Austrian Economics and Kirznerian Entrepreneurship
G. Stolyarov II
A Journal for Western Man-- Issue XLIII-- November 2, 2005
Professor Israel Kirzner’s theory of entrepreneurship uses the methods of Austrian Economics to explain the function of the man who perceives and pursues economic opportunities in the face of uncertainty. The entrepreneur, in seeking his own profit, is essential to correcting mistakes in the structure of prices and remedying the sheer ignorance and error exhibited by some economic actors. His profits derive from the services he performs in detecting and eliminating arbitrage opportunities, thereby allowing supply and demand for a given good to meet.
Kirzner describes alertness as the fundamental quality of the entrepreneur. Alertness is the entrepreneur’s ability to perceive new economic opportunities that no prior economic actor has yet recognized. The entrepreneur might foresee demand for a new product that has not hitherto been manufactured; he might then decide to manufacture that good himself. Alertness may also involve the entrepreneur’s detection of arbitrage opportunities on the market: opportunities to sell the same factor of production for a higher price than he bought it. The entrepreneur’s alertness detects arbitrage opportunities by recognizing that certain factors of production are underpriced; he then proceeds to act on this knowledge to earn profit.
The entrepreneurial function is possible due to the presence of sheer ignorance on the part of some economic actors. Sheer ignorance, in Kirzner’s definition, consists of not only not knowing a given piece of information but also of not knowing that one does not know it: no consideration of the information—positive or negative—even enters the economic actor’s mind. Sheer ignorance is the basis for uncertainty; economic actors neither know nor anticipate the future perfectly due to their incapacity to foresee every datum in that future. Future events might occur whose causes are not presently known to the economic actors. Sheer ignorance is the root cause of sheer error: mistakes made by economic actors as a result of not anticipating these future events or knowing their present causes.
The entrepreneur constantly remedies sheer ignorance and corrects sheer error. Through his alertness, the entrepreneur foresees economic developments that other actors have overlooked; he also recognizes where the other actors’ lack of information has created mistakes in the price structure and hence arbitrage opportunities for him. The entrepreneur has an incentive to remedy the sheer error in the price structure, since pursuing the arbitrage opportunity will result in personal profit for him. He thus bids up the price of an undervalued factor of production until the mistake in the price structure is corrected and the arbitrage opportunity disappears. While he has remedied the mistake, he has earned profit for himself—provided that his faculty of alertness was indeed correct in suggesting to him that a mistake in the price structure originally existed. The entrepreneur, too, acts in the face of uncertainty in that he never has assurance that his foresight into future market conditions is fully correct. He only obtains certain knowledge of whether his activity was properly directed after the fact: the only sure determinant of the success or failure of his perceptive faculty is the test of profit and loss. If the entrepreneur earns a profit, he has acted properly and usefully in the face of uncertainty. If he loses money as a result of his activity, he has evaluated the market mistakenly.
For Kirzner, entrepreneurship is not just another factor of production. Rather, it is “costless.” It does not involve the resource expenditures necessary to obtain the services of land, labor, or capital. One does not deliberately set out to become an entrepreneur; nor does one exert oneself to achieve entrepreneurial alertness. One cannot teach oneself to notice economic opportunities in the face of uncertainty. The noticing is primary and happens before any entrepreneurial action is possible. In the real world, the noticing is antecedent to all action, since all real human action occurs in the face of uncertainty and thus has an entrepreneurial component to it. One cannot be taught entrepreneurial awareness in the same manner that one can be taught management techniques or factual knowledge or skill in a given line of work. Every entrepreneur does use all of the above, along with taking calculated risks and purchasing land, labor, and capital for his activities. However, those functions are not in themselves entrepreneurship. Entrepreneurship is the alertness to and foresight of market conditions; it must necessarily precede actions taken in accordance with that alertness.
A possible challenge to Kirzner’s theory of entrepreneurship might cite the case of the popular novelist who enjoys a stream of income from his book. Was his activity entrepreneurial, having foreseen a widespread demand in the market for his work? Such a prediction necessarily involved uncertainty, since the book had not existed before, and there was no way to anticipate demand for it with perfect confidence. Or was his activity an exertion of his skill and labor in writing the book? That is, did the novelist write the book because he foresaw market demand for it, or did the market demand occur as a resultant side effect of the novelist’s writing the book?
Hypothetically, Kirzner’s answer to such a critique would have distinguished the author’s function as an entrepreneur from his function as a laborer. The author acted as an entrepreneur to the extent that he accurately foresaw the market’s demand for his product and acted on this prediction. To the extent that he created the literature as a means to his artistic expression and the conveyance of his intellectual values and observations—irrespective of popular economic demand—he acted as a laborer toward his own consumption. Even the actualization of his desire to sell the book, however, required him to function in the capacity of a laborer in actually writing it. The actual writing of the book was not inherently entrepreneurial, though entrepreneurial alertness may have led up to it and even justified it.
To challenge the Kirznerian theory of entrepreneurship, “mainstream” economists also refer to individuals’ intentional undertaking of market research. Market research gives the entrepreneur more accurate information on the basis of which he might decide what economic opportunities exist and how to benefit from them. However, market research is a systematic endeavor, requiring expenditure of time and resources—hence not being “costless” as Kirzner claims entrepreneurship to be.
A defender of Kirzner’s theory would state in response that the undertaking of market research is not in itself entrepreneurship. Rather, the exercise of entrepreneurial awareness occurs even before the research happens. Entrepreneurship here would consist of recognizing that the market research is a useful endeavor to undertake in the first place. Once this decision is made, the resource expenditures toward actually conducting the market research are not strictly entrepreneurial.
Kirzner’s theory underscores the importance of entrepreneurship to a successful market economy. Entrepreneurship cannot be taught; it cannot be planned or centrally managed. However, it is indispensable to addressing the uncertainty inherent to all human action and to allowing any mistakes made in the face of this uncertainty to be corrected. The entrepreneur’s selfish motivation for profit presents him with a reliable incentive to remedy sheer ignorance and error in the marketplace—thereby improving life for all.
Note: This essay was approved as an accurate representation of Austrian School economic ideas by Dr. Robert P. Murphy of Hillsdale College, one of the leading contemporary scholars of Austrian Economics.
G. Stolyarov II is a science fiction novelist, independent filosofical essayist, poet, amateur mathematician and composer, contributor to organizations such as Le Quebecois Libre, Enter Stage Right, and the Autonomist. Mr. Stolyarov is the Editor-in-Chief of The Rational Argumentator and a Senior Writer for the Liberal Institute (http://www.liberalinstitute.com). He can be contacted at firstname.lastname@example.org.
TRA feature has been edited in accordance with TRA's Statement
Visit TRA's Principal Index, a convenient way of navigating throughout the issues of the magazine. Click here.