The Chicago school economist who warned years ago of America's ‘business dynamism’ fading still sees 'something broken in the background'

A pioneer in the field of Quantitative Economic Growth, Akcigit examines how market innovation and policy combine to optimize an economy’s expansion—or the opposite. Akcigit’s work on “business dynamism,” a hugely important metric that gauges an economy’s ability to sustain growth, has borne grim tidings for his adopted country of the United States. Simply put, he’s found that over time, the American economy has become a hostile environment for innovation. 

In 2019, Akcigit and his co-author Sina T. Ates, of the Federal Reserve Board, released findings that pinned the blame for fading U.S. dynamism on “poor knowledge diffusion.” Four years later, he tells Fortune that the problems just haven’t gone away. 

“For productivity to improve, we need to have ‘creative destruction’ and turnover,” Akcigit told Fortune. “Better firms should replace worse firms in the economy, and that turnover will push productivity forward.”

(Ates, a principal economist at the Federal Reserve Board, was unable to speak on the record due to his position. The researchers’ findings do not reflect the opinion of the Fed.)

Something’s broken

Business dynamism, measured by the rate of new firm creation in markets, is directly tied to innovation and productivity. In Akcigit’s field, researchers have known that it’s been declining in the U.S. since the 1980s, the cause of which has prompted various theories. This decline in dynamism is significant because it’s linked to a general slowing of productivity and creative momentum, which need to be strong for the U.S. to remain the world’s dominant economy in the long term. 

The majority of U.S. markets have become more concentrated, and thus less competitive due to the slowing firm turnover rate, the co-authors argued. The result has been markets increasingly dominated by big players who don’t drive their sectors forward, and higher barriers for new businesses to enter markets. The dip in new entrants is a hit to the economy, as new entrepreneurs are the engines of growth under capitalism.

“Creative destruction,” a phrase coined in 1942 by the great Austrian economist Joseph Schumpeter, is the process where unproductive firms are cyclically edged out of a market as the natural result of healthy competition and as new, more productive companies surge ahead. It therefore bodes ill that, according to Akcigit, the number of new firms launching the U.S. economy has been declining for the past several decades in tandem with a productivity slowdown. 

The 2020s are providing evidence of green shoots for dynamism. In the three years since the pandemic, there’s been a well-reported rise in new business formation, while productivity has largely declined as CEOs nationwide weather remote and hybrid work, only for a surprise uptick in the second quarter of 2023. Still, the U.S. has seen a steady secular decline in establishment births for decades. This is especially troubling, Akcigit says, because the U.S. has been greatly increasing its investments in research and development. The government’s investment in R&D was an estimated $792 billion in 2021, nearly double the $407 billion it spent in 2010.

“There’s something broken in the background, these are the indicators according to the textbook definition,” says Akcigit, who is also a researcher at Germany’s Halle Institute for Economic Research. “Normally as we invest more in R&D and innovation, we should grow faster, but that’s not happening…and the amount of knowledge that diffuses from market leaders to followers seems to be the dominant factor to explain all these facts together.”

Akcigit and Ates modeled various “alternative horse races” to test which factors—including potentially corporate taxes, inflation, or subsidies—could be causing the decline in dynamism. They worked with quantitative data on firm entry rate, job reallocation, productivity dispersion, and other vectors, building on previous research with new models. Ultimately, their research indicates that the key to sustained economic growth may be a democratic distribution of great ideas. 

“Knowledge diffusion” is the dispersion of innovation across an industry. If one firm makes a breakthrough, the spread of its ideas can supercharge productivity across the sector, but siloing that information only benefits the original business. Knowledge diffusion is crucial for economic productivity, because productivity aggregates all firms and can’t be accelerated by just a few strong leaders. For a whole society to benefit from new knowledge, it has to be shared with as many potential users of that knowledge as possible.

But right now, Akcigit and Ates found, new breakthroughs are getting more concentrated. The existing big players across markets are becoming more entrenched, and the turnover rate among market leaders is declining. This means that firms that historically would be replaced by newer, more creative firms are remaining in power and dragging down the market’s productive potential. 

“Firms are experimenting less, they are entertaining less radical ideas over time,” Akcigit told Fortune. “They are trying to go for safer things.”

What broke?

Akcigit and Ates’ research posits three main reasons for the dynamism decline. First, the U.S. has outsourced more and more of its production over the past four decades. When production is concentrated in the same area, various firms have the benefit of learning from each other through interacting in the region. Increased offshoring of production abroad means communication—and thus cross-pollination of ideas—between firms has naturally declined.

Second, the rise of data as a form of capital interfered with traditional means of knowledge diffusion. In decades past, a smaller rival could better compete against an entrenched player by studying its production facilities: they could see what kind of machines were used and reverse-engineer them. But now, machines and data capital are not easily studied in person to be reverse-engineered.

“Today, one of the main ingredients for production is data, customer data, or A.I.,” Akcigit says. “Firm data is not something that you can replicate unless you share it and make it publicly available, which obviously firms don’t do. So as a result, whoever has managed to collect enough information on the largest possible customer base gets a disproportionate advantage.”

Data primacy, of course, favors established firms with larger, richer databases and customer bases from which to extract new data.

The third reason to which Akcigit and Ates attribute weak U.S. dynamism is the most significant: intellectual property hogging. They measure the growing concentration of intellectual property by patent ownership. In the early ’80s, 30% of patents were produced by the largest 1% of firms. By 2019, that number had doubled to 60%.

Not only are more than half of all new inventions owned by the economy’s largest firms, but those same firms are always vying to purchase more patents invented by other firms, to essentially monopolize new ideas. In the ’80s, 35% of the patents on the secondary market were purchased by the largest firms, but now it’s around 65%. 

“There’s a massive concentration of intellectual property within the hands of the market leaders,” Akcigit says. “You buy these patents to build a wall around yourself so that competition is harder, and followers cannot leapfrog your boundaries. And whenever they try to leapfrog you, you threaten them, you sue them, you take them to court.”

How do we fix it?

There are some listening to this—including in the White House. President Joe Biden has made what he calls pro-competitive reforms a priority of his administration, particularly with regard to antitrust policy, where he’s actively seeking to break with 40 years of precedent and practice. Notably, he nominated Lina Khan, flagbearer of the populist, hard on Big Tech “New Brandeis” movement in antitrust, as chairwoman of the FTC, and as chair of the agency she has formed a triumvirate of likeminded pro-competition regulators, with Jonathan Kanter at the Justice Department and Tim Wu at the White House’s National Economic Council, although Wu resigned in late 2022 to return to teaching at Columbia University. 

Khan is known for her anti-monopolism and goal of reforming federal merger guidelines. She’s taken on several big players in the tech industry, and endured many setbacks in her efforts to block mergers. While at Yale Law School, she published the influential article “Amazon’s Antitrust Paradox,” which takes aim at the retail behemoth and similar big players, calling for increased anti-monopoly, pro-competition policy.

Biden has also created a White House Competition Council and issued an executive order in July calling for the deconsolidation of American industries.

“[T]he answer to the rising power of foreign monopolies and cartels is not the tolerance of domestic monopolization, but rather the promotion of competition and innovation by firms small and large,” the executive order reads.

For his part, Akcigit says policies to bolster knowledge diffusion may be most effective in the intellectual property realm. Right now, most patent authorities monitor the amount of original patents being produced, but they should also be keeping a close eye on the secondary market. The leap in large firms purchasing patents on the secondary market, buying competitors’ inventions, is a primary contributor to idea-clogging in markets.

“The secondary market for technologies has to be watched,” Akcigit says. “Instead of having patent resale in a productive way, the secondary market is being used for so-called killer acquisitions. So the market leaders are buying out other firms or their intellectual property, not to use them, but to put them to sleep so that they don’t compete.”

The economist told Fortune that competition policymakers and authorities should keep a “dynamic and forward-looking” mindset. Small companies can be hugely important idea crucibles and become quickly successful, but are the most vulnerable to macroeconomic headwinds. If authorities don’t know which startups to keep watch over, important breakthrough firms can easily fail due to their fragility. 

Akcigit compared young firms to children in the economic family, who fall ill easily and have to be carefully protected. “We should look at their future potential,” he advised.“Whenever there’s some macro-turbulence, small firms get affected very easily—but, they are the future of the economy.”