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.