Monday, September 10, 2012

Peter Klein Responds

Peter Klein has responded in the comments section to my earlier post. I reproduce his observations below in bold followed by my comments.

Bob, a brief reply. I was obviously unclear in my post. My point -- which I borrow from Cantillon, Menger, Knight, and Mises, among others -- is not that uncertainty prevents individuals from acting. Quite the contrary, human action, in the Misesian sense, *is* acting under uncertainty! The point is to define profit and loss. When action is successful, meaning that it brings about the results sought, the result is profit (monetary or psychological). When unsuccessful, the result is loss. 

Peter in your original post you wrote:

The problem with Kirzner’s metaphor is not the idea that certain people are especially quick to notice things, but the idea that profits exist out there, objectively, waiting to be noticed. In a world of uncertainty, there are no profit opportunities to be alert to.
I think you  are in a box, while you recognize that uncertainty does not prevent individuals from acting, (a view I certainly don't object to), for some reason you refuse to accept that profit opportunities exist in an uncertain world in the same manner. It's clear that's what you write:
In a world of uncertainty, there are no profit opportunities to be alert to.
My argument is that you use "uncertainty" in too grand of a manner that causes you to fail to see that man acts with uncertainty all around AND searches for profit opportunities despite uncertainties in the grand sense.

Consider Mises's definition of the evenly rotating economy. In this imaginary construct, there are capitalists, earning interest, but no entrepreneurs, because there is no uncertainty, and hence no profit and loss. I.e., absent uncertainty, there are capitalists who are not also entrepreneurs. In the real world, the capitalist is always an entrepreneur, as Mises states in the passage I quoted in my post.

It's true there is no uncertainty in an evenly rotating economy, but I am not sure what this has to do with anything we are discussing. For example, if I spot a book in a used bookstore for $10.00 and I know I can sell it to my friend sitting in a car outside for $50.00. I can complete, what I would view as an entrepreneurial effort, and profit by buying the book from the bookstore owner and selling it to my friend in the car. In an ERE, since Mises rules out profit and loss, the bookstore owner would somehow magically become aware of this opportunity, I guess, and thus there would be no need for such type entrepreneurial alertness. My thought is so what? What does this have to do with entrepreneurs and capitalists in the real world other than making it clear that a capitalist is necessary in a world even where entrepreneurs do not exist, which makes it clear that there is an element to being a capitalist that has nothing to do with being an entrepreneur. I think this ERE discussion is making my point, not yours.

To answer your questions: 
1. Yes, it is not riskless. He may be mistaken. It may be a counterfeit bill. Someone else may grab it. The wind may blow it away. Of course, in this example the uncertainty is trivial but, then, it's a trivial example. Real-world business opportunities are not like this. Indeed, I use this example all the time in my teaching. The Knightian-Misesian entrepreneur thinks he sees a ten-dollar bill, but it is partly buried under a rock. To retrieve it, he must buy a five-dollar shovel. If it really is $10 then (ignoring the opportunity cost of his time), he has earned a $5 profit. Otherwise, he has earned a $5 loss. This is a better metaphor for real-world entrepreneurship than Kirzner's idea of costless discovery.

Your example presents a case probability which actually helps understand the Kirznerian perspective versus your narrow Knightian-Misesian entrepreneurial perspective. Because you fail to recognize the difference between an entrepreneur and a capitalist, you lump them together as one acting individual facing profit or loss. But in the real world, this is not generally the case as demonstrated by many financial transactions done on a daily basis. But lets keep it simple and stick to your possible ten dollar bill under a rock. As an entrepreneur, who spots the possible bill under a rock, instead of financing the bill digging venture with my own money (as you suggest), I may go to a capitalist and say, "Hey, I know where there might be a $10.00 bill under a rock, if you buy the shovel with your capital and use your labor to dig out the rock, if there is $10.00 under the rock, I'll split the profit with you, $2.50 to each of us, plus you get the return of your capital."

I am acting as a pure entrepreneur, with no exposure to risk. 

Of course, the question you have to answer is how, in your (and Kirzner's) framework, do you explain economic loss? Entrepreneurs lose money every day. Firms go bankrupt. Business debts go unpaid. If entrepreneurship is costless discovery, how can this happen?

See above, you are mixing up capitalist and entrepreneur. Also see my post on ex-ante and ex-post   profit opportunity.

2. No, as long as the production process in question involves the use of some capital goods. Those capital goods are owned by someone, and the party on whom the residual profits and losses fall -- in modern organizational economics terminology, the party possessing the residual rights of control -- is the entrepreneur. The "idea man" who approaches the capital owners and offers to speculate on his account, in exchange for a fee, is not an entrepreneur, but a consultant or some other kind of agent of the owner. As Rothbard once put it, "ideas without money are mere parlor games until the money is obtained and committed to the projects."

I see some progress here in that you recognize that there is an "idea man". I consider that man the catalyst,.i.e. the entrepreneur.

Rothbard is absolutely correct that "ideas without money are mere parlor games until the money is obtained and committed to the projects." It is part of the role of the entrepreneur to be alert to where money might exist for a project, otherwise it is a parlor game. But Rothbard doesn't say the money has to be the money of the entrepreneur. 

3. Sure, such people play an important economic function. It is labor. (Of course, to the extent that the agent is paid on a contingency basis, he is acting partly as an entrepreneur, because his return is uncertain. It all depends on the contract between the agent and the resource owner.)

Again, I am glad that you see such an "idea man" as playing an important function. This is progress. But, I still don't get why you want to lump this type of actor on a pile with capitalists or laborers, when it is clear that such an acting man may not put up any money or do any labor! 

4. I call them "idea men," or "consultants," or sometimes "founders," depending on the context. It's confusing because the practitioner literature typically calls them "entrepreneurs." Mises was quite clear that this is a different category than the entrepreneur, noting that economics "also calls entrepreneurs those who are especially eager to profit from adjusting production to the expected changes in conditions, those who have more initiative, more venturesomeness, and a quicker eye than the crowd, the pushing and promoting pioneers of economic improvement" (Human Action, p. 255). He suggests the word "promoter" to describe this kind of agent, lamenting that the economics literature has used the same word to refer to the distinct functions of uncertainty-bearing and eagerness etc. Unfortunately, Mises's terminological suggestion didn't catch on, so we're stuck using the E word for both concepts. 

I think there is major progress here in that there is recognition that acting man does something that is not labor and not in the role of a capital provider, but is still very important to the launch of economic projects. Call such individuals what you will, I will call them entrepreneurs, since there are other terms for the capital provider, capitalist, and for the worker, laborer.


  1. A rather interesting debate. As far as I can tell, you are BOTH right. Per Rothbard, an entrepreneur "is always on the alert, then, for discrepancies, for areas where he can earn more than the going rate of interest." (Man, Economy, and State)

    And yet, it is also the entrepreneur that bears the risk of the venture. As he realizes the profits, he bears the risk of losses. This action is inseparable. The consultant that advises the capitalist or laborer as to profit opportunities is not an entrepreneur, but an employee. It is the capitalist or laborer that is seeking the profit directly and bearing the risk of loss.

    At least, that's my two cents.

    1. We're getting close. I see the entrepreneur and the capitalist as two separate functions. They may however, exist in the same man and the same time. But not always.

      The entrepreneur (NOT a consultant, but a partner) may or may not risk anything tangible. He will always risk his efforts of course, but that is trivial in the grand scheme. What drives him is opportunity. He is a cockeyed optimist by definition.

      The capitalist risks tangible assets, and his focus is risk / reward, of course. He does not initiate the undertaking, and tends to be a passive investor.

      There is a continuum between these functions, however, as some capitalists are more "hands on", some entrepreneurs put up some money, etc.

    2. See, I disagree with that interpretation of the capitalist. What drives the capitalist is interest income. Hence, while the entrepreneur - as a bearer of uncertainty - would disappear in the ERE, the capitalist would remain as advancing present goods for future goods.

      I think looking at the stock investor as an entrepreneur (and not just capitalist, although they do perform this function as well) is illuminating here. Your average person investing in stock is not particularly "alert" to profit opportunity - the future behavior of the stock is essentially uncertain, and there is no objective prior measure of profit available there. They are bearing that uncertainty in the hope that profit can be found there - and will inevitably seek to ensure they maximize that profit.

      The rational optimism and "alertness" of the entrepreneur is a mark of what makes a *good* one, not a fundamental characteristic of entrepreneurship.

  2. I guess a lot of this disagreement is really the definition of "entrepreneur".
    It reminds me of the Keynesian duality of the word "savings".
    I took umbrage the other day at what I considered a mischaracterization of the word, me being an entrepreneur and all...
    So it's "class" vs "type". Unfortunate that Mises uses the same term for both. He does express regret, to his credit.
    Also, if Tom Woods is following this, my crack about economist's posteriors (no pun intended), was NOT directed at Peter Klein or any other Austrian. I meant the economics / business academics in general (mainstream). I don't think you can learn entrepreneurship in school.
    Also, I don't do ad hominem .

  3. This post clarified my misunderstanding of both sides. I'm actually with Wenzel firmly on this one as what he was originally stating was not as opposed to what I was thinking to begin with. What I think is going on is Wittgensteinian, misunderstanding due to the insufficiency of words.

    "Rothbard is absolutely correct that "ideas without money are mere parlor games until the money is obtained and committed to the projects." It is part of the role of the entrepreneur to be alert to where money might exist for a project, otherwise it is a parlor game. But Rothbard doesn't say the money has to be the money of the entrepreneur. "

    Wenzel is critically correct here. I think what I was missing is that there is still opportunity cost for the entrepreneur though he's making use of another's capital. Thus he is still taking a risk. Also his reputation may be at stake should he be continually wrong, or even if he is right. His capital is himself and he is lending it to the capitalist. Both men are entrepreneurs with one renting his service of being 'alert' to potentialities to the other whom is more capable to fund.

    Wenzel, you've wrapped then one up.

  4. "I am acting as a pure entrepreneur, with no exposure to risk."

    Nope. You risk your reputation and ability to do fundraising in the future. You risk your time which could've been spent on doing other gainful deeds. Because you risk less than in the situation when you invest your own money, you're willing to accept lower profit. Taking outside capital doesn't eliminate risk, it merely shares it.

    Not all things at risk are monetary or material. There's always a cost of opportunity.

    1. Are you trying to explain opportunity costs to a blogger?


  5. Here is Rothbard's critique of Kirzner's concept of Entrepreneurship: I quote some relevant paragraphs: "Kirzner’s entrepreneur is a curious formulation. He need not, apparently, risk anything. He is a free-floating wraith, disembodied from real objects. He does not, and need not, possess any assets. All he need have to earn profits is a faculty of alertness to profit opportunities. Since he need not risk any capital assets to meet the chancy fate of uncertainty, he cannot suffer any losses. But if the Kirznerian entrepreneur owns no assets, then how in the world does he earn profits? Profits, after all, are simply the other side of the coin of an increase in the value of one’s capital; losses are the reflection of a loss in capital assets. The speculator who expects a stock to rise uses money to purchase that stock; a rise or fall in the price of stock will raise or lower the value of the stock assets. If the price rises, the profits are one and the same thing as the increase in capital assets. The process is more complex but similar in the purchase or hiring of factors of production, the creating of a product and then its sale on the market. In what sense can an entrepreneur ever make profits if he owns no capital to make profits on? For example, I might have a brilliant idea on how to make a profit on the market. I might be keenly alert to a profit opportunity virtually lying at my feet. I may have a sure tip on the stock market. But if I haven’t got any money to invest, the profits, perceived opportunity or not, will simply not be made. Entrepreneurial ideas without money are mere parlor games until the money is obtained and committed to the projects.

    One Kirznerian reply to such criticisms is that the entrepreneur need not own any assets, need not be a capitalist, if he can induce other people with money to invest in his idea.

    But this reply is unsatisfactory. Let us consider two possible such cases. In one example, I, with a brilliant entrepreneurial idea, sell that idea to someone with money; we invest in that project, with him putting up all the money and letting me be a junior partner because I contributed the idea. He keeps, say, 80 percent of the shares, and gives me the other 20 percent. But the Kirznerian Concept is now contradicted. In the first place, the moneyed man, risking his own assets in the firm, has thereby become an entrepreneur. The employer who spends his capital and hopes for a profitable return is an entrepreneur, an uncertainty-bearer, and he is also to the same extent a capitalist, since that is the extent of assets that he is risking. But there is more to the problem than this. For I might have begun as a free-floating wraith, as a man with an idea and no assets. But because of my contract with the moneyed investor, I have now become a capitalist, since I now own assets to the amount of 20 percent of the firm. In other words, there are here two fundamental and fatal flaws in Kirzner’s notion of the alert idea man as the entrepreneur: one, that the capitalist is also an entrepreneur, and two, that the pure idea man has, willy nilly, become a capitalist."

    I could not include following two important paragraphs due to HTML character limits.

  6. And here is Joe Salerno's important article on the same topic - The Entrepreneur: Real and Imagined ( He clarifies many issues.

  7. I tried to reply here but I am over the character limit, so I posted my reply on Circle Bastiat:

    I hope it won't be too confusing for readers flipping back and forth between blogs.

    And now, you can stick a fork in me -- I'm done!