Our Relationship to Schumpeter and to Kirzner

As suggested in the introduction, our approach focuses on the decision­making environment confronting entrepreneurs. We take broad inspira­tion from Coasian insights on transaction costs, but also Hayek's (1948) and Simon's (1979) assertion that individuals are unable to optimize as traditional approaches suggest, and O'Driscoll and Rizzo's (2015) insights on learning through time; our technical apparatus comes from Yang (2001) and his colleagues (i.e., Yang and Ng 1993; Yang and Liu 2009).

To begin, our methodology is highly compatible with Schumpeter's evolutionary emphasis on “creative destruction.” For example, we concur with Schumpeter that “... the fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates” (1950, 83). To state the obvious, his emphasis on “new” and his nomenclature that emphasizes the “creative” aspect of the entrepreneurial process is very much aligned with our approach, as we hope will be made clear in the remainder of the paper. At the micro-level, we agree with him that a broad, workable definition of entrepreneurial action is the “carrying out of new combinations” ([1912] 1983, 74). Moreover, the feature that makes entrepreneurship a “special kind of‘function’” (79)—separate from the “manager”—is that entrepreneurs cannot rely on established routines: “What was a familiar datum becomes an unknown. Where the boundaries of routine stop, many people go no further... Therefore... entrepreneurs are a special type” (80-83).

On these broad contours—and many other lesser points—we agree with Schumpeter. However, while he provides an occasional glimpse into the decision-making environment for entrepreneurs, he is largely uncon­cerned with analyzing this level of the problem but rather with the macroeconomic dynamics in a world where entrepreneurs are the instiga­tors of change.^[4] As such, he does not explore how or why entrepreneurs do some things and not others. In contrast, our attention to the micro­level aspects of entrepreneurial decision-making means we largely avoid the macro-level dynamics upon which Schumpeter focuses.

With Kirzner, we have fundamental methodological disagreements (see, for example, Kirzner 1971, 1973). Before we outline those, we acknowledge that he solved a conundrum in mainstream theory: if all agents are, by definition, price-takers in perfectly competitive markets, who, in the model, would notice and act upon price discrepancies across different markets? Kirzner calls that agent the “entrepreneur” and so his theory is best understood as devising the agent who “perceives” and acts upon price differentials across markets (1973, 14). However, this characterization—which can be summed up as entrepreneurship-as - price-arbitrage—gives rise to a range of problems that are discussed in considerably greater detail in Buchanan and Vanberg (1991), Jakee and Spong (2003b, 2011), and Klein and Briggeman (2010).^[5] We highlight those points that are especially problematic for our approach here.

Kirzner claims throughout his work to be repudiating “equilibrium analysis” (Kirzner 1973, 1, 26-29), but he depends steadfastly upon neoclassical scaffolding because he accepts its general tenets.

Kirzner is, moreover, very clearly concerned with the optimal alloca­tion of resources, just as traditional micro theorists are. For example, in contrasting the differences between Schumpeter’s theory of creatively- destructive entrepreneurship and his own, Kirzner criticizes Schumpeter for his inability to “ensure that this best course of action—which can be carried out—will be carried out” (1971, 119). His theory is therefore not one of disequilibria that jettisons the notion of equilibrium altogether, as it is, for example, in Shackle’s (1972) or Lachmann’s (1986) approach, but one that preserves equilibrium and depends upon it.⁵

⁴Note, for example, “The pure entrepreneur... proceeds by his alertness to discover and exploit situations in which he is able to sell for high prices that which he can buy for low prices. Pure entrepreneurial profit is the difference between the two sets of prices.

⁵Much of Kirzner’s approach is captured in the following (lengthy) quote.

We may present our dissatisfaction with the Schumpeterian scheme as follows. At all levels of human action, whether in the market economy or the centrally planned economy, we must distinguish two separate problems associated with ensuring that the best possible course of action will be adopted. The first concerns the discovery of the best available course of action, and is essentially a matter of calculation from the relevant data. The second problem is how to ensure that this best course of action— which can be carried out—will be carried out.. [A]s soon as one recognizes the problem of ensuring that the individual “sees” the optimum course of action, the importance of this entrepreneurial element, of ensuring alertness to and awareness of “the data,” becomes apparent.... No matter the form of economic organization, laissez-faire or central planning or some attempted mixture, the second problem must be faced: what can ensure that the opportunities that exist be “seen” and embraced? It is here—in the market case—that the entrepreneurial element comes in.

In the market system the existence of opportunities is signaled by profit opportuni­ties in the form of price differentials. Now signals may not always be seen—but the kernel of market theory is that a tendency exists for them to be seen. The profit incentive is viewed as the attractive force. It is a force which not only provides the incentive to grasp the opportunities once perceived, but which ensures a tendency for these opportunities to be perceived. Entrepreneurship is seen as the responding agency; the alertness of the entrepreneur to profit possibilities is seen as the social mechanism ensuring the capture by society of the possibilities available to it... All this is missing in the Schumpeterian scheme (Kirzner [1979] 1971, 119, emphasis added).

This account leads Kirzner (1973) down some unusual paths. First, he insists “entrepreneurship is necessarily open to all” (20) and “anyone else could have done what he did” (22), but such a definition seems to contradict his assertion that entrepreneurs enjoy a special “alertness.” The entrepreneur, he also tells us, “needs no assets to engage in prof­itable market participation” (15) and therefore, “The discovery of a profit opportunity means the discovery of something obtainable for nothing at all.. the free ten-dollar bill is discovered to be already within one's grasp” (48, emphasis in original). And, while briefly raising the issue of the decision over what products to make, he provides no micro-level insight into that process, but instead assures us “... in the long run quality competition always involves the attempt to offer a better product, without commitment to any one commodity class, at a lower price” (Kirzner 1973, 24, emphasis added). In other words, this explanation for why an entrepreneur produces x rather than y reduces to the fact that the entrepreneur was alert to profit opportunities in x rather than y, a position we do not feel is terribly insightful for understanding micro-level decision­making among entrepreneurs.⁶ Indeed, the entire notion of the creative aspect—which we discussed in the context of Schumpeter—is difficult to reconcile with Kirzner's methodology.⁷

⁶Consider the profound difference between Kirzner's approach and Schumpeter's. Consider Schumpeter on the matter of price competition:

.the problem that is usually being visualized [by the “usual” theorists] is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them.. Economists are at long last emerging from the stage in which price competition was all they saw. As soon as quality competition and sales effort are admitted into the sacred precincts of theory, the price variable is ousted from its dominant position..

This passage from schumpeter, it should be noted, was written roughly 30 years before the quotes we take from Kirzner in this section.

⁷See Buchanan and Vanberg (1991) and Jakee and Spong (2003b, 2011) for detailed arguments on this point.

In contrast, our entrepreneurs are not driven solely—or perhaps even principally—by profit or a special alertness to a discrepancy in prices because our entrepreneurs cannot reduce the multiple decisions required to start an entrepreneurial venture into simple comparisons of prices and costs or even into manageable price vectors.^[6] On this point, we diverge from much of Schumpeter’s emphasis on the profit motivation as well. Neither can our entrepreneurs have anything approaching perfect ex ante expectations of profit, which means our approach clearly inte­grates a mechanism for entrepreneurial failure. Our entrepreneurs are likely directed much more by their own tastes, preexisting knowledge, and skills than their “alertness” to a preexisting “ten-dollar bill.”

Do our entrepreneurs attempt to calculate costs and benefits and attempt to anticipate the uncertainties of the future? Of course they do, but they are also much more prone to insurmountable ignorance, some luck, and failure, all things Kirzner seems loath to acknowl­edge. Moreover, while we are unable to predict, ex ante, who will become an entrepreneur—and thus it might appear that anyone could be an entrepreneur—we agree with Schumpeter that “Innumerable resis­tances of a social and political character work against [entrepreneurial innovation]. And the organization itself, still unknown, requires special aptitude...” ([1912] 1983, 133). We therefore fundamentally disagree with Kirzner on this point. Finally, we differ with both Schumpeter and Kirzner on the claim that entrepreneurial activity requires no assets; for Kirzner, this is an assumption that inevitably follows from his definition that entrepreneurship is essentially an arbitrage exercise. Our approach to entrepreneurs-as-business-owners or entrepreneurs-as-start-ups suggests they are indeed saddled with assets, which can include investments in one career trajectory and not another. Should the process of entrepreneur­ship involve assets, decisions concerning those assets are likely to be consequential—to the entrepreneur.