A few weeks ago economist William Baumol died at the ages of 95. His death was universally mourned by folks the economics community, many of whom shared the view that they had passed before finding a much-deserved Nobel Prize. One among us (Robert) had the great privilege of working 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 best is cost disease, which is why high-productivity industries raise costs and therefore prices in low-productivity industries. The insight is specially relevant now, as business activities 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 overwhelmed 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 improves the possibility that U.S. productivity is low because would-be entrepreneurs are devoted to the incorrect form of work.

In a 1990 paper, “Entrepreneurship: Productive, Unproductive, and Destructive,” Baumol argued that this degree of entrepreneurial ambition inside a country is basically fixed as time passes, and that what determines a nation’s entrepreneurial output is the incentive structure that governs and directs entrepreneurial efforts between “productive” and “unproductive” endeavors.

Many people imagine Entrepreneurship Books beeing the “productive” kind, as Baumol known it, the location where the companies that founders launch commercialize something totally new or better, benefiting society and themselves in the operation. A sizable body of research establishes why these “Schumpeterian” entrepreneurs, those who are “creatively destroying” that old in favor of the new, are crucial for breakthrough innovations and rapid advances in productivity and standards of living.

Baumol was worried, however, by way of a different form of entrepreneur: the “unproductive” ones, who exploit special relationships together with the government to develop regulatory moats, secure public spending for own benefit, or bend specific rules on their will, in the operation stifling competition to produce advantage for firms. Economists know this as rent-seeking behavior. As Baumol wrote:

…entrepreneurs are invariably with us and constantly play some substantial role. But there are a selection of roles among that your entrepreneur’s efforts can be reallocated, and several of these roles don’t stick to the constructive and innovative script which is conventionally due to the face. Indeed, at times the entrepreneur may even lead a parasitical existence which is actually damaging for the economy. How a entrepreneur acts with a with time and place depends heavily for the rules with 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, a change in the amalgamation of entrepreneurial effort between the two kinds of entrepreneurship would be to blame – specifically, a decline in productive entrepreneurship plus a coincident rise in unproductive entrepreneurship. But is what’s actually happening in the U.S.?

Well, to begin with, we among others have documented a pervasive decline in the interest rate of latest firm formation during the last 3 decades as well as an acceleration because decline since 2000. The truth is, we found out that by 2009 the interest rate of commercial closures exceeded the interest rate of commercial births initially in the three-decades-plus good reputation for our data. This decline in startup formation has took place each state and almost all urban centers, and in each broad industrial sector, including modern day. There has also been a slowdown in activity of high-growth firms, the relatively very few companies that take into account the lion’s share of net job gains. Doing this suggests a slowdown in the increase of productive entrepreneurship.

How about the opposite form of entrepreneurship? Should we also go to a rise in unproductive entrepreneurship, as Baumol theorized?

We don’t have a very smoking gun to confirm this hypothesis, but there is surely smoke, plus it is available in two forms: rising profits, in particular those earned through the largest businesses throughout the market, and suggestive evidence a boost in efforts to shape the policies with the game. This pattern is similar to the rise of economic rents and rent-seeking behavior.

As an example, Jason Furman and Peter Orszag, both former economic advisers to President barack obama, wrote a disciplined 2016 paper that argued that economic rents are rising, particularly since 2000, and were a main element in increasing wage inequality observed in those times. Similarly, a small grouping 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 revenue likely 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 single broad, residual “returns to shareholders” category.) He found out that the proportion of revenue earned by workers has become falling, as others have described, but in addition that this share earned by capital has, too. Indeed, both have been declining whilst the share of revenue likely to “markups,” or rents, has become increasing.

In reality, a good economic rents by itself doesn’t establish that there’s been a boost in unproductive entrepreneurship. For that to be true, there should be be evidence a boost in rent-seeking – which is, concerted efforts to stifle competition by influencing the reward structure or rules with the game inside a market.

James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior has become increasing. In a 2016 paper Bessen signifies that, since 2000, “political factors” take into account a considerable area of the rise in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang with the University of Illinois have discovered that companies that have executives with relationships to key policy makers have abnormally high stock returns.

Simply speaking, Baumol could have been in advance of his amount of time in warning that economies can suffer not merely from the cost disease but in addition from its entrepreneurial counterpart – a change in the policies that shifts the distribution of entrepreneurial effort from activity which enables the economy toward activity that hurts it. Unfortunately, there is certainly strong suggestive evidence that Baumol’s warnings have started to pass. When the U.S. will tackle its many problems, we intend to must find ways to encourage would-be entrepreneurs to start 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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