Is America Encouraging a bad Type of Entrepreneurship?

A few weeks ago economist William Baumol died in the day of 95. His death was universally mourned by people in the economics community, a lot of whom shared the vista which he had passed before buying a much-deserved Nobel Prize. Certainly one of us (Robert) had the truly great privilege of dealing with him, befriending him, and being able to regularly witness his economic wisdom, even during his later years.

Of Baumol’s many contributions to economics, the most common is cost disease, which is why high-productivity industries raise costs and for that reason prices in low-productivity industries. The insight is particularly relevant now, as economic activity 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 overwhelmed U.S. productivity growth overall.

But there’s a lesser-known concept of Baumol’s which is 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 devoted to a bad type of work.

In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that the degree of entrepreneurial ambition in a country is actually fixed after a while, understanding that what determines a nation’s entrepreneurial output may be the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.

Most of the people think of Buy Entrepreneurship Books being the “productive” kind, as Baumol referred to it, the location where the firms that founders launch commercialize something totally new or better, benefiting society and themselves in the process. A big body of research establishes that these “Schumpeterian” entrepreneurs, the ones that are “creatively destroying” that old 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 very different sort of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to make regulatory moats, secure public spending for their own benefit, or bend specific rules with their will, in the process stifling competition to create advantage for their firms. Economists call this rent-seeking behavior. As Baumol wrote:

…entrepreneurs are invariably around try to play some substantial role. But there are a selection of roles among that your entrepreneur’s efforts can be reallocated, and a few of the roles don’t continue with the constructive and innovative script which is conventionally attributed to that individual. Indeed, sometimes the entrepreneur could even lead a parasitical existence which is actually damaging to the economy. The way the entrepreneur acts in a given time and set depends heavily on the rules in the game-the reward structure from 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 general change in the amalgamation of entrepreneurial effort forwards and backwards kinds of entrepreneurship is to blame – specifically, a decline in productive entrepreneurship and a coincident surge in unproductive entrepreneurship. But is that this what’s actually happening from the U.S.?

Well, for starters, we while others have documented a pervasive decline in the rate of latest firm formation over the past thirty years and an acceleration in that decline since 2000. In reality, we found that by 2009 the rate of commercial closures exceeded the rate of commercial births initially from the three-decades-plus good reputation for our data. This decline in startup formation has occurred in each state and almost all metropolitan areas, as well as in each broad industrial sector, including hi-tech. There has been 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 points to a slowdown from the development of productive entrepreneurship.

What about the opposite type of entrepreneurship? Will we also see a surge in unproductive entrepreneurship, as Baumol theorized?

We don’t use a smoking gun to confirm this hypothesis, but there is smoke, also it also comes in two forms: rising profits, particularly those earned from the largest businesses in the economy, and suggestive evidence an increase in efforts to shape the guidelines 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 The president, wrote an influential 2016 paper that argued that economic rents are rising, particularly since 2000, and were a central aspect in increasing wage inequality observed during this time period. Similarly, a group of economists from MIT, Harvard, and Zurich found that industries where top firms’ business had most increased had experienced the most important declines from the share of income 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 a single broad, residual “returns to shareholders” category.) He found that the proportion of income earned by workers continues to be falling, as others have pointed out, but also that the share earned by capital has, too. Indeed, have been declining whilst the share of income planning to “markups,” or rents, continues to be increasing.

To be clear, the presence of economic rents by itself doesn’t establish that there’s been an increase in unproductive entrepreneurship. For your to be real, there needs to be be evidence an increase in rent-seeking – which is, 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 continues to be increasing. In a 2016 paper Bessen signifies that, since 2000, “political factors” account for an important part of the boost 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 close ties to key policy makers have abnormally high stock returns.

In a nutshell, Baumol was before his time in warning that economies can suffer not only coming from a cost disease but also from its entrepreneurial counterpart – a general change in the guidelines 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. In the event the U.S. will tackle its many problems, we’re going to must find methods to encourage would-be entrepreneurs to start out innovative, productive businesses, as an alternative to dedicating their efforts to co-opting government to be able to secure economic advantage.
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