The Dangerous Rise Of Unproductive Entrepreneurship

For many years now, we’ve talked about Andy Kessler’s concept of political entrepreneurs vs. market entrepreneurs. In Kessler’s telling, market entrepreneurs are the kind of entrepreneurs that people usually think about — the ones creating startups and high growth companies and the like. While not everyone appreciates it, those entrepreneurs tend to provide a lot more to the world than they take away. They may get filthy rich in the process, but they tend to make the world a better place by creating lots of value. The “political entrepreneurs,” on the other hand, are those who basically look to abuse the system to create monopoly rents and to limit competition. Those entrepreneurs may also get filthy rich, but they tend to do it by limiting value and locking it up so that only they can get it. Obviously, one of those is a lot better for society than the other.

Of course, this idea certainly didn’t originate with Kessler, either. Just recently, we had James Allworth on our podcast where we talked about this issue in response to an excellent article he’d recently written about how prioritizing profit over democracy was actually damaging American entrepreneurship. In that article, he referred back to the work of William Baumol, who wrote a paper back in 1990, entitled: Entrepreneurship: Productive, Unproductive, and Destructive. As you can see, that one divides entrepreneurship into three categories. Productive loosely maps to “market entrepreneurs” in Kessler’s world, while “Unproductive” loosely translates to “political entrepreneurs” as well. Baumol also includes destructive entrepreneurs, who are actively making the world worse — and getting rich off of people’s misery (think drug dealers, and such).

But part of the point of Allworth’s article is that it feels like too many people are just focusing on “profit” as the end goal, and thus either unwilling or unconcerned with determining if the entrepreneurship that drives the profit is “productive” or “unproductive.” And, now the Economist has weighed in on this issue as well, noting that we’re seeing more and more unproductive entrepreneurship in America, and that’s a problem. The article focuses on the work of two economists, Robert Litan and Ian Hathaway, who are building on Baumol’s concepts and are concerned about where things are heading. One interesting thing: they find that the issue can’t be neatly put into the category of “too much regulation” or “too little regulation,” but rather find that both of those situations can create the same rise in unproductive entrepreneurship:

What explains this shift? One factor appears to be the success of various professional groups in convincing the government to tailor regulation to their needs, for instance by lobbying for occupational licensing. Jason Furman, then the chair of the Council of Economic Advisors, observed in 2015 that the share of the American workforce covered by state licensing laws grew from less than 5% in the 1950s to 25% by 2008, arguing that this deterred new competition.

The proliferation of occupational licensing might be seen as harmful overregulation. Other sectors are plagued by the opposite. Jeffrey Zhang, an economist at the Federal Reserve, argues that banking deregulation in the 1990s led to rapid bank concentration alongside “sub-optimally higher levels of risk-taking”. As a result, the salaries of senior bank employees grew rapidly. Zhang concludes that the rent-seeking enabled by financial deregulation played a sizeable role in the growth of income inequality: bankers were able to skew the system in their favour, to the detriment of everybody else.

Indeed, we see this in areas that we cover as well. Certainly it seems like letting the big cable and telco companies run free for a decade decreased competition, lowered the quality of service (massively) and allowed those companies to create massive monopoly rents for themselves. But in many other industries, we’ve pointed out the problems with excessive occupational licensing. I know not everyone agrees, but we think the rise of car hailing services and home sharing like Airbnb has been quite revolutionary (even if companies like Uber may have been run by some awful people). Similarly, we’ve discussed repeatedly how excess regulations in the drone space have really held back what could be a huge area of innovation.

The Economist article suggests that the ability of industries to steer regulations in a way they want is a big part of the issue:

The success of such lobbying depends on the government’s susceptibility. This does not appear to be in short supply in America. James E. Bessen, an economist at Boston University,links high profits through regulatory advantages to political factors including lobbying and campaign spending. The work of other economists reinforces his observation. Jeffrey R. Brown and Jiekun Huang, two researchers writing for the National Bureau of Economic Research, use data> from White House visitor logs during the Obama administration to show that corporate executives’ meetings with White House staff were associated with a bump in their company stock price, more government contracts and positive regulatory decisions. Firms that had better access to the Obama White House also experienced a large drop in stock prices when the 2016 election result was announced.

In the tech world, this is unfortunate. It used to be that tech companies didn’t need to have a presence in DC, because they could just innovate, rather than having to deal constantly with policy pressure. But, nowadays that’s increasingly difficult — and not necessarily because everyone else is lobbying — but rather because the political landscape has become something of a shakedown game. As we’ve discussed in the past, while many outside of DC view lobbyists as making all of this happen, those involved suggest the roles are reversed here. Politicians — desperate to raise campaign cash — are often the ones reaching out to companies and basically threatening them with certain regulations if they don’t decide to step up and donate.

So what’s the end result here? That’s… not clear. Unfortunately, it appears that crony capitalism is on the rise, and with it, more and more unproductive entrepreneurship. The real problem, as James and I discussed in our podcast, is that this is unsustainable, and most likely will mean growing productive entrepreneurship happening elsewhere (and we’re already seeing some evidence of that today). There certainly doesn’t seem to be any real concerted effort to move away from unproductive entrepreneurship in the US — but perhaps by making more people aware of it, people will start to recognize how big a problem it truly is.

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