Bob Wenzel has written several additional posts on our disagreement regarding entrepreneurship (here, here, and here). I’ve greatly enjoyed the discussion, and I thank Bob for the space he’s devoted to this topic. I hate to sound like a cranky old professor, but I’ve explained my position about as clearly as I can in two books and a series of published journal articles, and I’d like to suggest (politely) that interested parties turn to those for the rest of the story. The following in particular may be useful:
- Foss, Nicolai J., and Peter G. Klein, “Alertness, Action, and the Antecedents of Entrepreneurship,” Journal of Private Enterprise 25, no. 2 (Spring 2010): 145-164.
- Foss, Nicolai J., and Peter G. Klein, Entrepreneurial Alertness and Opportunity Discovery: Origins, Attributes, Critique,” in Hans Landström and Franz Lohrke, eds., The Historical Foundations of Entrepreneurship Research (Aldershot, U.K.: Edward Elgar, 2010), pp. 98-120.
- Klein, Peter G., “Opportunity Discovery, Entrepreneurial Action, and Economic Organization,” Strategic Entrepreneurship Journal 2, no. 3 (2008): 175-90.
- Klein, Peter G., “The Mundane Economics of the Austrian School,” Quarterly Journal of Austrian Economics 11, nos. 3-4 (2008): 165-87.
You can also find a bunch of videos of me talking about entrepreneurship. And if you don’t believe my argument, try Rothbard or Salerno, both of whom take the same basic position as me. (BTW I’m far too modest to point out that the Journal of Private Enterprise article won the journal’s annual Best Paper Award.)
In closing, I think the differences between Bob and me are partly semantic. It’s no wonder, because the words “entrepreneur” and “entrepreneurship” are used in so many different ways. In particular, economists use terms like “entrepreneur” and “capitalist” in particular ways, differently from the way business practitioners and lay people use those terms. For the economist, these are generalized economic functions, not personality traits or psychological profiles or descriptions of flesh-and-blood individuals. E.g., “worker” or “wage earner” is an abstract economic function, describing one who provides labor services in exchange for specified remuneration, and applying equally to a Walmart cashier and a Fortune 500 CEO. Of course, in everyday discourse, we don’t refer to Timothy Cook or Meg Whitman as wage slaves, though that’s exactly what they are, in their capacities as salaried employees of their companies. Likewise, those who put capital at risk have been known, since Cantillon in the 18th century, as “entrepreneurs,” even if they don’t look like Richard Branson or Steve Jobs. Entrepreneurship is simply that which generates profit and loss, and there is no profit and loss without resources at risk. (The economic function of the capitalist is to advance funds in the present, in exchange for repayment in the future, in return for interest; absent uncertainty, the capitalist function stands on its own, but under uncertainty, the capitalist is necessarily an entrepreneur.)
Of course, in the real world, some people are especially eager, bold, creative, alert, aggressive, shrewd, adventurous, and imaginative, and they play a hugely important role in the a market economy. We admire them, we study them, we write books about them. Young people want to be like them. That is all wonderful. But none of these traits is essential to the entrepreneurial function, which is to be the residual decision-maker about the use of resources under uncertainty.
Bob says that entrepreneurs can make money using other people’s money, and gives his own version of the $10 bill story. I had written:
The Knightian-Misesian entrepreneur thinks he sees a ten-dollar bill, but it is partly buried under a rock. To retrieve it, he must buy a five-dollar shovel. If it really is $10 then (ignoring the opportunity cost of his time), he has earned a $5 profit. Otherwise, he has earned a $5 loss. This is a better metaphor for real-world entrepreneurship than Kirzner’s idea of costless discovery.
Bob responds:
As an entrepreneur, who spots the possible bill under a rock, instead of financing the bill digging venture with my own money (as you suggest), I may go to a capitalist and say, “Hey, I know where there might be a $10.00 bill under a rock, if you buy the shovel with your capital and use your labor to dig out the rock, if there is $10.00 under the rock, I’ll split the profit with you, $2.50 to each of us, plus you get the return of your capital.”
I am acting as a pure entrepreneur, with no exposure to risk.
This is simply relabeling. Bob calls the person who thinks he sees the cash (perhaps because he is more aware of his surroundings than other people), and who persuades somebody else to spring for a shovel, the entrepreneur. Fine, we can call him whatever we like, but this is arbitrary. What about the financier? In Bob’s version of the story, the financier is a completely passive player. But why should the financier believe the guy asking him for money? Why does the financier choose to advance the $5 to this guy, and not some other guy with an equally persuasive scheme? The financier has to choose what projects to invest in — a classic example of what Knight and Mises call judgment. (Think I’m exaggerating? Ask venture capitalists or business angels if they exercise judgment!)
Bob and I agree with Rothbard that ideas not backed by money are games. Bob wants to call the idea person the entrepreneur. OK, fine, but the Austrian tradition in economic theory calls the money person the entrepreneur. After all, the money person makes the final call on whether the project will be undertaken or not. In Ludwig Lachmann’s (1956) terminology: “We might . . . distinguish between the capitalist-entrepreneur and the manager-entrepreneur. The only significant difference between the two lies in that the specifying and modifying decisions of the manager presuppose and are consequent upon the decisions of the capitalist. If we like, we may say that the latter’s decisions are of a ‘higher order.’” In my example, the financier’s decision is of a “higher order” than the idea man’s decision, because the former decides whether the latter’s idea will be pursued or not.
Anyway, this is fascinating stuff, and I’m delighted to see it get so much attention in the pages of CB and EPJ.
Follow Circle Bastiat
“Of course, in everyday discourse, we don’t refer to Timothy Cook or Meg Whitman as wage slaves, though that’s exactly what they are, in their capacities as salaried employees of their companies. Likewise, those who put capital at risk have been known, since Cantillon in the 18th century, as “entrepreneurs,” even if they don’t look like Richard Branson or Steve Jobs. Entrepreneurship is simply that which generates profit and loss, and there is no profit and loss without resources at risk. ”
If I correctly understand the argument, Meg Whitman is a mere wage slave, whereas a stockholder of Hewlett Packard owning $100 of shares and having absolutely no influence nor any responsibility whatsoever for how the company’s money is invested, why, in what production processes and so on, is an entrepreneur?
You got it!
Look, the classification of activities and their income streams into economic functions has nothing to do with the quantitative *importance* of that activity. The main determinant of whether the Lakers win on a given night is probably how well Kobe Bryant plays, but that doesn’t change the fact that his $27m per year is wage income. Also, keep in mind that individuals typically exercise more than one economic function. Meg Whitman’s salary is wage income, but she probably also owns substantial shares of HP stock or stock options, and in that capacity she is an entrepreneur earning profit and loss. If she has corporate bonds or T-bills in her 401K she’s also a capitalist earning interest. If she owns rental houses she’s a landlord as well. And that’s just at a moment in time — she’s occupied these different roles in various capacities over her career. (Let’s not talk about the potentially ugly role as governor of California….) Likewise, a Walmart greeter who owns one share of H-P is an entrepreneur, in that very small capacity, though most of his or her meager income is presumably wage income.
This is pretty standard stuff in mainstream principal-agent theory. Shareholders (as a group) exercise the role of principal, and corporate executives, even the most highly paid, exercise the role of agent (in their capacity as salaried employees). In the Knight-Mises-Rothbard-Klein approach, shareholders exercise entrepreneurial judgment, and corporate executives, like other employees, do not. Two qualifications: (1) The case of jointly owned assets is complicated, because there are two issues going on: the function of owners as a group, and the function of any individual owner relative to the entire ownership group. Shareholders collectively exercise ultimate decision rights, but no individual shareholder, if ownership is widely dispersed, can exercise any influence over corporate decision making. So with dispersed ownership you have a collective-action problem on top of the usual owner-manager relationship. But it’s really no different, in principle, from any kind of joint ownership. Imagine a small startup organized as a partnership with two owners. No one would dispute that these two owners make the ultimate decisions about how the business is run (though they may delegate some day-to-day control to a hired manager). The fact that neither owner can exercise complete control without the consent of the partner doesn’t change the fact that they jointly hold the residual control rights. It’s the same with shareholders, no matter how many.
(2) The Fosses and I develop a theory of delegation to explain the specific decision rights that are delegated to managers in a multi-layered, multi-person organization (see this paper). In our terminology, the owners (VCs, partners, shareholders, etc.) exercise “original judgment,” but they give a lot of proximate decision authority to subordinates and task them with acting in the owners’ interest. We call this “derived judgment.” So a factory worker may exercise little derived judgment, with a few specified tasks to perform and not much latitude. An executive, a sales agent paid on commission, or any other employee with a lot of latitude exercises substantial derived judgment, meaning that he or she is allowed to make decisions using local knowledge, and with strong performance incentives, to increase the value of the organization. Still, the discretion of these employees is limited in important ways by the fact that they are not, themselves, owners of the firm (e.g., the sales agent can’t sell the company car). Their judgment is circumscribed by, and subordinate to, the judgment of the owners who hired them, who can fire them, who decided how much authority to delegate to them, and so on. So the theory, when applied to large corporations, is not as crazy as it might seem.
Still there’s fuzziness in the distinction between the function of “original judgement”. The worker too chooses the opportunity to accept or reject an employment offer made by the capitalist, just like a co-investor does. And the length of his employment, i.e. his profit, depends partly on his daily judgement which determines the profitability of his work to his employer. Actually, what human action is not an investment of at least time and effort (and opportunity costs), if not cash money, which requires judgement?
Spontaneously, I think that the core of entrepreneurship is about something else than the distinction of functions being discussed here. I would guess that it has more to do with the action of looking for new opportunities to choose from. And maybe more specifically how to actively think about possibilities to combine resources in order to offer other humans opportunities which beats their previously best one. And just like figuring out a about better ways of hitting a nail, it’s rather a technical thought process than a purely economic one.