Is America Encouraging the incorrect Form of Entrepreneurship?

Recently economist William Baumol perished on the chronilogical age of 95. His death was universally mourned by people in the economics community, lots of whom shared the scene which he had passed before getting a much-deserved Nobel Prize. One among us (Robert) had the fantastic privilege of utilizing him, befriending him, or being able to regularly witness his economic wisdom, even during his old age.

Of Baumol’s many contributions to economics, the most common is cost disease, which explains why high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is especially relevant now, as economic activity has shifted into low-productivity services like medical 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 and that can help explain America’s productivity slump. Baumol’s writing adds to the possibility that U.S. productivity is low because would-be entrepreneurs are dedicated to the wrong sort of work.

In the 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued how the amount of entrepreneurial ambition in a country is actually fixed over time, 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 think about Kogan Page Entrepreneurship Books as being the “productive” kind, as Baumol known as it, where the firms that founders launch commercialize a new challenge or better, benefiting society and themselves in the act. A substantial body of research establishes why these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the previous in favor 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 very different type of entrepreneur: the “unproductive” ones, who exploit special relationships using the government to construct regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the act stifling competition to produce advantage for their firms. Economists refer to this as rent-seeking behavior. As Baumol wrote:

…entrepreneurs are always around and always play some substantial role. But there are a selection of roles among that this entrepreneur’s efforts could be reallocated, and a few of people roles don’t stick to the constructive and innovative script which is conventionally attributed to see your face. Indeed, sometimes the entrepreneur might even lead a parasitical existence which is actually damaging towards the economy. The way the entrepreneur acts at the given time and place depends heavily on the rules with the game-the reward structure inside the economy-that occur to prevail.

In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t to blame for periods of slow economic growth; rather, a modification of the mix of entrepreneurial effort between the two types of entrepreneurship is usually to blame – specifically, a loss of productive entrepreneurship as well as a coincident boost in unproductive entrepreneurship. But are these claims what’s actually happening inside the U.S.?

Well, to begin with, we and others have documented a pervasive loss of the rate of latest firm formation throughout the last thirty years and an acceleration because decline since 2000. The truth is, we found out that by 2009 the rate of commercial closures exceeded the rate of commercial births the first time inside the three-decades-plus good our data. This loss of startup formation has occurred in each state and virtually all urban centers, and in each broad industrial sector, including high tech. There has been a slowdown in activity of high-growth firms, the relatively very few businesses that be the cause of the lion’s share of net job gains. All this items to a slowdown inside the development of productive entrepreneurship.

What about one other sort of entrepreneurship? Will we also go to a boost in unproductive entrepreneurship, as Baumol theorized?

We don’t have a smoking gun to substantiate this hypothesis, but there is surely smoke, also it also comes in two forms: rising profits, in particular those earned by the largest businesses in the economy, and suggestive proof an increase in efforts to shape the rules with the game. This pattern is consistent with the rise of economic rents and rent-seeking behavior.

By way of example, Jason Furman and Peter Orszag, both former economic advisers to Barack obama, wrote an important 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 period. Similarly, a group of economists from MIT, Harvard, and Zurich found out that industries where top firms’ business had most increased had experienced the biggest declines inside the share of capital gonna workers.

Perhaps most convincing, University of Chicago economist Simcha Barkai carefully tabulated the proportion of industry income provided to labor, capital, and “profits.” (Normally, capital and income is included together in one broad, residual “returns to shareholders” category.) He found out that the proportion of capital earned by workers has been falling, as others have talked about, but additionally how the share earned by capital has, too. Indeed, have been declining even though the share of capital gonna “markups,” or rents, has been increasing.

In reality, the use of economic rents alone doesn’t establish that there’s been an increase in unproductive entrepreneurship. For your actually was, there must be be proof an increase in rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules with the game in a market.

James Bessen of Boston University offers suggestive evidence that rent-seeking behavior has been increasing. In the 2016 paper Bessen demonstrates that, since 2000, “political factors” be the cause of a considerable part of the boost in corporate profits. Such a thing happens through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang with the University of Illinois have realized that firms that have executives with relationships to key policy makers have abnormally high stock returns.

Simply speaking, Baumol might have been before his time in warning that economies can suffer not just from a cost disease but additionally by reviewing the entrepreneurial counterpart – a modification of the rules 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 started to pass. In the event the U.S. is going to tackle its many problems, we will need to find solutions to encourage would-be entrepreneurs to begin innovative, productive businesses, rather than dedicating their efforts to co-opting government as a way to secure economic advantage.
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