Klein Versus Kirzner

There was a lively and enlightening discussion this past Monday at NYU’s Colloquium on Market Institutions & Economic Processes (formerly named the Austrian Economics Colloquium), when Peter Klein presented an excerpt from his new book , Organizing Entrepreneurial Judgment, co-authored with Nicolai Foss and published by prestigious Cambridge University Press.   Israel Kirzner, who is the leading theorist of entrepreneurship in Austrian economics as well as in the broader economics profession was present.  Also present were NYU professors David Harper who wrote a notable book on the subject and Mario Rizzo whose co-authored book and subsequent articles on the cognate topics of time and ignorance are highly influential in Austrian circles   The engagement among these prominent Austrian theorists was highly anticipated among colloquium participants and none of us were disappointed.

In his presentation, Klein challenged Israel Kirzner’s influential alertness paradigm of entrepreneurship.  Kirzner argues that alertness to and discovery of  profit opportunities–conceived as objectively and simultaneously existing differences in the prices of resources and products–is the crux of entrepreneurship.  Thus for Kirzner the entrepreneur is essentially an arbitrageur who buys a given good where prices are low and sells the same good where prices are high.  He faces no uncertainty, risks no capital, and always profits from his superior alertness to the existing profit opportunity.  Foss and Klein propose instead an approach to entrepreneurship based on Frank Knight’s and Ludwig von Mises’s focus on the “judgment” of uncertain future market conditions.   Judgment is exercised in the act of investing in  and allocating resources to specific time-consuming production processes that are organized and controlled by the entrepreneur until the completion and sale of the product.  For Foss and Klein the entrepreneur is therefore a capitalist and owner.  The capitalist firm is the organization created by the entrepreneur to facilitate ownership and decision-making control  over the productive resource combinations that embody his judgment of future product prices and markets.

The difference between the Kirznerian and the Knight-Mises (and Foss-Klein) conceptions of the entrepreneur was neatly summarized  in an illuminating exchange between Klein and a pro-Kirzner colloquium participant.  The participant gave the example of an owner of an orange grove, in the pre-orange juice era,  who discovers the “fact” that orange juice is valued more highly than fresh oranges by consumers.  The owner acts entrepreneurially by alertly discovering and costlessly exploiting the profit opportunity afforded by the price differential between lower valued fresh oranges and higher valued orange juice.  In doing so he also improves coordination between production plans and consumption plans in the economy and thereby moves the economy closer to equilibrium.

Klein responded by denying that the orange grower had discovered any “fact” at all.  What the grower did was to  judge that under future market conditions the price of orange juice would exceed the the production cost of the inputs, including fresh oranges, and, based on this speculative judgment, to invest his capital in purchasing these resources and organizing them accordng to a specific production plan.   Because his judgment and his  investment and organizational decisions turned out to be correct, he earned profits.  Had they been incorrect he would have suffered losses.  So, Klein maintained, the profit opportunity was not an ex ante  fact waiting to be discovered;  rather the profit opportunity was only realized , ex post,  as the successful outcome of an action based on a speculative judgment.  Whether or not the plans of economic agents are better coordinated and the economy is closer to equilibrium than before is “irrelevant,” Klein explained; the important point is that ex post profits indicate that resources have been reallocated from less valuable to more valuable uses from  the point of view of consumers.

Klein also disputed Kirzner’s contention that the entrepreneur qua arbitrageur was merely a “metaphor.”  In the excerpt presented, Foss and Klein perceptively wrote:

At least in usual parlance, a metaphor is a figure of speech in which a term and concept is used as a reference to something that it does not literally denote so that a potentially illuminating similarity is revealed.  Isn’t Kirzner talking about real-world entrepreneurs?  . . . Arguing that a construct is a metaphor drives a wedge between the reality that the construct is supposed to throw light over and the construct itself.  In particular , use of metaphorical reasoning is different from using models, constructs, or ideal types meant  to capture essential qualities of real phenomena (which a metaphor need not do).

This statement was challenged by another colloquium participant, who asserted that constructs and models were metaphors in the same way that a map was a metaphor for the actual  highways, roads, and streets whose configuration it depicted.  After all, the map “abstracted from” some essential characteristics of the real phenomena that it represented.  Klein’s critic was misled into equating metaphors with models and constructs just because both were abstract.  But, of course, as Mises emphasized repeatedly, all thought is necessarily “abstract.”  When we say that a disruptive co-worker is a “hurricane,” a brave warrior is a “lion,” or an under-performing athlete is a “dog,”  these  are metaphors that refer to real  phenomena that we perceive and that are part of our living experience.  They are abstractions in that they do not call to mind  the multifarious characteristics of these  really existing things things in all their particularity; but neither do they deny them.  In these examples they  refer to one outstanding attribute of an animal or natural occurrence by which we wish to characterize a person’s behavior.  Metaphors may also employ mythical or literary figures such as unicorns, ogres, classical demigods, witches and so on, but their purpose is always to highlight an outstanding characteristic of the person or thing to which it is compared.

The purpose of an economic construct or model is completely different.   Let us take the construct of the evenly rotating economy.  It is an entirely fictitious construction in which change is completely absent and which is populated  by automatons  who repeat  the same round of activities over and over again and never experience surprise or regret, profit or loss  from the outcome of their endeavors.  This construct is completely imaginary and does not refer to any realizable state of affairs in our world.  In fact it  deliberately specifies conditions that falsify reality.  It is not a metaphor, it was not formulated to make our rhetoric more vivid, intelligible or compelling;  it is a tool of thought used by economists  to  analyze the cause and essence of profit and loss.  Other economic models, like the ”plain  state of rest,” are  also abstract, but do not falsify reality.  For example, the plain state of rest describes  the outcome of the  process by which real people acting under conditions of uncertainty interact to  bring about actual market prices and exploit the mutual benefits of exchange.   It is abstract in the sense that it does not refer to the actors’s hair color, weight, age,  religion, etc., but it does not make any false or contradictory analytical assumptions.  And it also is not a metaphor, comparing one thing to a different thing, but the description of the essence of a real process of human interaction.

Klein’s provocative presentation evoked many other thoughtful comments, challenges,  and objections during the colloquium, but in my judgment Peter expounded and defended his position superbly.

Comments

  1. I read Peter Klein’s paper with great interest. I fundamentally agree with his economic views but I take some issue with his organizational analysis. For example, he makes this observation:

    A commodity standard, for example, removes even the possibility of central government intervention in the monetary system. If rules are better than discretion, the best policy is to eliminate all discretion, and to achieve a monetary standard that is wholly independent of political or technocratic interference.

    He then goes on to provide empirical data to support the premise that the existing system is not really “better” after all.

    My question is, better for whom? His apparent assumption that the purpose of the opposing view is mistaken because it does not produce the results he judges as “better” (and I agree) ignores the possibility that it is designed as it is precisely because it better serves those whose interests are best supported by its current design.

    In Rothbard’s History of Money and Banking In The US, he describes the history of the Federal Reserve Act, and it’s development and implementation through subsequent legislation, including the Banking Act in 1935, as being the results of the epic struggles between the then industrial giants, the house of Morgan, and the competing Rockefeller ambits, and the later confiscation of the power of the FED by FDR, the Federal Reserve Board in Washington, and political appointees pulled directly from those banking and industrial giants, all working together to agitate for popular political angles in the public arena, while maneuvering for ever greater control of the economy through the public/private/central government/ New Dealer’s cartelization.

    It is precisely the exercise of that power, to the detriment of free markets and the benefit of banking and industrial cartelization, that were and remain the design points of the current Federal Reserve system.

    My point is this; although it is important to argue the economic theory that supports the Austrian school view, and while I fully agree this is the correct view, this framing of the problem completely ignores the political dimensions of the problem; very well organized, funded, and politically connected interests are opposed to the position you argue for, precisely because the current arrangement is far superior to their collective purposes than the alternatives you advocate. It is not that they are mistaken; it is that we are ineffective.

    While I understand Klein is writing as an economist, the Fed is primarily a political problem that produces certain economic consequences. It cannot be overcome solely by a superior economic theory, no matter how correct that theory may be. It is not enough to show that the economic consequences of the current policies to not produce the promised outcomes (the problem stated in terms of economic theory), but it must also be demonstrated that the political process is failing to insulate us from powerful cartels formed between the current financial giants and our increasingly centralized government. Reduction of central government power in the public sector will necessarily weaken the financial cartels in the private sectors, and thus make it possible for public policy changes to take root despite the opposition of well-connected interests in both. They are each products of each other.

    This perspective appears to be missing in the analysis of the organizational behavior of the Fed in the context of these American institutions of power.

  2. Hello Joe,

    Just as a note, I think it would also be useful to be mindful of the distinction between what neoclassical economists refer to as “models” and what Mises refers to as “imaginary constructions” utilized in praxeology and economics.

    The models used in neoclassical economics often seem to be made and justified along the lines that they are admittedly faulty, approximate but (mathematically) tractable representations of the reality they wish to expound. Even more so once formulated if they can be found to fit historical data statistically, then they are deemed “good”, or better than others. Toward achieving this goal the descriptive accuracy of these “metaphorical” models is often dropped too, reflecting a methodology crystallized in practice by Solow and in theory by Friedman.

    The later approach seems to be based on a misunderstanding of a methodology of engineering and applied sciences. In these there is a distinction between theories and models. Though there are far too many caveats than can be summarized here in a blog comment, the former involve deductions from hypothetical propositions whose truth character are originally unknown that produce conclusions based on the premises that can be tested among the predictions they produce in reproducible, controlled experiments. The aim is to falsify and discard theories built from hypothetical premises that yield conclusions that produce false predictions as this therefore reveals the falsehood of (at least one of) the underlying premises themselves.

    The constant, quantitative relations that have been found in this mode of more basic inquiry, as repeatedly emphasized by von Mises have been essential in ensuring its success, but by no means allow, for an easy direct translation to the field of economics, whose subject matter, if we were to take a naturalistic view is the result of complex, interchanging concatenations of physical phenomena.

    On the other hand, theories originally constructed from hypothetical propositions(not already false) that have been showed to be strongly supported(and not falsified), are an essential input to the construction of models that are aiming to produce knowledge useful for practical, technological applications. Hence a model used in providing GPS navigation in smart phones may or may not include special and general relativistic corrections to a standard Newtonian model to the extent that these corrections are essential in serving the aims of the users of this technology.

    The Method of Imaginary Constructions as outlined by Mises quite definitively in Human Action seems distinct from both of the above approaches. Praxeological imaginary constructions can be based on true or false premises but they’re goal is not to approximate but contrast, and to deduce fully the implications following from defined modes of action, the realization of the origin of profit in contrasting the ERE and a changing world of uncertainty, and the operation of economic calculation realized by contrast between autistic and direct exchange to indirect exchange being two simple examples.

    In any case, I take it as encouraging sign these types of fundamental issues are finally becoming the subject of lively debate among Austrian School economists.

    Apologies for the wall of text but i thought i should contribute my 2 cents.

    Thanks,

    Abhi

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