Despite record investment in research and development (R&D), productivity growth across advanced economies has been sluggish for decades. University of Chicago economist, Professor Ufuk Akcigit, argues that the “productivity paradox” lies in the changing structure of competition and innovation itself.

Prof. Akcigit recently sat down with UNSW Business School’s Associate Professor of Finance, Elvira Sojli, a Scientia Fellow Alumni in the School of Banking and Finance, to discuss his world-leading research on business dynamism – the birth, growth, and death of firms that fuel creative destruction, which has been in steady decline since the 1980s. 

In the 1960s, the US economy spent five times less on R&D as a share of GDP than today. “Any growth model would predict that more R&D should lead to faster growth, but the opposite has happened,” he said. The share of new firms entering the market each year has halved, falling from about 14% to 7%. “You need fresh blood,” explained Prof. Akcigit. “But entry rates have collapsed, and market concentration has surged.”

The widening gap between market “leaders” and “followers”

According to Prof. Akcigit, at the heart of the problem is a decline in knowledge diffusion – the process by which new ideas and technologies spread from leading firms to others. “It’s not enough to come up with a new technology,” said Prof. Akcigit. “It must diffuse across the economy.”

Yet his data shows that this diffusion is slowing dramatically. One explanation lies in increasing market power and intellectual property (IP) protection. In the mid-20th century, competitors could visit each other’s factories and learn through reverse engineering. Today, much of production is digital – based on proprietary data and algorithms that can’t be easily replicated.

“Knowledge diffusion has decreased,” said Prof. Akcigit. “Either firms are learning less from market leaders, or they are afraid to use what they learn because of IP threats and patent wars.”

The result is a “winner-takes-all” economy where dominant firms capture ever-larger market shares, raising markups and stifling new entrants. “When graduates consider starting a business, they fear they’ll be eaten up by giants,” explained Prof. Akcigit. “Creative destruction is declining, and that’s dangerous for long-term growth.”

The impact on small businesses

While policymakers often celebrate small businesses as the engine of job creation, Prof. Akcigit cautions that “small business” does not capture the whole story. 

Prof. Akcigit’s research has revealed a crucial difference between what he calls “transformative entrepreneurs” – startups with growth potential – and “subsistence entrepreneurs,” those who run small, stable, often family-owned operations.

“Take two firms that both employ two people,” he explains. “One is 60 years old; the other is three months old. Only one has the potential to scale, and that is the three-month-old firm.” 

Yet governments frequently fail to distinguish between the two. “Industrial policy should target productivity and jobs,” Prof. Akcigit said. “Social policy should support those in need. Mixing the two misallocates resources.”

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Prof. Akcigit’s research has also uncovered surprising findings about who becomes an entrepreneur. Analysing intelligence scores and occupational outcomes, his team found a negative correlation between IQ and the likelihood of becoming an entrepreneur until they distinguished between transformative and subsistence business types. 

Once separated, transformative entrepreneurs, or those who hire technical staff and aim for growth, showed a strong positive relationship between ability and entrepreneurship. “The data is very clear. There are two types of entrepreneurs. And policy must ensure that the transformative ones can thrive,” said Prof. Akcigit.

A real-time view of small business health

Because traditional surveys underrepresent small firms, policymakers often lack visibility into how these businesses are performing – especially during economic shocks. To close this gap, Prof. Akcigit collaborates with Intuit QuickBooks to create the Small Business Index, which tracks real-time data from micro-firms (those with nine or fewer employees) across the US, UK, and Canada.

“The smallest firms are like children in a family. They are the future, but also the most fragile,” he said.

During the post-COVID inflationary period, the index revealed stark trends: small business employment declined sharply, and entrepreneurs increasingly relied on personal credit cards to finance operations. When the US Federal Reserve began raising interest rates in March 2022, these firms’ debt burdens ballooned.

“High inflation and rising interest rates hit small firms first and hardest. They were paying more interest on their balances as their share of employment fell. Without timely data, policymakers would have missed this,” said Prof. Akcigit.

Ultimately, Prof. Akcigit argued that supporting small businesses is essential for future productivity, not just current jobs. “Today’s small and young firms are tomorrow’s superstars. We need better economic MRI scans – real-time data to detect where the economy’s weak spots are,” he said.

Education and innovation must evolve together

Innovation policy often focuses on firms, especially through well-known levers such as tax credits, subsidies, and R&D incentives. However, Prof. Akcigit said that without an adequate supply of skilled young talent, these interventions will have a limited impact.

“You can spend as much as you want, but without good players, your team won’t win the championship,” he said. “Industrial policy must go hand-in-hand with education policy.”

Every economy channels a new cohort of students through its education system, but inequality in access to quality schooling can distort who becomes a scientist, inventor, or entrepreneur. 

“Not everyone is born the same," Prof. Akcigit said. "A good system identifies and nurtures talent, allowing for social mobility. But if opportunities depend on family background rather than merit, we get talent misallocation.”

The cost of ignoring human capital

Prof. Akcigit’s analysis draws on evidence from the US showing how R&D tax credits can unintentionally inflate engineer salaries rather than boost innovation. “If the supply of talent is fixed, then increasing demand just raises prices. That’s what we see – firms get the subsidy, but innovation doesn’t rise because the inventor talent pool doesn’t expand,” he said.

This dynamic underscores a broader point: policies that boost demand for innovation must also expand the supply of innovators. This means investing in high-quality early education, technical training, and equitable access to universities.

“In the age of AI and digital transformation, we have to ask: are we training talent at the same speed that technology is advancing?” Prof. Akcigit said. “If not, either firms will leave in search of talent, or talent will migrate to where it’s valued.”

A truly dynamic economy requires both firms and institutions to evolve in sync. “You can’t have dynamic businesses without a dynamic education system. Both must adapt together,” he said.

A new blueprint for economic dynamism

Prof. Akcigit’s research suggests the innovation slowdown dominating news headlines is not due to a lack of ambition or ideas, but to bottlenecks in diffusion, entrepreneurship, and talent development. Market power and IP regimes have limited the spread of knowledge. Small businesses, although vital, often face financing and data gaps. And the education-to-innovation pipeline needs reinforcement.

To reverse the trend, economies must reignite creative destruction by making it easier for new firms to enter, learn, and scale; by aligning industrial and education policy; and by using real-time data to guide decisions. “If the water flowing through the pipe is weak, the blockage could be anywhere. We need to inspect the whole system, talent, firms, and policies, to restore the flow of innovation,” he concluded.