Entrepreneurship and Austrian Business Cycle Theory

0:00Hello. I'd just like to start saying I'm glad to be back here at the Mises Institute. It's been a number of years, and I really appreciate the opportunity. It's great to be here. Thanks to everyone in attendance and to the supporters of the Mises Institute as well. Our paper is on Austrian business cycle theory, entrepreneurship and Austrian business cycle theory. So we're looking at the intersection of two major strands in the Austrian economics literature. The basic problem that we're looking to investigate, Austrian economics has extensive literatures developed on both the theories of entrepreneurship, Mises, Hayek, Kirzner, Schumpeter to the extent that he's an Austrian, and as well on business cycle theory, Tim got into a little bit in his paper, but I'm sure we're all familiar with the basics of both of those areas of research in Austrian economics.

0:50There's not a lot of very explicit treatment of the specific roles and actions that entrepreneurs necessarily take at each stage in the business cycle. So we do see it mentioned in some more or less detail, sometimes more just in passing as in Hayek. But to develop that more specifically, and our basic question is, can we really gain new insights into Austrian business cycle theory by focusing directly on the concrete actions that entrepreneurs take at each stage in the cycle. We start with Menger, one of the founding fathers of Austrian School, obviously, who writes entrepreneurial activity includes a, obtaining information about the economic situation, b, calculation, all the various computations that must be made, c, an act of will by which which goods of higher order are organized, are assigned to production processes, and finally D, the supervision.

1:49So I outline these, A, B, C, and D, A being perceiving, which we see most characterized in the opportunity discovery literature. We also see this mentioned in Mises as well, of course, all of these are throughout the different strands of Austrian entrepreneurship literature, calculations, so we have profits and Losses, the basic arguments all around economic calculation. C is Acting. Of course, entrepreneurs must control real resources in order to do this, something we see much more from the Misesian tradition of entrepreneurship in Austrian economics. And then, Judgment under Uncertainty from Knight and others. The last one, D, is one we don't see often emphasized explicitly, but I feel is important. It really speaks to the Austrian emphasis on Processes Occurring Over Time in Markets Through Entrepreneurial Action here, that all three A, B and C are continuously revised and updated and occur over time in a production process.

2:50We classify in the paper three basic approaches in the Austrian entrepreneurship literature. The first one starting from Boehm-Bawerk, Knight, Mises and Rothbard. This is the judgment under uncertainty paradigm where entrepreneurs must control real resources and take their own risks of profit and losses actually acting through the production process. The second coming first originally from Wieser, somewhat from Hayek and really exemplified in Kirzner where the entrepreneur is a pure opportunity discoverer, is alert to opportunities but doesn't necessarily have to control any resources or actually execute the investment and production plans that need to be undertaken to exploit that opportunity. And lastly, Schumpeter, again, to the degree that his theory is really Austrian, I liked what Samuel Bostaff had to say a lot about what Schumpeter was writing the other day, which is exemplified in creative destruction.

3:46The entrepreneur is a disequilibrator, taking the economy from one Valerian equilibrium to another. One connection that we do see in Schumpeter's entrepreneurship theories is the almost dependence on credit creation. So there's a connection here to Austrian Business Cycle Theory already that in order to bid real resources away from other users, entrepreneurs depend on some form of new credit entering the economy in order to actually execute their new innovative production Plans. My professor and co-author, of course, favors the first approach, so I strongly agree with him. Next, moving on to the basic outlines of Austrian business cycle theory, we have three phases, the initial being the boom, where entrepreneurs are really the active of Agents.

4:45None of these phases happen on their own. The central bank could print as much money as it wanted if entrepreneurs aren't actually investing those funds in, well, malinvesting those funds into projects of longer and longer time horizons. You don't have a business cycle. So the boom, you must have entrepreneurs acting as agents, adjusting the capital structure of the economy to the expanded level of credit, flow of credit. and being the point of crisis, so the bust, the revelation of entrepreneurial errors here. So now we see some effect of which projects that entrepreneurs began in the early stages of the business cycle will actually be able to obtain the resources they need to be seen to completion. And last, the recession or recovery, as Mises said, the recession is the recovery.

5:34Entrepreneurs as agents of liquidating the malinvestments and reallocating the resources to new and more profitable, well, actually profitable projects as the economy returns to a more efficient state. So how do we interact these? We look at the relationships between the three strands of entrepreneurial theory and three phases of the business cycle here. In the first school of entrepreneurial thought, the judgment, Misesian School, entrepreneurs in the initial stages of the business cycle because of falsified interest rates and in some cases over optimism about the course of the economy, expected future course of the economy, make mistakes in their economic calculation and in the actions that they take on the basis of those calculations because they aren't pure alert discoverers in this tradition.

6:30In the bust, we see an increase in uncertainty, a spike in 19 uncertainty as a flow of credit is cut off as some plans cannot be completed, businesses fail and we have a sorting effect between entrepreneurs whose plans can be carried through to completion and those who can't, those who must go bankrupt, they enter the workforce, become unemployed, retire, what have you. and then in the recovery is actual asset reallocation and reinvestment. So we have very active agents of the recovery here and the entrepreneurs. In the alertness school of thought, in the boom phase, the malinvestment is essentially a misperception of time preference.

7:15There's not necessarily being carried through to action, but this is the alertness, the opportunity discovery. Of course, some of these will later be revealed not to have been opportunities, which is a In the bust we see, are they discovering errors essentially? The opportunities that they discovered ex-ante in the boom phase turn out not to be profitable. So apparently they're not really opportunities, not sure what those would be other than pure error. And then the discovery of new opportunities in the recovery phase as falling prices. We see entrepreneurs taking advantage of liquidated assets to reallocate the structure of production. Lastly, the creative destruction, Schumpeterier paradigm, in the boom phase you have to have credit expansion again to allow that innovation to occur.

8:06So the entrepreneurs in a way are already connected to business cycles. At the starting point and the end point, we're in valuation equilibrium, there essentially is no role for the entrepreneur. During the bust, we see overinvestment in some of these new technologies. technologies, entrepreneurs get overextended into the new plans, irrational exuberance going into things like the tech bubble, and of course the obsolescence of older technologies, the buggy whip industry, those factories all closed down. And the final recovery is where we actually see the creative destruction being carried to completion as the economy moves into that new equilibrium. So the question now is so what? We can make laundry lists of various theories of entrepreneurship from the Austrian perspective and the different characteristics of phases of the business cycle, but does this really provide us new insights, and if not, is it really worth the effort?

9:05So what we've derived basically from this analysis is three claims, first being that the entrepreneur-discoverer, the alertness paradigm, the Kurtznerian paradigm, essentially Actually these entrepreneurs are passive, they could be observing the economy through a telescope from the moon, they're not actually necessarily acting on anything, they're just perceiving opportunities and they're responding to price signals, they're responding to changes in the market rate of interest in the boom phase, in the bust and recovery, they're responding to falling prices for various productive factors. But where do these prices actually come from in the first place? It must be through the action of entrepreneurs in the first place. And second, in Schumpeter's view, my contention is that contrary to his, the idea of the entrepreneur being a bold leader of men, the entrepreneur is actually somewhat weak and timid.

10:00The entrepreneur is paralyzed, absent the injection of new credit into the economy, unable to bid resources away into his new and innovative projects, which if they were are really worthwhile, you'd think someone would be interested in funding those, but apparently not in Schumpeter's framework, while simultaneously being overconfident as we see overinvestment in new technologies leading to the bust. So there's some contradiction here within Schumpeter's framework. Lastly, we claim that it's really the judgment-based Misesian view that best frames entrepreneurial action over the business cycle. This is where we see the entrepreneur really as an active agent of the economy and the business cycle.

10:47So this is the best way to look at how can we analyze business cycles with the emphasis on individual entrepreneurial action. So some theoretical implications of this. We see that the judgment-based view best describes how entrepreneurial beliefs can impact the Business Cycles. Entrepreneurs, as Mises said, who understand the business cycles better, maybe we wouldn't have business cycles if they knew that engaging in a given project would turn out to be malinvestment. Of course they don't know that ahead of time, but it's clearly the entrepreneurial beliefs carried into action that dictate the course of the business cycle from start to finish. And also an ideal I got from Tim's paper, that when you have greater uncertainty during boom phases, perhaps you'd see less investment in highly and any specific high order roundabout production processes.

11:39How would this affect the course of the business cycle? We see a much longer period until reaching the final bust as entrepreneurs invest in more of the putty assets, the less specific capital goods. Next we see entrepreneurial characteristics affect business cycles over the course of the cycle. Some recent research really follows this kind of paradigm. Evans and Vax and Dale's work on how credit expansion induces sub-marginal entrepreneurs to enter markets, that again, contrary to Schumpeter, it's not the bold leaders who are engaging in new and innovative investments during the boom phase leading up to the crisis. It's actually sub-marginal entrepreneurs, those whose judgment would not readily suit them to become entrepreneurs under normal conditions.

12:31Third, that the judgment-based view implies that actual entrepreneurial decisions over the cycles are not pure opportunity discovery, but must be carried through into action to actually make a business cycle happen. Again, a central bank could print as much money as it wanted. Entrepreneurs could be pure opportunity discoverers, could see that maybe there's some money to be made there. But unless somebody takes action, in this case, in this paradigm, entrepreneurs take action, exercise judgment to arrange assets into constellations that are going to consist of those longer plans of production at higher orders, you don't have a business cycle. Again, some recent research really falls into this paradigm.

13:18paradigm. So because we see also some of the most productive empirical and theoretical work is falling within this view, this judgment-based Misesian view is another argument in its favor. Karelian Dempster's 2001 paper where even if entrepreneurs know that maybe there's going to be some malinvestment they have faced a prisoner's dilemma of they must invest in some of these malinvested projects because everyone else is doing it and they'll be left behind, essentially miss the boat.

13:50Lastly, some empirical implications. This is something I'm particularly interested in, that the judgment-based view provides the best basis for empirical extensions of Austrian business cycle studies because it focuses on micro-level individual potential data that's out there, and phenomena anyway, rather than the large-scale aggregate data that we see in most macro studies of business cycles, that the actions, characteristics and beliefs of actual entrepreneurs, those are more readily observable. We have survey data on the opinions and attitudes and sentiments of different types of business people being periodically carried out. It's easier to assemble data, you know, really directly on the performance of different sectors of the economy and even specific businesses with the level of disclosure by publicly traded firms especially.

14:45So what we have is readily observable facts and even some counterfactuals for time periods or other geographic areas where the same business cycle maybe is not proceeding, which raises the bettenoir for Austrians at least of testable hypotheses, you know, actual falsifiable statements that maybe can be the basis of empirical or even econometric work. And here we actually have a literal bettenoir, so. And that's the conclusion basically of our paper, so thank you for your time.