The ossifying economy

An enduring narrative about the U.S. economy, a key ingredient of the american dream, is that it is a dynamic market where new ideas can thrive and new businesses can reshape the economic landscape.

Evidence indicates that over the past few decades business dynamism has been declining:

Measured productivity growth has slowed, investment by firms (relative to their profits) is lower than in the past, job mobility across firms has declined, and labor’s share of income has fallen. All of these trends have multiple causes, but all are consistent with reduced market entry by new firms—something that may be both a cause and a consequence of reduced competition.

Shambaugh, Jay, et al. ‘The State of Competition and Dynamism: Facts about Concentration, Start-Ups, and Related Policies’. The Hamilton Project, 2018.

A report by the Hamilton Project at Brookings published in June analyzes these trends and the policies affecting competition.

Firm concentration is rising, particularly in retail and finance. Concentration is high in markets with large returns to scale and network effects. Mergers and acquisitions have become more common Common ownership (the extent to which ownership of competitors overlaps) may increase effective market concentration. The investment rate has fallen by more than one-third since the early 1960s.

Many firms have substantial power in labor markets. Employer concentration appears to be high in many local labor markets. Fewer mergers are being blocked when at least five competitors would remain. Start-up rates are declining across all sectors.

The employment share of young firms has decreased by more than one-third since 1987. Businesses are taking longer to form, while business applications have declined. The entrepreneurship rate has fallen by almost half for workers with a bachelor’s degree.

State subsidies to businesses have tripled since 1990.

In a working paper published in September, William Naudé, to whom we have already found in Mind the Post before, argues that these explanations are largely supply-side oriented and moreover fail to explain why the decline in entrepreneurship is associated with high levels of economic complexity.

Entrepreneurship in most advanced economies is in decline. This comes as a surprise: many scholars have expected an upsurge in entrepreneurship. What are the reasons for the decline? In this paper I first document the extent of the decline in terms of entrepreneurial entry rates; the share of young and small firms; and in terms of labor market mobility and in innovativeness. I then critically discuss the explanations that have been offered in the literature: slow population growth, market concentration, zombie-firm congestion, slower diffusion of knowledge, and burdensome business regulations. While having merit, these explanations are largely supply-side oriented and moreover fail to explain why the decline in entrepreneurship is associated with high levels of economic complexity. I argue that we need to consider the potential of negative scale effects and evolutionary pressures from rising complexity, as well as long-run changes in aggregate demand and energy costs. Whether the decline in entrepreneurship and the ossifycation of the economy is undesirable, is a point for debate, calling for more research and more attention to entrepreneurship in growth theories.

Naudé, Wim. The Decline in Entrepreneurship in the West: Is Complexity Ossifying the Economy? 2019.

Closely following the approach to economic complexity put forward by Geoffrey West, César Hidalgo, and others, Naudé argues that there are complexity brakes on entrepreneurship that may constitute an ultimate cause for declining business dynamism. In particular, three:

  • Negative scale effects,
  • Widening technological distance (meaning that more products and services and specialization contibute to declining rates of return to innovation), and
  • Ideas are getting harder to find.

Do notice that the second cause, in particular, is very close to Joseph Tainter’s recipe for collapse.

Too many factors indeed. Therefore complexity is very likely playing a role. However, thinking about this other idea—biological complexity diminishing with aging— I’m not sure what to think… back to the complexity black hole.

Thoughts are welcome.

____________________

Shambaugh, Jay, et al. ‘The State of Competition and Dynamism: Facts about Concentration, Start-Ups, and Related Policies’. The Hamilton Project, 2018.

Naudé, Wim. The Decline in Entrepreneurship in the West: Is Complexity Ossifying the Economy? 2019.

Features image: Normal bone tissue

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