Bad Entrepreneurship (Harvard Business Review article on ‘rent-seeking’)

“[William] Baumol was worried, however, by a very different sort of entrepreneur: the ‘unproductive’ ones, who exploit special relationships with the government to construct regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the process stifling competition to create advantage for their firms. Economists call this rent-seeking behavior.”

– Robert Litan and Ian Hathaway. “Is America Encouraging the Wrong Kind of Entrepreneurship?” Harvard Business Review, June 13, 2017.

MasterResource covers business entrepreneurship, not only the in’s and out’s of energy history and energy policy.

Good entrepreneurship is about serving consumers in a private property, voluntary exchange, rule-of-law setting. Bad entrepreneurship is about a business receiving special government favor to advantage itself at the expense of consumers and (free market) competitors. (For previous posts on free-market versus political capitalism, see here.)

Think Ken Lay at Enron. James Rogers at Duke Energy. Jeff Immelt at GE. Elon Musk in all things solar and electric. It is a very long list in today’s mixed (up) economy.

In the most recent Harvard Business Review (June 13, 2017), Robert Litan and Ian Hathaway have an essay, “Is America Encouraging the Wrong Kind of Entrepreneurship?” In their tribute to the late, great William Baumol, the authors focus on the political economy theme of good versus bad entrepreneurship in the mixed economy.

Most people think of entrepreneurship as being the “productive” kind, as Baumol referred to it, where the companies that founders launch commercialize something new or better, benefiting society and themselves in the process. A sizable body of research establishes that these “Schumpeterian” entrepreneurs, those that are “creatively destroying” the old in favor of the new, are critical for breakthrough innovations and rapid advances in productivity and standards of living.

Baumol was worried, however, by a very different sort of entrepreneur: the “unproductive” ones, who exploit special relationships with the government to construct regulatory moats, secure public spending for their own benefit, or bend specific rules to their will, in the process stifling competition to create advantage for their firms. Economists call this rent-seeking behavior. As Baumol wrote:

…entrepreneurs are always with us and always play some substantial role. But there are a variety of roles among which the entrepreneur’s efforts can be reallocated, and some of those roles do not follow the constructive and innovative script that is conventionally attributed to that person. Indeed, at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy. How the entrepreneur acts at a given time and place depends heavily on the rules of the game—the reward structure in the economy—that happen to prevail.

In Baumol’s theoretical framework, depressed rates of entrepreneurship aren’t the culprit for periods of slow economic growth; rather, a change in the mix of entrepreneurial effort between the two kinds of entrepreneurship is to blame — specifically, a decline in productive entrepreneurship and a coincident rise in unproductive entrepreneurship. But is this what’s actually happening in the U.S.?

The authors later state:

What about the other kind of entrepreneurship? Do we also see a rise in unproductive entrepreneurship, as Baumol theorized?

To be clear, the presence of economic rents by itself doesn’t establish that there’s been an increase in unproductive entrepreneurship. For that to be true, there must be be evidence of an increase in rent-seeking — that is, concerted efforts to stifle competition by influencing the reward structure or rules of the game in a market.

James Bessen of Boston University has provided suggestive evidence that rent-seeking behavior has been increasing. In a 2016 paper Bessen demonstrates that, since 2000, “political factors” account for a substantial part of the increase in corporate profits. This occurs through expanded regulation that favors incumbent firms. Similarly, economists Jeffrey Brown and Jiekun Huang of the University of Illinois have found that companies that have executives with close ties to key policy makers have abnormally high stock returns.

Litan and Hathaway conclude:

In short, Baumol may have been ahead of his time in warning that economies can suffer not only from a cost disease but also from its entrepreneurial counterpart — a change in the rules that shifts the distribution of entrepreneurial effort from activity that helps the economy toward activity that hurts it. Unfortunately, there is strong suggestive evidence that Baumol’s warnings have come to pass. If the U.S. is going to tackle its many problems, we are going to have to find ways to encourage would-be entrepreneurs to start innovative, productive businesses, rather than dedicating their efforts to co-opting government in order to secure economic advantage.