Entrepeneurs and Uncertainty: Back to the Future

0:00Thank you. Well, the last time I spoke to a group of students, the title of the talk was from a movie that was made in the 60s, and the reference today is from movies from the 80s, so it's a little bit more updated, but I'm guessing it's not exactly relevant for you guys, so I apologize in advance that I can't talk about vampires or whatever it is that you care about. Dr. Thornton explained it quite nicely how markets and prices are constantly solving this very complex problem of coordinating the use of resources and coordinating different types of labor and different skills and so on.

0:49My talk is kind of a development of that idea because I get to talk about entrepreneurs The word entrepreneur is tossed around a lot, especially in bad economic times like the ones we're in right now. In fact, it's become kind of a catch-all term, and for a lot of people represents just everything that will solve all our economic problems. Entrepreneurship means the American spirit and the struggle to overcome and the face of adversity and all these other terrible cliches about the good life.

1:42And so for example, Obama in his State of the Union speech said he wants to encourage entrepreneurs, although he was kind of sketchy about what that actually means. And that's sort of the problem. Entrepreneurship is one of these ideas that most people might have a hard time defining. But somehow, despite that, we know that whatever entrepreneurship is, we like it and we want more of it. Everyone likes the word entrepreneur and likes to say that they support entrepreneurs politically. And I don't think, for example, that any politician in history has ever gone on record as being against entrepreneurs.

2:47because thinking about entrepreneurs gives us a very useful way to look at basically any economic problem and it allows us to see some concrete effects of government policies that might otherwise appear maybe kind of abstract or just way too complex. Okay, but before we talk about some of this big picture stuff I'll get back to in a minute, we'll take things down just to the fundamentals and think about a few basic principles of of Economics. And this is where time and uncertainty come in. We've already had a little bit of an introduction with some of the Dr. Thornton's discussion of time, but we'll add a little bit more. Everything human beings do is designed to have a positive influence on our future, even if the future that we're trying to get at is just a few seconds from now. The implication of this is that We exist in time and time only moves forward, right? So there's an uncertainty in everything we do.

3:52There's always a possibility that things can go wrong because there's this gap between the time you start something and the time that the result happens. And the future is unknown. So this introduces the problem of uncertainty. In economic terms, we say that action is forward-looking. In other words, what we're doing right this minute is an attempt to change something that hasn't hasn't happened yet. We're to try and bring about something that wouldn't happen without us. And depending on the amount of time involved and the size of the undertaking, some things are much more uncertain than others. I mean, I think people get the general idea without too much trouble. We're probably all pretty sure where our next meal is coming from, for example. But what we'll be doing in 30 years, well, that's almost impossible to even get at.

4:40So there's much more uncertainty with something like that. So we face a series of problems in our everyday lives that arise because of uncertainty and uncertainty is just a part of life that we can't ever really get rid of because there's always this unknown future out there that we can't completely account for, that we can't totally anticipate. So time and uncertainty become kind of a nuisance for us In economic terms, this translates into a very big problem, because in an economy as complex as ours, we have this insanely large amount of resources that we have to decide what to do with, and there's always this possibility that we could make bad decisions with resources and end up essentially poverty-stricken.

5:34But fortunately, there's a group of individuals in society who specialize in bearing the burden of this uncertainty, and bearing the burden of decision making, and who take those uncertainty and decisions from people who don't want to deal with them and put it onto themselves. And these people are entrepreneurs. And as I said, the main theme of this talk is entrepreneurs and what they can and can't do, and the role that they play in driving the economy. With that, let me just say a few words about what entrepreneurs do exactly and then I'll spin out a few of the details. Entrepreneurs bear uncertainty and what that means is they take their own property and they invest it on the market.

6:21Entrepreneurs invest and investment takes time and at the end of that time, they produce It's a product, like an iPhone or an iPad, that they sell in the hope of making a profit. But their profit is determined by other people's decisions, namely the consumers. If people hate the product, Apple makes losses instead of profits. This kind of behavior is what economists call entrepreneurship, and entrepreneurship exists everywhere and at all levels of the economy. CEOs like Steve Jobs can be entrepreneurs just the same as small business owners. So let me give you an analogy that might make some of these points clearer. This isn't a perfect story for a reason I won't get into, but I think it should give you enough of an idea to see what I'm talking about.

7:11One way to think about what entrepreneurs do is to imagine sports competitions. The spectators are the consumers. We watch the competition between the teams. The teams are the entrepreneurs. And we get enjoyment out of the performance of the players. The performance is the product. And ultimately, the teams compete for us. That's how they make their money. But it's important to note that it's the players who have the specialized skills to handle what goes on down on the field. We're not down there because we don't have the skills and the insight to make those calls, and of course if the players play well, they earn more because we pay more to see them, and if they're awful, then people stop going to see them and they make nothing.

7:56And just like in the economy, there are big leagues for superstar players like Steve Jobs, and just as there are local competitions for the people who provide you with more everyday things. The idea is that successful entrepreneurs are masters at figuring out how to deal with the future. They demonstrate, through their success, that they have a kind of judgment about the future that is more accurate than other people's judgment. They guess better than other people, and in fact, that's why they're the entrepreneurs and not somebody else like the people who work for them. I'm not sure if you guys work yet, but whenever you do get a job, you'll find out that no matter where you work, the same thing always happens. The people at the bottom always criticize what the higher-ups are doing, and every, for example, assembly line worker always believes that he has the answers that could just revolutionize the whole process that his boss is just too dumb to think of.

8:57But the thing is, lots of people can have great ideas, but knowing what to do with those ideas, that's what entrepreneurs are good at. The example of someone like Steve Jobs is very useful here. He and the other people that he worked with were extremely good, not just at inventing new things, but at figuring out exactly what kind of things people would want in the future. There are always a great amount of ideas and technologies that people could choose to develop, but we have limited resources, so someone, namely an entrepreneur, has to make the decision which ideas to support and which ones to reject, and furthermore has to bear the responsibility of that decision. On the little graph here, this would be something like below concept, you would have something here, decision-making, judgment, and really you would have, instead of one concept, you would have a whole tree, millions of concepts, and it comes down to just one that somebody picks up on.

10:04And this notion of decision-making, this is where the uncertainty problem happens. Because all the technologies that we have today, like iPads and things, they've been in development for years. Five or ten years ago, someone came up with that idea, and Steve Jobs had to make a judgment and say, okay, this idea for an iPad is good enough that I'll give you $100 million to develop it. But all these other ideas that you offered me, for things like the iCar or whatever, or whatever. Those are just useless, so we're ignoring those. And then it's only years later, after investing an incredible amount of time, effort and money, that Apple actually finds out whether or not the iPad was a good idea in the first place all those years ago. And they find out whether people do actually want to pay money for it. And it turns out that people do want it.

10:55So Apple has another success story. But it could easily have gone the other way as well. People People could have wanted something else, and Apple could have lost all their money to people producing more useful things. So in exchange for doing this specialized task of making decisions about how to use resources and bearing the weight of the future, entrepreneurs are capable of earning a kind of income that most other people don't earn, and that income is called profit. Profit is the market's reward for making good decisions, for being good at producing things people want to buy. And likewise, losses are like a market punishment because they show that people aren't willing to buy what you're making and that you've invested in bad ideas and wasted people's resources.

11:46One of the strange but important implications of this is that even though particular entrepreneurs entrepreneurs can go completely belly up and wind up bankrupt, that this is actually a good thing. The reason is that failing means unsuccessful entrepreneurs have to give up their resources and their decision-making abilities to other more successful people who can use them better. In the big picture, the market is always in this process of readjustment, moving valuable resources between different entrepreneurs and between different industries, always pushing Now, you may be able to guess where this is going next.

12:31The big question becomes, what happens when we don't let this process work? What happens when we interfere with this profit and loss mechanism? For example, what if we bail out car companies like GM who fail at business? Well the answer is pretty logical, supporting failed entrepreneurs and businesses means that valuable resources will continue to be wasted producing things people don't want. And at the same time, the waste means that we're not getting something that we actually do want. Everything has a cost, and the cost of producing things nobody wants is that we lose the ability to produce something genuinely useful. So we actually punish entrepreneurs who are trying to produce useful innovative products.

13:20Everything gets switched around when you try to use government to manipulate the market in this way, because you're replacing the decisions of real entrepreneurs who are risking their own livelihoods with arbitrary decisions by government employees who never have to bear responsibility for the economic damage they cause. and when that happens all of a sudden you end up in the situation where government is rewarding people who fail and punishing people who succeed so it's this perversion of the profit and loss mechanism. Another important implication of the idea of profit and loss and the rest of this talk is basically a development of this idea is that it's also important to let entrepreneurs keep to keep their profits, because taxes, for example, on things like profit, remove the major reason, the major incentive to risk your money in the market, because if your profit is taxed away, you have very little to gain, but you still have a lot to lose.

14:20So you have to encourage entrepreneurs by emphasizing the importance of private property so that entrepreneurs know that if they succeed at providing valuable goods and services to to society, that they won't be, in turn, punished for that by government. Five, huh? Well, challenge accepted. Okay, so everything I've talked about so far has been describing the kind of uncertainty that happens in markets, and that kind of uncertainty is difficult to deal with, but by shifting it from people who don't want it to entrepreneurs who specialize in dealing with it. in dealing with it. We can actually cope with it pretty well. And as long as we allow entrepreneurs and markets to do their work, this sort of uncertainty really isn't that much of a problem.

15:13But I just want to quickly talk about a kind of uncertainty that we do have trouble coping with, and that's the uncertainty created by government. An economist, Robert Higgs, who is a friend of the Institute and a very good economic historian, came up with an idea that calls regime uncertainty, which is a way of describing the kind of uncertainty that government imposes on markets and that entrepreneurs have a great deal of trouble dealing with. In this context, the regime means politicians and bureaucrats who make economic policies and invent various economic regulations. The idea of regime uncertainty is that there are certain things the government can do or And when they do this, it makes it extremely difficult for entrepreneurs to do what they do best, which is to try to gauge what's going to happen in the future.

16:07So what kind of things does government do that have this effect? Well, basically any time the government announces that it's working to add more regulations to the economy, or any time it expresses hostility toward the profit motive, It sends a signal to entrepreneurs that it's dangerous to be investing in the market. To go back to the sports analogy, imagine if you give the players, the entrepreneurs, a new kind of problem to deal with. Usually the players worry about the other team and they know what to do and how to play the game and they can strategize about what sort of things to expect. They know that they have to score X amount of touchdowns and the rules for how to do that are very clear. But then what if the referees say all of a sudden, okay, wait, for this play, we're going to change the score that's already on the board.

16:58Plus, we're changing the rules for how you earn points. Also, we're not going to tell you what the new rules are. And going into the future, we may change the rules again without warning you and take away any points you earn no matter what you do. But just go about your business as usual. Everything's fine. Well, obviously, no one would play a game like this Business, because no one would know how and no one would have any reason to spend any effort on trying to figure out the game because it could always just change and you could always lose everything through no fault of your own. And that's sort of what goes on with regime uncertainty. Instead of trying to anticipate the ordinary uncertainty in markets, instead of trying to anticipate what consumers will want and trying to figure out how to satisfy consumers, And so economists end up having to worry about trying to figure out how government works and what new regulations are going to pop up next week and how they can manipulate that.

17:54So maybe this is a bit abstract, so I'll try and give you a historical example to make more sense of this. This idea was first started being discussed in relation to the Great Depression. America's Great Depression lasted longer than anyone thought it would, and so economists have always wondered why that was. And one reason that an economist discovered was that the Roosevelt administration and the New Deal undermined confidence in business because they interfered so much in the economy with all the New Deal's taxes, regulations, and price controls that entrepreneurs during the Great Depression didn't want to invest. They didn't want to take risks or make decisions because they thought their profits were just going to be taken away from them as soon as they succeeded.

18:40And there were even concerns that there was going to be a large-scale government takeover of private business. And if those things had happened, entrepreneurs would have lost their investments. So they held back their money and waited to see what would happen. And so there was very little investment during the Great Depression. And that's one of the reasons why the recovery took so long. Now again, that might seem like an old example, but it's relevant to us today because the situation during the Great Depression is actually very similar to the one that exists right Now, Obama and his supporters have earned a reputation as being big regulators and it's expected that they will gradually expand control over the economy in the coming years. So right now, entrepreneurs feel threatened and they don't want to invest for fear that some new regulation will pop up to interfere with their business or to confiscate their profits.

19:33I've said Obama's name a couple of times, but I don't want to imply that this is something or something that originated with him or this is something that only happens with Democrats or something like that. Other political ideologies cause the same kind of problems because of their stance toward business and their support for economic regulation. But that being said, I can't emphasize enough that all the big legislation that's on the table right now and which will continue to be discussed for the next few years holds potential problems for entrepreneurs. The government's budget and its debt, health care legislation, environmental regulation, taxes, and so on. All of these discourage people from taking risks. And when entrepreneurs don't take risks, innovation stops, goods and services stop being produced, and the economy doesn't grow in a healthy way.

20:25And going into the future, if things keep going the way they're going, With more and more government regulations and more uncertainty about our economic way of life, that's the challenge that everyone will have to face to deal with not knowing from one month or one year to the next what economic controls the government will impose next, or when, or how, or anything. This affects entrepreneurs especially, but also all of you as well, because you're the ones that investments being made right now, or I should say, not being made right now, you're the ones these investments are designed for, is to meet your future demand that people invest in the present. So the uncertainty being created by government at this minute will seriously affect your welfare in the future.

21:14I won't tread on Danny's toes too much, but I do want to finish by restating that the The problems I talked about are very real and very important, and they run much deeper than simply wondering whether or not we'll get a new iPad in a couple of years. What we have to do in the coming years is get away from this future that's being made for us now by bureaucrats and regulators, a future that ends in economic disaster. And we need to get back to a future that we create for ourselves that is genuinely free and Prosperous.