Driving the Market Process: Why Entrepreneurial "Alertness" Trumps "Creative Destruction"

0:00Well, I'm afraid this paper grew beyond my intention as I was writing it, and so there's no way I can read it to you, but I will read a little bit of it and intersperse with a summary. I changed the title a bit. It's now titled, Driving the Market Process, Entrepreneurial Alertness Versus Creative Destruction. The paper argues that Israel Kirzner's theory of entrepreneurial action as the driving force of the market, an extension and further development of Ludwig von Mises' theory of entrepreneurship, contributes to a fundamental understanding of the market process. In contrast, Joseph Schumpeter's theory that entrepreneurship is the agent of creative destruction of an ongoing state of general equilibrium, as well as being the internal force for the economic development of any economy, market or non-market, is argued to be spurious and to reveal his profound lack of understanding of both the market process and of the economics of non-market economies.

1:00The next section of the paper, the second section of the paper summarizes Schumpeter's concept of entrepreneurship and his use of it as a Deus ex machina, god of the machine, for economic development. Kirzner's concept of entrepreneurial alertness as the driving force of the market process is explained in the third section. The fourth section compares and contrasts the two visions and section five presents the conclusion that Kirzner's concept of coordinating alertness trumps Schumpeter's entrepreneurial Entrepreneurial Creative Destruction, although it is argued that much additional work is required to complete the theory of entrepreneurial action. We start with Sean Pater and his 1911 theory of economic development.

1:45His concept of the entrepreneur there is that the entrepreneur is a leader, a person, a man of action, driven by the pleasure provided by creative construction, and he strives to to acquire goods to gain social power. He forces his products onto the market because the masses can't be persuaded to cooperate for development, so they have to be forced. In non-market economies, the entrepreneurial force is direct authority in physical coercion. Whereas in a market economy, the entrepreneurial force is exerted through the use of money to create a new combination of existing goods and innovation. The entrepreneur is the cause of economic development, because he creates change of the economy out of the economy itself, says Schumpeter.

2:36So what Schumpeter's created is this god of the machine to drive the process of economic development. There is neither a reason nor a historical explanation of why or how entrepreneurship is exerted by such a unique man of action. The right innovational choices are done with, says Schumpeter, quoting him, without any particular deliberation, unconsciously and without precisely identifying his reasons to himself. Now, I have to admit, before I wrote this paper, I had never read anything of Schumpeter's except his history of economic analysis. So all of this was new to me. I had heard such complimentary things said about Schumpeter that as I read through what And he actually wrote, I was astonished.

3:25And I urge you to read Schumpeter so that you will be astonished. The economic context for the man of action or entrepreneur is a temporarily existing static circular flow of economic activity in his theory of economic development. Development in its deepest character, says Schumpeter, constitutes a disturbance of the and the Existing Static Equilibrium. So what we have here is theoretical dualism. He's got two theories, the theory of the static state, which as we're going to find out in his business cycle book is Volresian General Equilibrium, and a theory of economic development which is driven differently by your entrepreneur. He revised his theory of economic development in 1926 and recast his vision.

4:13Now it's new firms that introduce the innovations. He now views entrepreneurship as a type of conduct or a characteristic created by, as he says, quoting, aptitudes differing in kind and not only in degree from those of mere rational behavior. It's the result of an intuition that leads to an effort of will, he says. In 1928, he wrote another article, or he wrote it actually in 26, and it was printed and published in 1928 in the Hohenwerder Buch des Staatswissenschaften. It was titled The Entrepreneur, and in it he said that whether an economy is a socialist or an exchange economy, their essential economic principles and results are analogous.

5:04The modern enterprise, he says, actually approaches the character of a public administration. From the entrepreneur as a unique sort of person, he's moved to viewing entrepreneurship as a unique social function imposed somehow by special circumstances that present new possibilities. Then we have his business cycle book that was published in 1939. I'm still recovering from that cold lunch down at Chipotle. It was colder inside than it was outside, and I can't get enough hot coffee. What he does in the business cycle since 1939 is he presents a model of the economic process that begins and ends in a Volrasian general equilibrium.

5:50And this is hardly surprising given that Schumpeter said in his history of economic analysis that The Walrasian General Equilibrium concept is the Magna Carta of economic theory, and he asserted that so far as pure theory is concerned, Walras is the greatest of all economists. Innovation, says Schumpeter, is the outstanding fact in the economic history of capitalist society. It's a change in the production function. It disrupts the Walrasian General Equilibrium. And where do the innovations come from? They come from what Schumpeter calls the new men that start these firms.

6:37The achievements of capitalism and industrial organization, he says, and I quote, undermines the social institutions which protect it and will inevitably lead to its decomposition and replacement by a state socialist economic order, a centrally planned economy. As he sees it, the fact is that progress is becoming mechanized. Innovation is routine. Economic progress is depersonalized and automated. He said this in the 1930s. If capitalism is inevitably to yield to state socialism, can the planned economy work? Of course it can, quoting Schumpeter, he claims. Against Mises, Mises cites specifically, Schumpeter reveals tells his utter ignorance of the gist of Mises' arguments against socialist planning.

7:26He does so by claiming that production is nothing but the rational combination of existing factors. This guy is called an Austrian economist. He was Austrian, that's true, by nationality. And this leads of course to his capitalism, socialism and democracy and is the theory that capitalism basically is so successful that it destroys itself. Before we get to Kirzner, I have to say a couple of words about Mises. Mises defines and uses the word entrepreneur in three different ways.

8:13His first concept of the entrepreneur is one of an ideal type. He says that you use it to get an historical understanding of economics. The entrepreneurial function is his second concept of the entrepreneur, and this is the function in catalactic theory. It's necessarily performed by all actors in a market economy, said Mises. It's acting man exclusively seen from the aspect of the uncertainty that is inherent in every action. And it's restricted to the context of the market economy because it involves the economic calculation of profit and loss, and the action is taken with a view towards future profit.

8:59So there's no entrepreneur, according to Mises, in planned economies. It requires the theoretical context of market disequilibrium because there's no money profits Entrepreneurian Mises, Entrepreneur Promoters He focuses on designating individuals as entrepreneur-promoters rather than on the functional entrepreneurship of acting man, and this makes it descriptive rather than theoretical and I think makes it akin to the ideal type concept.

9:47What is regarded as a particular market, of course, is purely a matter of analytical convenience. The theory of the market process concerns the understandings of the workings of the entire market economy. Now turning to Kirzner. Kirzner presents the basic theory in his, actually in his textbook that he published back in 1963 titled Market Theory in the Price System. He presents the basic theory of the market economy that he later uses both to refine and extend Mises' explanation of functional entrepreneurship. Kirzner conceptualizes all participants in the market process as being purposive individuals. Interaction between the decisions made by all participants in a market is what he means by the market process. What is regarded as a particular market is merely a matter of analytical convenience.

10:36The theory of the market process concerns the understandings of the workings of the whole market economy. Particular markets in that economy are assumed always to be in disequilibrium, although the activities of their participants are unintentionally equilibrating in their effects. The responses of individuals to failures of their particular plans are to revise those plans so that further actions taken tend to be more consistent with the decisions and actions of others. The result is greater overall consistency. If you offer a price for something and nobody takes it, then you raise your price until you get to the point where somebody is willing to take it. And that's what he means by consistency in the actions of the participants. They become more consistent. Constant changes in the basic data of the market preclude any final market equilibrium.

11:25Every participant in the market process acts as an entrepreneur in some aspect of their decisions and subsequent actions. The entrepreneurial aspect of all decision-making is the speculative one, as Kirzner says, for which uncertainty is of the essence. In particular, the awareness of a difference in prices and the search for profit is a search for misallocation of resources. In Competition and Entrepreneurship, which he published in 1973, Kirzner talks about pure entrepreneurship, it's an aspect of consciousness possessed by any market participant.

12:13of being alert to changing buying and selling possibilities. The result is that the market process itself becomes an essentially entrepreneurial one. Entrepreneurial actions still analytically reduce, says Kirzner, to arbitrage. After competition and entrepreneurship, he wrote a number of other papers that further clarified his concepts of entrepreneurship that were published in a series of books all Kirzner adapted Hayek's argument, in particular, that the dispersed knowledge and particular intentions of market participants are brought into agreement by the market process. His adaptation is a claim that it is entrepreneurial alertness that provides this mechanism for market participants to discover useful information and revise their plans.

13:09So that makes Kirzner, Hayek thought that this view of knowledge and how it is people's knowledge improves was an empirical question. Kirzner says it's theoretical because entrepreneurial function is part of acting man. The discovery of new information must be a spontaneous movement out of ignorance into the knowledge as a result of entrepreneurial alertness. Kirzner fleshed out his concept of alertness as the motivated propensity of man to formulate an image of the future in these later writings and in fact create the future for which his present acts are designed. The motivation is that of pure profit seeking.

13:56His later work expanded the concept of entrepreneurship to include innovation. The incentive of pure profits brings this forth and he added an emphasis on competition as a Stimulant to the Exercise of Entrepreneurial Alertness. Sean Pater argues that entrepreneurial activity is disruptive of existing production functions and is the primary source of disequilibrium. Its sources are power-seeking behavior and the desire to create new orders of production. Its primary means to those ends is innovation. Kirzner argues that entrepreneurial activity is a coordinator of human action and analytically reduces basically to acts of arbitrage. It is stimulated by the discovery of profit opportunities. Its primary means to this end is a state of alertness to the possibility of such discoveries. Both Schumpeter and Kirzner see entrepreneurship as the driving force of a socioeconomy, but Schumpeter endows it with a grander role.

15:02He applies it to all economies, whether market or non-market, and presents it as a force of transformation that shatters existing production and consumption relations, and drives the economic development of economies to ever higher levels of wealth. Kirzner views entrepreneurship as a human action that begins in one market of a market exchange economy, with its effects eventually spreading throughout the whole economy. The market economy itself is viewed as a process of adjustment of human action so that the The increased coordination among market participants created by entrepreneurship better enables participants to achieve their separate goals. Whether the results are higher levels of wealth or the transformation of production and consumption is not really germane to Kirzner's theory. Nevertheless, the individual striving to better his condition through exchange relations produces the betterment of all in Kirzner's theory just as unintentionally as does the undertaker in Adam Smith's Invisible Hand metaphor for wealth creation through production.

15:59Schumpeter's theory of entrepreneurship is radically different from that of Kirzner's. It is particularly apparent in Schumpeter's argument that entrepreneurial activity is characteristic of both market and non-market economies and drives their development. He thus reveals his moorings in conventional neoclassical microeconomic theory rather than in Austrian school market process theory. There are several serious flaws in Schumpeter's theory of entrepreneurship. The Walrasian general equilibrium model on which he bases his theories of development and business cycles profoundly misrepresents the market process for reasons that are extensively treated elsewhere, particularly by Mises and other Austrian school theorists. Schumpeter's entrepreneurial God of the Machine as a disruptor of general equilibrium lacks reasoned motivation. It's He's a Prometheus without a first cause, a mere pragmatic device to get things going.

16:52He also posits innovations as acts of entrepreneurship without an explanation of the source of the new possibilities that are used in innovation. He denies that they are found or created by entrepreneurship. They just come into existence, somehow lie about for a while, and are stumbled upon and get applied. His perfect knowledge assumption for a general equilibrium to exist in a market economy removes and Any Reason Source of Entrepreneurship Kirzner's theory of entrepreneurship has obvious and substantial moorings in Austrian school market process theory, as it has developed through the work of Menger, Mises and Hayek. His extensive development of the specifics of the entrepreneurial aspect of human action has added significantly to our understanding of it, in sharp contrast to Schumpeter. Nevertheless, there are discordant elements in Kirzner's vision.

17:40To find the essence of entrepreneurship and alertness to profit opportunities is insightful, but there must be more to it than that. It takes an act of will to be alert and a further act of will to decide to do something about it. The capacity to be alert to opportunities and to strive to profit from them is gutsy and not always present all the time or in all people. Further, Kirzner's own comparison of the concept of entrepreneurship with that of Schumpeter is inadequate, in that he accedes to Schumpeter's view of the entrepreneur as an ideal type, rather than being, as Kirzner himself recognizes, an aspect of human consciousness present in exchange relations. He does this when he characterizes the difference between their respective views as one between that of the entrepreneur as disrupter versus that of equilibrator, thus leaving out the ignorance, uncertainty and purposefulness that give rise to the entrepreneurial aspect of Human Action only in the market process.

18:41It's also difficult to separate innovation from entrepreneurship if entrepreneurship is entwined with boldness, self-confidence, creativity and innovative ability, as Kirzner says it is. Expanding the definition of arbitrage to include innovation seems more like a sleight of hand than an argument. A focused alertness to possible market profit opportunities of whatever sort and the will To be able to pursue them seems a necessary part of the concept of entrepreneurship. Kirzner's later writings appear to concede this. And lastly, it may be time to drop the use of the words equilibrium and disequilibrium from economics. The market process is not about attaining equilibrium, whether temporary or terminal. It's about purposive individuals seeking to achieve personal goals through exchange with others in a context of ignorance and uncertainty that requires speculation.

19:36Market exchange is just one of the means for the peaceful pursuit of human ends. The language of classical mechanics provides inappropriate metaphors for the explanation of the process of exchange. The first law of thermodynamics applies only to physical science phenomena, not to catallactics, which is a science of human action in which value is created rather than equilibrated or merely not lost.