Austrian Economics for Capitalists and Entrepreneurs

0:00Next up is a gentleman who received his PhD in economics from the University of California at Berkeley, but don't hold that against him. BA from the University of North Carolina at Chapel Hill. He's edited a couple of books. He is the professor in the Division of Applied Social Sciences at the University of Missouri. His research focuses on the boundaries and internal organization of the firm, and he has served as senior economist with the Council of Economic Advisors. He has a brand new book out on the table that he is actually teaching an online class for us from. It's called The Capitalist and the Entrepreneur.

0:45He studied under Nobel Laureate Oliver Williamson. He's talking to us today about Austrian economics for capitalists and entrepreneurs. Please help me welcome Dr. Peter Klein.

1:06Good morning, everyone. I'm not as easy on the eyes as Doug French, so I prepared some visuals to make the presentation a little bit more enjoyable for you. As Doug mentioned, I want to talk about Austrian economics and some of its implications for capitalists and entrepreneurs. Now the reason for choosing this topic is twofold. First, as most of you know, there's been a great resurgence of interest in the Austrian school over the last couple of years, and it's no surprise with what's been going on In the macroeconomy, as people have tried to make sense of the financial crisis, the subsequent economic recession, tried to understand the government's policy response, the sort of vulgar Keynesianism that is now all the rage in Washington and in parts of academia, they've begun to look at alternatives and many are rediscovering or discovering for for the first time, the works of Mises, Hayek, Rothbard, other Austrians who have written extensively and persuasively about the business cycle, about the problems with government,

2:16with central bank expansion of credit, about the misallocation of resources that is manifest in the cycle of boom and bust. And of course this is a fantastic thing for Austrians. While While in one sense it's a bit depressing to watch the resurgence of John Maynard Keynes, the monster we thought we had killed off once and for all decades before, at the same time exposing many new people to the teachings of the Austrian School is extremely encouraging. What I would like to discuss today is some implications of Austrian economics, not specifically Specifically for the business cycle, not specifically for what mainstream economists call macroeconomic issues, but rather to talk a little bit about so-called microeconomic issues, namely some implications of Austrian economics for the theory of entrepreneurship, for the theory of the business firm, for the theory of firm strategy, and a little bit for the theory of investment.

3:20Now the second reason for speaking about Austrian economics for capitalists and entrepreneurs as Doug mentioned is that I have this wonderful new book that is available for sale on the table just outside the door and I certainly hope that you will take a look at it. The book was published just a few months ago by the Mises Institute and the Institute did a terrific job putting the book together. I've been thinking about implications of Austrian economics for entrepreneurship and for business Entrepreneurship is an extremely popular topic at universities these days, not only in business in schools, but in other parts of the university as well, in engineering, in law, in medicine, even in the liberal arts, there are many courses and programs on entrepreneurship.

4:30How do we know that entrepreneurship is so hot? Well, there's lots and lots of courses, there are many, many research publications, there are academic journals that focus on entrepreneurship, You know, sort of the typical empirical research findings with charts and tables describing various aspects of the entrepreneurial process. There's been a huge explosion of funded research centers at major U.S. universities. There's Stanford, Illinois and MIT to give you just a couple of examples. There's increased research funding for entrepreneurship. The Kauffman Foundation in Kansas City, not too far from our campus in Columbia, is one of the leading funders of academic research in entrepreneurship. Even among policy makers in fields like economic development, there's Mr. Eunice, the winner of the Nobel Peace Prize before the distinguished theorist Mr. Obama was the winner this year. Eunice, as you know, is an economist by training who specializes in microfinance, microentrepreneurship, microenterprise, and some people describe the Nobel Peace Prize from the previous year as being effectively a Nobel Prize for entrepreneurship.

5:59What is an entrepreneur though? In most of this literature, in business schools, elsewhere on campus, in the media and so on, the word entrepreneur usually is meant to invoke particularly important innovators in the economy, people like Steve Jobs, for example, Bill Gates, etc., maybe Thomas Edison, maybe Nicholas Tesla, others who were particularly important technological innovators in society. Sometimes we have in mind particular companies, Google or Apple or 3M. We say that Google seems to be a particularly entrepreneurial firm or Apple is a more entrepreneurial company than IBM let's say or some more staid and more established rival. Although some of these Sometimes we use the word entrepreneurial to describe entire societies or even countries.

7:07One of the leading scholars in this field, David Audresch, recently came out with a book called The Entrepreneurial Society, contrasting the economy of the U.S. and the economies of the EU with economies elsewhere in the world that he perceived as being less dynamic, less innovative, less entrepreneurial. Three scholars from the Kauffman Foundation came out with a book a couple of years ago called Good Capitalism, Bad Capitalism, in which they distinguished what they called entrepreneurial capitalism as it's practiced in much of the West with a kind of more bureaucratic capitalism that they saw in other parts of the world. Now this is all very well and good, these are all perfectly legitimate ways to think about the entrepreneur, to think about entrepreneurship, to think about entrepreneurial organizations or societies, but in a sense all of these characterizations of entrepreneurship are somewhat limited, right? They either refer to a specific type of person, an entrepreneur is a person who runs a business or a person who founds a company or a person who brings

8:16Finds New Goods and Services to Market, or an entrepreneurial company is one that invests a lot in technological innovation or produces many new goods and services. An entrepreneurial society does more R&D than another type of society, for example. If we look at the Austrian literature, however, we find a notion of entrepreneurship that, in an important sense, is much more general than the notions that one finds in the mainstream Ludwig von Mises, in Human Action, defined entrepreneurship this way. He said the term entrepreneur, as used by economic theory, means acting man exclusively seen from the aspect of the uncertainty inherent in every action.

9:12In other words, according to Mises, in the real world, in the real economy, not, in other words, in the abstract mathematical models of mainstream economic theory, action is always made under conditions of uncertainty. All of us, when we make decisions about what to do in our daily lives, in the commercial world, when we invest resources in anticipation of future gains, we never know with certainty what the outcome of those investments or those actions will be. If there were no uncertainty in Mises' interpretation, there would be no action, because there would be no point in doing anything with purpose if we knew for certain what the outcome was going to be. Therefore, according to Mises, there is an aspect of entrepreneurship in all human behavior. Mises went on, however, in Human Action to distinguish or to discuss in particular one type of entrepreneurship that is especially important in an industrial market economy.

10:18What Mises called the entrepreneur promoter, or what I call in most of my texts, the capitalist entrepreneur. This is a specific category of action, a specific type of acting man who is involved specifically in the investment of valuable capital resources in anticipation of the creation of future economic value. And Mises pointed out that this decisive, uncertainty-bearing, capitalist agent is really at the heart of the market economy. The entrepreneur in this sense is the driving force of the market. As Mises put it in a discussion of mathematical economic modeling, quote, it is impossible to eliminate the entrepreneur from the picture of a market economy.

11:09The various complementary factors of production, he means capital resources, human labor, land, so on, these various complementary factors of production cannot come together, cannot come together spontaneously. They need to be combined by the purpose of efforts of Men Aiming at Certain Ends and Motivated by the Urge to Improve Their State of Satisfaction. So there are purposive efforts of men to reorganize, to put together, complementary factors of production to produce the goods and services that satisfy consumer wants. In eliminating the entrepreneur, Mises continues, one eliminates the driving force of the whole market system.

11:58So what I've tried to do in my work and in the book is to bring entrepreneurship and capitalism together by linking the entrepreneur in Mises' sense to other aspects of the industrial market economy. So that's exactly what I try to do in the book, the capitalist and the entrepreneur. A little bit of background, as I mentioned earlier, most of my academic work is influenced by two primary research traditions, the Austrian School of Economics and also what is sometimes in the mainstream literature described as the economic theory of the firm or organizational economics.

12:43And my main influence in the Austrian literature is Murray Rothbard, the great 20th century Austrian economist who taught for several years here at UNLV and whom Doug mentioned in his introduction. My dissertation advisor is this fellow Oliver Williamson. Doug mentioned just a moment ago Williamson, who was the co-winner of the Nobel Prize this This past year is one of the founders of the modern field of organizational economics or the theory of the firm. I might mention just for fun that usually I'm pretty skeptical about the Nobel Prize, not only the Nobel Peace Prize, but the Nobel Prize in Economics, certainly the award to Professor Krugman a year and a half ago was not particularly inspiring, but I was very I'm very happy, of course, for personal, sentimental reasons, that my old professor and colleague and friend was able to snag the prize this year, and I might just mention, in talking to him a little bit, I've learned a bit about the privileges of being a Nobel laureate. And there are a few. Let me highlight some of them. You get accolades, right? You get fame and fortune. This is Professor Williamson at the press conference at Berkeley the day the Nobel Prize was announced.

14:03You get the hardware, of course. It's a pretty nice metal made out of gold, and at a recent visit to Professor Williamson's home, I got to see and actually touch the thing, but then they told me that was not the real one. That was a replica that was on display. The real one is, you know, in a vault in Switzerland somewhere. You get to hang out with royalty. So here's Professor Williamson escorting the Swedish Princess Madeline at the Nobel Prize dinner. And according to my Swedish graduate student who sent me this photo from one of the Swedish tabloids, Princess Madeline, who is the youngest of the royal children in Sweden, is known to the paparazzi as the party princess.

14:51and my students said, I wonder if that's why Williamson looks so nervous in the picture. He doesn't know what she's going to do next. But at Berkeley, the best the best perk of all is none of these things. If you've ever visited the Berkeley campus, it's a very pretty place. It's a very beautiful campus. But like most universities, like most urban university campuses, there isn't very much parking. And having access to a good parking place is one of the major perks of having sort of elite status at the university. So if you get the Nobel Prize at Berkeley, you get a spot in the NL parking lot. So they actually have a parking lot reserved exclusively for Nobel laureates, although I understand they still have to pay and renew every year to Going back to the story, how does the entrepreneur fit into all this?

15:49Well, as those of you who have studied the Austrian School know, Austrians have always paid particular attention to entrepreneurs and to entrepreneurship. Entrepreneurship is largely absent from neoclassical economics and from mainstream economic theories Studies of the firm, though it's extremely important, indeed central to the Austrian understanding. And so there are some opportunities to bring those two areas of study together. So what I have tried to do in my own research that's summarized in the book is to apply Austrian economics to managerial and organizational problems, which leads to, in my judgment, sort of an entrepreneurial theory of the business firm.

16:35and really a new perspective, new to the mainstream that is, on the very nature of capitalism itself. So the book contains a series of essays written from 1994 to 2008 dealing with various aspects of capitalism and entrepreneurship and how they can be brought together. Why is any of this important? Well some of the questions that I've tried to address in my work include the following. Can entrepreneurial ideas, discoveries or judgments, that's a word that is favored by the great economist Frank Knight and one that I use in my own work, can entrepreneurial judgments be traded in markets? Can you buy and sell entrepreneurship or do entrepreneurs need to establish firms holding real assets in order to realize their visions?

17:31Can existing firms stimulate entrepreneur-like behavior among their employees? Does this necessarily create economic value, or does it give employees opportunities to behave in ways that owners might not approve of? How can firms organize themselves to be more innovative? This has been an extremely important question in the mainstream literature and and one that I think our entrepreneurial perspective can inform. How do institutions, background institutions, in particular the state, how does government intervention, in other words, affect the exercise of the entrepreneurial function? In what ways does government intervention hamper entrepreneurs as they attempt to allocate resources in accordance with consumer wishes?

18:25Now, why appeal to the Austrian School to try to answer some of these questions? Well, Austrian economics has some unique attributes that make it particularly well-suited to address these kinds of questions. For example, the Austrian School, going back to its founder, Carl Menger, emphasizes that resources, productive resources, are heterogeneous. Capital goods are not alike. Now, this insight is, you know, absurdly trivial to anyone who's ever... who knows anything about the real world, but, you know, you would never know it if all you read is Keynesian macroeconomics in which all capital goods are assumed to be identical, equally exchangeable or transformable into anything else.

19:12You old timers may remember the Shmoo from Little Abner. The Schmoo is this funny little creature in a comic strip, old American comic strip that could transform itself into any shape, could take any form, for you younger people, sort of like the Terminator in T2, okay? And mainstream macroeconomics has a Schmoo concept of capital, that differences between factories, between assets, between resources, are sort of trivial or uninteresting, all that matters is aggregate demand. Austrians have always emphasized that production takes time, that resources must be invested in the present, to produce consumer goods that will only materialize in the future, and future market conditions are not known with certainty.

20:01Some of you who have studied Austrian business cycle theory may recognize the so-called Hayekian Triangle, this diagram that was introduced not in this exact version of it, in F. A. Hayek's great works in the 1930s. Roger Garrison and Mark Skousen have written extensively on the Hayekian Triangle and the Austrian notion of the structure of production. Ludwig von Mises' concept of economic calculation, which Doug mentioned in his talk this morning, is the primary tool that is used by entrepreneurs in their judgmental decision-making about the future. And Mises' insights on economic calculation and how economic calculation requires private ownership of the means of production is extremely important for understanding what What it is that entrepreneurs do.

20:55And of course competition in the market, as Mises emphasized in his 1951 book, Profit and Loss, can be thought of as a selection process in which the market chooses among skilled and less skilled entrepreneurs, directing productive resources toward those who are better stewards of resources and away from those who are less able to invest in ways that Satisfy Eventual Market Wants. The Austrian economist Ludwig Lachmann put it this way in his 1956 book, Capital and Its Structure. He said, we are living in a world of unexpected change. Hence, capital combinations will be ever-changing, will be dissolved and reformed. In this activity, we find the real function of the entrepreneur.

21:48The real function of the entrepreneur, in other words, to Austrian economists, is to manage, to direct, to govern, to coordinate the productive process in a modern capitalist economy. Some of the highlights, some highlights from the book, and these are only highlights to get the full story, of course, you have to plunk down a few bucks and go across the hall and buy the book, and I'd be happy to sign it for you. I can sign it Doug French, Lew Rockwell, Tom Woods, whatever you like. The book emphasizes the notion of entrepreneurship as this generalized function that Mises characterized. Judgmental decision making about the investment of resources under uncertainty.

22:35So entrepreneurship is not merely an employment category entrepreneur or employee that you might check on a tax return. It's not merely a type of firm that Apple is entrepreneurial, IBM is not. No, it describes a general and critical function that is performed in the market economy. And, as I said before, according to Mises, that function is judgmental decision-making about the investment of resources under conditions of uncertainty. Now, this perspective immediately helps us to link the capitalist and the entrepreneur because it emphasizes the entrepreneur as an owner of of Productive Resources. And it highlights how economic calculation is the entrepreneur's primary decision-making tool.

23:22And it reminds us that capital markets, that markets for productive resources, including, and most importantly, markets for financial assets, are at the heart of the market economy, are the ultimate drivers of economic prosperity. Implications from the management and organization of firms include the following. First, conceiving of business firms as manifestations of entrepreneurial visions. Second, characterizing the design of business firms, organizational design, as a nested hierarchy of judgment. With the resource owner's judgment at the very top of that hierarchy, and subordinates in the organization to whom a decision-making authority is delegated as other members of that nested hierarchy of judgment.

24:17Third, that changes in firms, in firm boundaries, mergers and acquisitions, divestitures, changes in internal organizations such as restructurings, re-engineerings and so on, can be understood as processes of entrepreneurial experimentation. So, while in mainstream economics, changes in firm structure, expansions, contractions, reorganizations, are typically seen as the response to errors made by entrepreneurs, or examples of market failure that the government should correct make sure that firms are always at their optimal size and always have their optimal structure. In contrast to that perspective, in a world of uncertainty, entrepreneurs will continually experiment with different combinations of resources to find those that are best able to satisfy consumer wants.

25:16Some of the policy implications are fairly straightforward, right? As I described before, referring to Mises' 1951 book, here's the new edition from the Mises Institute, a market economy is not just a profit system, it is a profit and loss system. And so just as profits should be encouraged, losses too are part of the capitalist market economy. If there are no losses, or if the government always bails out entrepreneurs who make losses, Even resource allocation might as well be random. So no bailouts, no bailouts of large firms, no tarp, I couldn't agree with you more.

26:02No bailouts for banks, no Bernanke, no ultra low 0% interest rates to encourage entrepreneurs to make investments that are not economically rational. No Stimulus The freedom to succeed in a capitalist market economy also includes the freedom to fail. In the absence of that freedom, we don't have market competition. We have government-coordinated, government-controlled, pseudo-competition. Just to conclude, as I mentioned before, it's been depressing to see the return of Keynes. is sort of the man of the hour, reported by Time in this article in 2008.

26:48We are all Keynesians now, a phrase that entered public discourse in 1965. Now it's coming back into fashion, according to Time Magazine. Well, all of us aren't, okay? There are a few holdouts, fortunately. But again, as I said, the good side of this new interest in economic controversies and and Debates has been the resurgence of interest in the Austrian School. F. A. Hayek, in particular, there's the famous Hayek-Keynes rap video that some of you have seen. And I think this is all to the good and it's wonderful that Austrian business cycle theory is starting to get some attention in the public domain among academics, among policy makers. But I would urge that Austrians, I would urge us all to remember that Austrian economics is There's more than just business cycle theory. There's much, much more. In particular, Austrian economics has important implications for business firms, for how business firms are owned, managed and organized, how entrepreneurial decision-making is done, and I think to gain insight on this

27:55we should go back to Ludwig von Mises and his concept of the entrepreneur as the driving and force of the market economy as the agent who owns and controls productive resources and invest them using judgment under conditions of uncertainty. If we rediscover this Misesian notion of entrepreneurship, I think we can build on the interest in Austrian economics and the interest in entrepreneurship among mainstream scholars and practitioners to develop a better and sounder understanding of the capitalist market process. Thank you.