, as others have pointed out, but additionally that the share earned by capital has, too. Indeed, have been declining whilst the share of greenbacks gonna “markups,” or rents, may be increasing.
To be clear, the presence of economic rents alone doesn’t establish that there’s been a boost in unproductive entrepreneurship. For that really was, there should be be proof of a boost in rent-seeking – that is certainly, concerted efforts to stifle competition by influencing the reward structure or rules in the game inside a market.
James Bessen of Boston University offers suggestive evidence that rent-seeking behavior may be increasing. In the 2016 paper Bessen shows that, since 2000, “political factors” are the cause of a considerable part of the rise 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 partners to key policy makers have abnormally high stock returns.
To put it briefly, Baumol may have been before his time in warning that economies can suffer not only from your cost disease but additionally looking at the entrepreneurial counterpart – changing your the rules that shifts the distribution of entrepreneurial effort from activity that assists 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 probably tackle its many problems, we’re going to must find methods to encourage would-be entrepreneurs to get started on innovative, productive businesses, as opposed to dedicating their efforts to co-opting government so that you can secure economic advantage.
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