Baumol’s productive and unproductive entrepreneurship after 25 years

The purpose of this paper is to consider the impact of Baumol’s work on entrepreneurship has had on framing the economic development puzzle.

In many ways, the intuition behind the paper is straightforward. Entrepreneurs allocate their time and attention based on the relative payoffs they face in any given social setting. If the institutional environment rewards productive entrepreneurship, then the time and attention of entrepreneurial actors in the economy will be directed toward realizing the gains from trade and the gains from innovation. If, on the other hand, there are greater returns from the allocation of that time and attention toward rent-seeking and even criminal activity, alert individuals will respond to those incentives accordingly. The simplicity of the point being made is part of the brilliance in Baumol’s article. As with other classics in economics, once stated the proposition seems to be so basic it is amazing that others did not put it that way beforehand.

It has been 25 years since Baumol published his paper in the Journal of Political Economy, and as pointed out, it has had a significant scientific impact. But to put things in perspective, James Buchanan’s “An economic theory of clubs” published in 1965 has accumulated roughly 3,500 citations, F.A. Hayek’s “The use of knowledge in society,” published in 1945 has over 12,000, and Ronald Coase’s “The problem of social cost” published in 1960 has over 28,000 citations. So Baumol’s paper would put him in rather elite company. The great strength of the paper is to focus the attention on the relative payoffs of productive, unproductive and destructive entrepreneurial activity. But one of the most significant disappointments of the subsequent history of this paper is a methodological one. The comparative case study approach that Baumol employed did not result in a renewed appreciation for narrative forms of empirical research in political economy. It could legitimately be argued that the sort of questions about the fundamental institutional causes of economic growth and development can only be captured with these more historical methods. Attempts to force fit this analysis into a set of methodological tools which have already revealed themselves to be inadequate to do justice of the role of institutions and disregard the underlying cultural norms and beliefs that characterize human sociability.

In this paper, the authors will focus on the contribution made by Baumol’s 1990 paper on the field of comparative political economy, and in particular on the literature on transitional political economy. Section 2 places Baumol’s argument in the context of the failure of neoclassical growth theory. Section 3, the authors argue that although the Baumol framing was an improvement over the old comparative economic systems literature, contemporary transitional political economists have failed to fully realize the implications of the institutional revolution. They have therefore been unable to understand the causes of the heterogeneity of outcomes among those countries that transitioned from communism to the market economy in the 1990s. In Section 4, the authors argue that the political economy of transition will gain from a more sophisticated view of the economic process of the market economy, an appreciation of the entrepreneurial function, and a deeper understanding of the role of formal and informal institutions and their effect on entrepreneurship. The authors will illustrate the point with some examples from the recent history of the Russian political and economic transition. Credible commitment problems and the deficiencies of the institutional reforms of the early 1990s were responsible for the failure of reallocating the entrepreneurial talent that existed in the Soviet economy to productive economic activities. The framework can therefore be used to solve the puzzle of why the announced liberalization of Russian markets and privatization of previously state-owned resources led to economic stagnation, the growth of black markets, and the rise of organized crime, instead of economic development through the operations of smoothly operating markets. Section 5 briefly concludes.