Sunday, May 13, 2012

The Battle Over the Essence of Entrepreneurship: Klein Versus Kirzner

Joseph Salerno reports on a fascinating discussion that took place at a recent NYU Colloquium:

There was a lively and enlightening discussion this past Monday at NYU’s Colloquium on Market Institutions & Economic Processes (formerly named the Austrian Economics Colloquium), when Peter Klein presented an excerpt from his new book , Organizing Entrepreneurial Judgment, co-authored with Nicolai Foss and published by prestigious Cambridge University Press.   Israel Kirzner, who is the leading theorist of entrepreneurship in Austrian economics as well as in the broader economics profession was present.  Also present were NYU professors David Harper who wrote a notable book on the subject and Mario Rizzo whose co-authored book and subsequent articles on the cognate topics of time and ignorance are highly influential in Austrian circles   The engagement among these prominent Austrian theorists was highly anticipated among colloquium participants and none of us were disappointed. 
In his presentation, Klein challenged Israel Kirzner’s influential alertness paradigm of entrepreneurship.  Kirzner argues that alertness to and discovery of  profit opportunities–conceived as objectively and simultaneously existing differences in the prices of resources and products–is the crux of entrepreneurship.  Thus for Kirzner the entrepreneur is essentially an arbitrageur who buys a given good where prices are low and sells the same good where prices are high.  He faces no uncertainty, risks no capital, and always profits from his superior alertness to the existing profit opportunity.  Foss and Klein propose instead an approach to entrepreneurship based on Frank Knight’s and Ludwig von Mises’s focus on the “judgment” of uncertain future market conditions.   Judgment is exercised in the act of investing in  and allocating resources to specific time-consuming production processes that are organized and controlled by the entrepreneur until the completion and sale of the product.  For Foss and Klein the entrepreneur is therefore a capitalist and owner.  The capitalist firm is the organization created by the entrepreneur to facilitate ownership and decision-making control  over the productive resource combinations that embody his judgment of future product prices and markets. 
The difference between the Kirznerian and the Knight-Mises (and Foss-Klein) conceptions of the entrepreneur was neatly summarized  in an illuminating exchange between Klein and a pro-Kirzner colloquium participant.  The participant gave the example of an owner of an orange grove, in the pre-orange juice era,  who discovers the “fact” that orange juice is valued more highly than fresh oranges by consumers.  The owner acts entrepreneurially by alertly discovering and costlessly exploiting the profit opportunity afforded by the price differential between lower valued fresh oranges and higher valued orange juice.  In doing so he also improves coordination between production plans and consumption plans in the economy and thereby moves the economy closer to equilibrium. 
Klein responded by denying that the orange grower had discovered any “fact” at all.  What the grower did was to  judge that under future market conditions the price of orange juice would exceed the the production cost of the inputs, including fresh oranges, and, based on this speculative judgment, to invest his capital in purchasing these resources and organizing them accordng to a specific production plan.   Because his judgment and his  investment and organizational decisions turned out to be correct, he earned profits.  Had they been incorrect he would have suffered losses.  So, Klein maintained, the profit opportunity was not an ex ante  fact waiting to be discovered;  rather the profit opportunity was only realized , ex post,  as the successful outcome of an action based on a speculative judgment.  Whether or not the plans of economic agents are better coordinated and the economy is closer to equilibrium than before is “irrelevant,” Klein explained; the important point is that ex post profits indicate that resources have been reallocated from less valuable to more valuable uses from  the point of view of consumers.

I tend to fall into the camp that supports the Kirzner view of entrepreneurship, given that I believe I have actually profited in the economy by doing what Kirzner describes, namely, profiting without risk because of a discrepancy in market prices.

But, the best real world example I can think of that demonstrates Kirznerian entrepreneurship involves an acquaintance of mine who made thousands of dollars off a book he sold on Amazon.

Warren Buffett partner Charles Munger published, through a charity, a book Poor Charlie's Almanack: The Wit and Wisdom of Charles T. Munger. When the book was initially published, it was listed on Amazon, but Munger never listed any books for sale. My acquaintance correctly assumed that there would be people that would be looking for the book at Amazon, so he listed the book for sale on Amazon for $100. When he received an order (a few daily), he would simply call the charity provide the name of the person who wanted the book and have it shipped and pay the $50 the charity was asking for the book. He then kept the other $50 as profit. Profit, alertness, no capital at risk. Call this entrepreneurship, or whatever you like, but this type of alertness does exist.  As I say, I believe I have been involved in these types of transactions also.

Further, this also, I believe, describes investment banking in its purest sense. One can read often in the press about the battles at investment banks between the traders (who put capital at risk) and dealmakers (who are actually doing Kirznerian type entrepreneurship). A pure deal maker can make millions simply by suggesting a certain acquisition or merger take place. I have seen this a few times up close (although the deal maker will often couch the essence of a deal in a more complex fashion so that the two parties to the acquisition or merger believe that they "need" the deal maker to complete the transaction, after it is suggested.)

Note: I am not saying that there is no such thing as profit and loss by someone who puts capital at risk, buttsuch a person is probably better identified as a "risk capitalist" than as an "entrepreneur".

I further note that this is not simply some dry academic discussion that has limited real world application. I believe it has very important real world application. If the subtlety, between Kirznerian entrepreneurship and a risk capitalist is not understood, it creates a situation where it seems nearly impossible for youth in poverty to lift themselves out of poverty via entrepreneurship, since they will require capital they obviously do not have. It is in a way, a laissez faire sentence of poverty for such youth or, at best, success only through labor. However, if on the other hand, it is recognized that only alertness is needed for profit, then there is a shining light for those in poverty to follow. Indeed, more about this type of alertness should be discussed amongst the poor. The opportunities are out there, in my view, they just need to be grabbed via Kirznerian-type entrepreneurship.

I look forward to Professor Klein's book and will have further comments at that time.


  1. I would have to agree with Klein here, but ultimately I think this is two sides to the same issue. This really is a semantic argument. What you are basically saying is that if you put capital on the line you're a risk capitalist, but if you do nothing but notice and opportunity you're an entrepreneur. Webster defines an entrepreneur as: one who organizes, manages, and assumes the risks of a business or enterprise. What it sounds to me like you and Kirchner are saying is that if you assume risk you're not an entrepreneur, you're a risk capitalist, and you back that up with an anecdote of someone who made money as a middle man. I would say that is a narrow sighted view, and only one avenue of being an entrepreneur. I would consider a small business owner to be an entrepreneur. They are putting their own capital on the line to try and sell their product or service.

  2. Why can't we all get along? :)

    Obviously, this is a debate among friends.

    I like your distinction between the two forms of entrepreneurship.

    They obviously co-exist and complement each other. The pure entrepreneur can hustle an arbitrage, but he may need front money from the risk capitalist. Think Zuckerberg / Thiel.

  3. At the end of the day, we're all Austrians!

  4. I see a distinction without a real difference. Some entrepreneurial opportunities will not require capital investment or risk assumption, some will, though one could quibble that even the Munger book entrepreneur had to invest some of his time, and he faced at some some very small risk that he might find, when he called the charity, that they now wanted $125 donation, causing him a $25 loss.

    In the real world, the probability of finding such an (almost) pure profit, no-risk, no exchange approaches zero (not *is* zero, I'm going to stay out of that swamp!), and so the Klein case predominates. Must a Klein entrepreneur have Kirznerian alertness to profitable price discrepancies, either present or future (perhaps of goods, such as iPhones, that don't exist yet!)? Emphatically, yes. Is this sufficient; is is the essence of entrepreneurship? Maybe, but to stop there leaves out most of the story, especially the parts about creating goods that don't yet exist, and taking on risk.

  5. In my opinion Klein has the edge here. This is based on my personal experiences. Austrian economics alltogether makes sense to me because it is the only school that has theoretical insight into what I have experienced in practice.
    Bob, Klein has your example with the Munger book covered through the risk of opportunity cost. After all, time is the ultimate scarcity and individuals take chances every time they make an ex ante expectation that whatever they do in the present will benefit them with a psychic profit in the future. Therefore, even though your buddy did not put down cash, he invested time which he could have used to listen to music, work at McDonald's, play the lottery, etc. As you well know, there is no free lunch, nor is there a sure thing. (In your example, if the Munger book was a sure thing, then Amazon would have exerted more effort to cash in on it. They didn't precisely because they did not expect that there would be sufficient return on the investment.)

    1. "...if the Munger book was a sure thing, then Amazon would have exerted more effort to cash in on it."

      But it was a sure thing. Maybe Amazon just wasn't aware of it.

      As for the time it took to set up the entrepreneurial opportunity, I don't deny that this cost exists, but, it is different from the capital risks that are at the heart of Klein's entrepreneur.

    2. I suppose this is a fine detail, but wouldn't the Rothbardian approach be that the sure thing only proved itself after the fact.

      I'm conceding the point of the Kleinian entrepreneur if he only recognizes an entrepreneur as someone who risks capital--and not simply a risk taker. My understanding of the Rothbardian thesis (which completely agrees with practical experience) is that the entrepreneur is both the capitalist and the risk taker, though not necessarily always both at the same time. To that point I would say that an entrepreneur takes many risks similar to the Munger book re-seller even if they don't work out every time.