Austrian Economics and Entrepreneurial Studies (Advances in Austrian Economics, Volume 6)

LIST OF CONTRIBUTORS David B. Audretsch

Institute for Development Strategies, Indiana University, USA

Nicholas W. Balabkins

Department of Economics, Lehigh University, USA

William J. Baumol

Department of Economics, New York University, USA

Markus C. Becker

Department of Marketing, University of Southern Denmark

Peter J. Boettke

James M. Buchanan Center for Political Economy, George Mason University, USA

William N. Butos

Department of Economics, Trinity College, USA

Young Back Choi

Department of Economics and Finance, St. John’s University, USA

Christopher J. Coyne

James M. Buchanan Center for Political Economy, George Mason University, USA

Peter E. Earl

School of Economics, University of Queensland, Australia

Geoffrey M. Hodgson

The Business School, University of Hertfordshire, UK

Randall G. Holcombe

Department of Economics, Florida State University, USA

Stavros Ioannides

Department of Political Science and History, Panteion University, Greece ix

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Thorbjørn Knudsen

Department of Marketing, University of Southern Denmark

Roger Koppl

Department of Economics and Finance, Fairleigh Dickinson University, USA

Richard N. Langlois

Department of Economics, The University of Connecticut, USA

Maria Minniti

Division of Economics, Babson College, USA

G. B. Richardson

St. John’s College, Oxford University, UK

Richard Swedberg

Department of Sociology, Cornell University, USA

A. Roy Thurik

Tinbergen Institute, Erasmus University, The Netherlands

Ulrich Witt

Max Planck Institute for Research into Economic Systems, Jena, Germany

ADVISORY BOARD Don Bellante University of South Florida, USA

Uskali M¨aki University of Helsinki, Finland

James Buchanan George Mason University, USA

Ferdinando Meacci Universit`a degli Studi di Padova, Italy

Stephan Boehm University of Graz, Austria

Mark Perlman University of Pittsburgh, USA

Peter J. Boettke George Mason University, USA

John Pheby University of Luton, England, UK

Bruce Caldwell University of North Carolina, USA

Warren Samuels Michigan State University, USA

Jacques Garello Universit´e d’Aix-Marseille, France

Barry Smith State University of New York, USA

Roger Garrison Auburn University, USA

Erich Streissler University of Vienna, Austria

Jack High George Mason University, USA

Martti Vihanto Turku University, Finland

Masazumi Ikemoto Senshu University, Japan

Richard Wagner George Mason University, USA

Richard N. Langlois The University of Connecticut, USA

Lawrence H. White University of Missouri, USA

Brian Loasby University of Stirling, Scotland, UK

Ulrich Witt Max Planck Institute, Germany

Ejan Mackaay University of Montreal, Canada

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EDITORS’ INTRODUCTION Publication of Advances in Austrian Economics has been interrupted for several years. This volume marks the return of the series to regular publication. We anticipate a new volume at least once a year. We wish to connect the Austrian tradition of economics with other research traditions in economics and related areas. To that end, we are planning a series of special issues, each devoted to a separate theme. The current volume is devoted to “Austrian Economics and Entrepreneurial Studies.” We are planning future volumes on “Austrian Economics and the Dynamics of Interventionism” and “Austrian Economics and Evolutionary Psychology.” We invite both Austrian and non-Austrian contributions that establish fruitful links between the Austrian tradition and other perspectives on important theoretical and practical problems. We seek articles from authors who are interested in constructive exchange between Austrian economists and specialists in the theme area. All submissions are subject to double-blind refereeing. Potential guest editors are invited to submit proposals to the editor. Our editorial policy is based on the conviction that Austrian economics is not a doctrine or a method, but a rich tradition of research in the social sciences whose potential has by no means been exhausted. The tradition began with Carl Menger’s great 1871 work, Principles of Economics. For more or less accidental and historical reasons, however, the term “Austrian economics” generally refers only to that part of Menger’s legacy passing through the work of Ludwig von Mises and F. A. Hayek. In the years since the Second World War, the Austrian tradition of Mises and Hayek has been cultivated most actively and self-consciously in the United States. (The story is best told in Vaughn, 1994.) It must be admitted that some participants in this “American-Austrian” tradition have treated it as a f xed doctrine (see Vaughn, 1994, pp. 92–111, especially footnotes 20 and 21). Others, however, have adopted the view we follow, namely, that Austrian economics is a living tradition and an open inquiry. If Austrian economics is an open tradition, then it should have the potential to engage other traditions in dialogue. It is our intention that Advances in Austrian Economics be a vehicle for such dialogue. It is probably true that only a minority of contributors to the current volume, for example, are Austrian economists. Some might be labeled “ambiguous Austrians.” But all are seriously engaging Austrian issues and Austrian literature. The volume represents, we believe, a serious dialogue between Austrian and non-Austrian approaches to entrepreneurship. It xiii

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is our hope that this volume and others to follow will encourage both the export of Austrian ideas to other traditions and the import of non-Austrian ideas into the Austrian tradition. It is not an accident that two of us are Europeans both by birth and institutional affiliation Scholars in many European countries, including Austria, Denmark, France, and Italy are now making serious contributions to Austrian economics. It is our hope that Advances in Austrian Economics will serve as a vehicle for increased communication and cooperation between “Austrians” on both sides of the Atlantic and, indeed, throughout the world.

REFERENCE Vaughn, K. (1994). Austrian economics in America: The migration of a tradition. Cambridge, UK: Cambridge University Press.

GAINS FROM TRADE BETWEEN AUSTRIAN ECONOMICS AND ENTREPRENEURIAL STUDIES: AN INTRODUCTION TO THE VOLUME Roger Koppl Austrian economics and entrepreneurial studies have both expanded greatly in the last 20 or 30 years. Unfortunately, they have developed more or less independently of each other. Austrian economics has enjoyed a revival since 1973 or 1974. In 1973 Israel Kirzner published his classic book, Competition and Entrepreneurship, which outlined an entrepreneurial theory of the market process. In 1974 F. A. Hayek was awarded the Nobel Memorial Prize in Economics. The same year saw the famous South Royalton conference, which is the traditional origin of the “Austrian revival.” The intellectual history of entrepreneurial studies reaches back at least as far as Richard Cantillon (1755). As an intellectual movement, however, entrepreneurial studies began about the same time as the Austrian revival. The beginnings of the entrepreneurship movement might be dated to sometime before 1978 when Babson College established its Center for Entrepreneurial Studies, the firs such center in the U.S. In all this time, however, there has been limited exchange between Austrian economics and entrepreneurial studies. It is high time we expanded trade across the border between Austrian economics and entrepreneurial studies. Intellectual exchange between these two groups has been frustrated by at least two factors. Austrians have been discouraged from reading entrepreneurial works because of the frequent repetition of a famous remark of Ludwig von Mises. Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 1–7 © 2003 Published byElse vier Science Ltd. ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06001-0

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Entrepreneurship, Mises said, “defie any rules and systematization. It can be neither taught nor learned” (Mises, 1949, p. 584). This remark has been repeated often in Austrian seminars, usually with the purpose of dismissing the notion that Austrians might gain from exchange with scholars of entrepreneurship. Such resistance is surprising in a group so uniformly enthusiastic about free trade. Mises’ remark seems to deny that a theory of entrepreneurship is possible. But Mises’ student Israel Kirzner created just such a theory on the very foundations Mises had laid down (Kirzner, 1973). It is true, of course, that no one can teach an entrepreneur the specifi innovation that he creates. What, indeed, would that mean? But one can teach business students the tools and skills required to transform a new idea into a practical business plan. We can also teach them to be not afraid. We can teach them, that is, that new ideas can become business plans and that they are perfectly free to found new enterprises and think new things. Mises’ remark should no longer discourage Austrians from reading in entrepreneurial studies. Scholars of entrepreneurship have sometimes been discouraged from reading much Austrian economics by the apparent limits of Kirzner’s theory. Kirzner seems to neglect the entrepreneurial process, to view profi opportunities as external to the entrepreneur, and to restrict entrepreneurship to simultaneous arbitrage. Koppl and Minniti (2003) have argued that these limits to Kirzner’s theory “are more apparent than real.” When Kirzner’s theory is placed in the context of a broader Austrian theory of market process, it is revealed to be more dynamic than it initially appears. More recent developments within the Austrian tradition also tend to break down the impression that the Austrian theory is static or otherwise less than useful in entrepreneurial studies. David Harper, for example, has developed an “Austrian” theory of the entrepreneurial process (Harper, 1996, 1998). Butos and I have outlined a theory of entrepreneurial learning in which Kirznerian entrepreneurs are Hayekian learners (Butos & Koppl, 1999; Koppl, 2002). Scholars of entrepreneurship should no longer ignore or dismiss Austrian theory. It is hard to predict what gains will come from trade between Austrian economics and entrepreneurial studies. There is some reason to think, however, that Austrian economics has a comparative advantage in theoretical unity, while entrepreneurial studies has a comparative advantage in empirical richness. In her contribution to this volume, Maria Minniti notes the different meanings of “entrepreneurship.” “In principle,” she notes, “this diversity of meaning is not necessarily a problem. In practice, however, the result has been that we are getting more pieces of the puzzle, but no picture is emerging.” She uses “Kirzner’s theory as the starting point and unifying theme” of her survey. The Austrian school has an overarching theoretical framework that might be used to organize much of the literature in entrepreneurial studies.

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Austrian economists have probably devoted too little effort to empirical work in the past. This trend has changed radically in the last few years as Demmert and Klein (2003), Koppl (2002), and Keeler (2001) illustrate. Nevertheless, Austrian economics is still not very well endowed with empirical findings Scholars of entrepreneurship, by contrast, have been very energetic in confronting theory with the facts of history. Entrepreneurial studies is rich with empirical studies of how entrepreneurs think, what they do, how entrepreneurship is geographically distributed, whether entrepreneurship is correlated with growth, and so on. In this volume the contribution of Audretsch and Thurik reviews much of the empirical literature on entrepreneurship and growth. With their co-authors, they have made many valuable contributions to this literature. Baumol’s contribution includes a summary treatment of his historical analysis (Baumol, 1990, 2002) of the institutions encouraging either productive or unproductive entrepreneurship. Austrian economists considering entrepreneurship as a research topic should immerse themselves in such empirical results and, in most cases, make their own contributions to the empirical literature. I believe Austrian economics has much to add to the conversation. If so, it is likely that an Austrian perspective can lead to the discovery of new and interesting facts about entrepreneurship. Looking at the world from a different angle, we are likely to see what others miss. Continued exchange between Austrian economics and entrepreneurial studies is likely to lead to changes in the distribution of comparative advantage. It is my personal hope that continued exchange will help the budding Austrian tradition of empirical work to develop further. Entrepreneurial studies may gain from the “epistemic-cognitive turn” (Boettke, 2002) of the Austrian school. The fiel of entrepreneurial studies has produced many theoretical insights and models. If scholars of entrepreneurship import significan portions of Austrian theory, it is only a matter of time before they will have improved theories ready for export to Austrian economics. In the meantime, we can make a few more guesses about where the initial gains from trade may lie. I have already suggested that Austrian economics has the potential to make a significan contribution to the literature on entrepreneurship and economic growth. In this volume, Boettke and Coyne emphasize the Austrian view that entrepreneurship is an aspect of all human action. They infer (rightly, I believe) that institutions decide whether the human disposition to entrepreneurship produces economic growth. In particular, “the two core institutions, necessary for achieving the goal of encouraging entrepreneurship, are private property and the rule of law.” The legal structure is a vital factor deciding whether entrepreneurial calculations will be farsighted and “rational” in Max Weber’s sense. As their paper illustrates, Austrian economists emphasize the role of culture in determining how the “same” institutional structure may function very differently in different places.

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Scholars interested in entrepreneurship and growth should probably consult Audretsch, Baumol and Burke (2001) who discuss the migration of Austrian ideas to the mainstream literature in industrial organization. Their review provides a good example of the gains from exchange between Austrian and non-Austrian traditions. They note a fundamental difference between the arguments for laissez faire coming from the Chicago and Austrian schools. They “both advocate a laissez faire approach to regulation, but for very different reasons; the former [Chicago] on the presumption that the supply of entrepreneurs is infinit in the long-run while the latter [Austrian] concerns itself with the incentives needed to expand the limited supply of entrepreneurial resources” (p. 620). The model in Yates (2000) illustrates their point nicely. In his model of the entrepreneurial market process, “the market adjustment process is consistent with static Walrasian equilibrium” when “entrepreneurs do not make mistakes.” If, however, “entrepreneurs do make mistakes, then the market adjustment process is generally consistent with another kind of equilibrium” in which a uniform price emerges, but not all units are sold. In his model, the welfare implications of a tax “cannot be studied in isolation from the features of the disequilibrium adjustment process that directs the market from one equilibrium to the other.” He thinks this result “suggests that further study of disequilibrium and, in particular, market process theory, will illuminate interesting insights into other welfare issues” (p. 81). Austrian economists constantly investigate the role of knowledge in society. “It is characteristic of the Austrian approach,” Richardson notes in his contribution, “to keep the epistemology, as well as the logic, of decision taking in the foreground.” His notion of the “structure of their awareness” is an essential insight into who perceives what profi opportunities. Differences in the structures of fir awareness contribute to the emergence of enduring capabilities that are hard to replicate. They are an important source of the differentiation and continuity that allow competition to function reasonably well. Butos develops a theme briefl touched on at the end of Richardson’s essay, namely, the growth of knowledge. He examines the role of Kirznerian entrepreneurs in generating knowledge. Butos argues that entrepreneurs do not merely use dispersed knowledge, they produce knowledge. Building in part on McQuade (see Butos & McQuade, 2002; McQuade & Butos, 2003), Butos argues “market process involves a transformation of knowledge at the individual level into a new form of quasi-knowledge” existing at the level of markets, not individuals. (It is quasi-knowledge rather than knowledge because “the market order is non-teleological and non-conscious.”) Butos describes markets as “knowledge-generating entities.” Entrepreneurs are learners. Entrepreneurship is change in knowledge and knowledge is a foundational concept in Austrian economics. Thus, it seems

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reasonable to hope that a serious look at problems in entrepreneurial studies though the lens of an Austrian view of knowledge will lead to new results. For example, casual empiricism suggests that immigrants often become entrepreneurs. Immigrants would seem to have less knowledge of local culture than natives, and one might expect this knowledge defici to thwart entrepreneurship. But if immigrants are often entrepreneurs, then the knowledge defici would seem to have benefits What view of knowledge might clarify the issues and suggest testable theories of immigrant entrepreneurship? One good candidate is the connectionist perspective of Peter Earl’s contribution to this volume. Familiarity consists partly in the strength of connection between certain ideas. These strong connections may carry the mind away from crosscutting connections, some of which may represent entrepreneurial opportunities. A more naive observer may make such connections more easily than cultural insiders. Austrian perspectives on knowledge also shed light on an important aspect of entrepreneurship, namely, leadership. In his contribution to this volume as in other writings, Ulrich Witt address the issue of cognitive leadership within the firm Entrepreneurs typically act through firms They are the founders and leaders of business enterprises. An essential leadership function within the fir is to induce employees to adopt the entrepreneur’s basic business conception and the corresponding workplace values. (He notes that Langlois and I offer a “different, though related, interpretation” of the same issues in Koppl & Langlois, 2001.) Ioannides notes that failure to achieve cognitive leadership may cause the entrepreneur’s organization to “dissolve” into a spontaneous order. The fir may carry on, but it will no longer function effectively to pursue the founder’s business vision. The complementary analyses of Witt and Ioannides may be useful to scholars working on problems of family business. In this context, the founder must exercise cognitive leadership within the firm within the family, and across generations. Randy Holcombe argues that the innovating entrepreneur cannot help himself from acting as a teacher to other potential entrepreneurs, including his potential competitors. They are made more alert to opportunities by his example and may recognize errors or insufficiencie in his business model or the possibility of applying it elsewhere. McDonald’s gives rise to Burger King and Taco Bell. Holcombe’s paper develops his earlier argument that entrepreneurship breeds entrepreneurship. This argument has arisen independently in the entrepreneurship literature in the work of Minniti (Minniti, 1999; Minniti & Bygrave, 2000, 2001), who uses non-linear stochastic processes to model certain dynamics of entrepreneurial choice. The striking overlap here suggests the likely benefit of further exchange across the border between Austrian economics and entrepreneurial studies. Joseph Schumpeter is a figur of continuing interest to both Austrian economics and entrepreneurial studies. My co-editors and I were thus very happy to have

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this opportunity to publish his 1928 essay “Entrepreneur” as translated by Markus Becker and Thorbjørn Knudsen. They made one valuable contribution to scholarship in the translation and a second valuable contribution with their introduction. We are pleased to have brief comments on Schumpeter’s essay from Geoffrey Hodgson, Nicholas Balabkins, Young Back Choi and Richard Swedberg. A more extensive commentary comes from Richard Langlois who may be viewed, perhaps, as analyzing Das Joseph Schumpeter Problem. Langlois find that the real Problem is not any tension between a supposed early and late Schumpeter, which is often claimed in the Anglo-American literature on technological change. The real Problem is Schumpeter’s simultaneous adherence to two different views of knowledge, one “rationalist,” the other “empiricist.” Langlois’ interpretation returns us to a theme raised in many contributions to this volume, namely, knowledge. As Israel Kirzner has taught us, entrepreneurs innovate and, therefore, entrepreneurship entails change in knowledge. It is reasonable to expect that Austrian and Austrian-inspired contributions to entrepreneurial studies will tend to involve the epistemology of decision taking. They will tend to involve, that is, a dynamic Austrian view of knowledge and its growth in market economies. Contributions to Austrian economics from scholars of entrepreneurship are likely to modify those same Austrian views of knowledge and to enrich them with grounded empirical studies of how entrepreneurship operates in the world. This volume shows by example, I think, that continued interaction between Austrian economics and entrepreneurial studies will enrich our understanding of markets in exciting, if unpredictable ways.

REFERENCES Audretsch, D. B., Baumol, W. J., & Burke, A. E. (2001). Competition policy in dynamic markets. International Journal of Industrial Organization, 19, 613–634. Baumol, W. J. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political Economy, 98, 893–921. Baumol, W. J. (2002). The free-market innovation machine: Analysis of the growth miracle of capitalism. Princeton: Princeton University Press. Boettke, P. (2002). Information and knowledge: Austrian economics in search of its uniqueness. The Review of Austrian Economics, 15, 263–274. Butos, W. N., & Koppl, R. (1999). Hayek and Kirzner at the Keynesian beauty contest. Journal des Economistes et de Etudes Humaines, 9, 257–298. Butos, W. N., & McQuade, T. J. (2002). Mind, market, and institutions: The knowledge problem in Hayek’s thought. In: J. Birner, P. Garrouste & T. Aimar (Eds), F. A. Hayek: A Political Economist (pp. 113–133). London and New York: Routledge. Cantillon, R. (1755) [1931]. Essay on the nature of commerce. H. Higgs (Trans.). London: Macmillan.

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Demmert, H., & Klein, D. B. (2003). Experiment on entrepreneurial discovery: An attempt to demonstrate the conjecture of Hayek and Kirzner. Journal of Economic Behavior and Organization, 50, 295–310. Harper, D. (1996). Enterpreneurship and the market process: An inquiry into the growth of knowledge. London: Routledge. Harper, D. (1998). Institutional conditions for entrepreneurship. Advances in Austrian Economics, 5, 241–275. Keeler, J. P. (2001). Empirical evidence on the Austrian business cycle theory. The Review of Austrian Economics, 14, 331–351. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Koppl, R. (2002). Big players and the economic theory of expectations. New York and London: Palgrave Macmillan. Koppl, R., & Langlois, R. N. (2001). Organizations and language games. Journal of Management and Governance, 5, 287–305. Koppl, R., & Minniti, M. (2003). Market processes and entrepreneurial studies. In: Z. Acs & H. Audretsch (Eds), Handbook of Entrepreneurship Research: An Interdisciplinary Survey and Introduction. Boston: Kluwer Academic Publishers. McQuade, T. J., & Butos, W. N. (2003). Order-dependent knowledge and the economics of science. Review of Austrian Economics (forthcoming). Minniti, M. (1999). Entrepreneurship and economic growth. Global Business and Economic Review, 11, 31–42. Minniti, M., & Bygrave, W. (2000). The social dynamics of entrepreneurship. Entrepreneurship: Theory and Practice, 24, 25–36. Minniti, M., & Bygrave, W. (2001). A dynamic model of entrepreneurial learning. Entrepreneurship: Theory and Practice, 25, 5–16. Mises, L. von (1949). Human action: A treatise on economics. New Haven, CT: Yale University Press. Yates, A. J. (2000). The knowledge problem, entrepreneurial discovery, and Austrian market process theory. Journal of Economic Theory, 91, 59–85.

ENTREPRENEURSHIP STUDIES: A STOCKTAKING Maria Minniti ABSTRACT In recent years, the topic of entrepreneurship has attracted increasing attention from academics and policy makers. Although much of the debate has taken place in business schools, its protagonists are sociologists, psychologists, organization theorists, and, of course, economists. The purpose of this paper is to take stock of this debate and of what we have learned so far about entrepreneurship. Using Kirzner’s theory as the starting point and unifying theme, the paper reviews works about entrepreneurs and what they do, the socio-economic factors influencing entrepreneurial decisions, the relationship between entrepreneurship and organizations, and the possible links between entrepreneurial activity and economic growth.

1. INTRODUCTION In recent years, the topic of entrepreneurship, broadly defined has attracted increasing attention from both policy makers and academics. In 1998, for example, the OECD launched the program Fostering Entrepreneurship, while the European Union released the report Fostering Entrepreneurship: Priorities for the Future. Also, in the last few years, the governments of Finland, Germany, Israel, Italy, United Kingdom and several other countries have launched a series of initiatives designed to enhance entrepreneurship and to promote it as a source of employment Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 9–37 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06002-2

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and economic growth (Reynolds et al., 1999). Entrepreneurship is now at center stage in the public policy arena of many countries and international organizations. Entrepreneurship has also gained increasing popularity among academics. Although much of the debate has taken place in business schools, it has had as protagonists, scholars from a variety of disciplines such as sociology, psychology, organization theory, and, of course, economics. Unfortunately, because of the variety of methodological approaches, it is difficul to gain a comprehensive view of what the academic community at large has learned, if anything, about entrepreneurship. The purpose of this paper is to take stock of what we have learned. Using Kirzner’s theory as the starting point and unifying theme, the purpose of this paper is to provide a survey of the literature on entrepreneurship for scholars, in various disciplines, who may be interested in entrepreneurship in general or in some specifi aspect of the entrepreneurial process. Entrepreneurship is clearly a multifaceted phenomenon. The paper reviews contributions in various disciplines in the hope of capturing the potential richness that a diverse mix of approaches can bring to our understanding of the subject. The survey is introductory and does not pretend to be comprehensive. The list of references, however, should suffic to provide interested readers with a wide springboard of suggestions. A proper analysis of the literature requires firs a clear understanding of what the subject of inquiry is about. Unfortunately, one of the limiting features of entrepreneurship literature is the variety of meaning attributed to the word entrepreneurship. Already in 1990, Gartner’s survey of business and academic professionals revealed a diversity of concepts falling under the label “entrepreneurship.” In particular, Gartner’s cluster analysis showed that there exist at least two different basic concepts of entrepreneurship. The firs concept is concerned with the “characteristics of entrepreneurship”; the second with the “outcomes of entrepreneurship.” Thus, sometimes entrepreneurship means what the actor is like; sometimes it means what the actor does. This inconsistency is present even in research within the same discipline (Gartner, 2001). In principle, this diversity of meaning is not necessarily a problem. In practice, however, the result has been that we are getting more pieces of the puzzle, but no picture is emerging and scholars of entrepreneurship fin themselves in the awkward position of using the same word to identify very different things (Shane & Venkataraman, 2000). Koppl and Minniti (2003) argue that Kirzner (1973, 1979) provides a definitio in which what the entrepreneur is like determines necessarily what the entrepreneur does. “In Kirzner’s work, entrepreneurship is firs the ‘alertness’ to new opportunities. Entrepreneurs are alert; this is what they are like. Second, entrepreneurship is seizing an opportunity by taking innovative actions. Entrepreneurs innovate; this is what they do. Alertness leads to the discovery of

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new opportunities. If the opportunity discovered is a real one, the entrepreneur acts on it. Alertness necessarily leads to innovative actions such as founding a new venture” (Koppl & Minniti, 2003, p. 87). Thus, in Kirzner’s theory, what the entrepreneur is like determines necessarily what the entrepreneur does. According to Kirzner, entrepreneurship is a change in the ends-means framework of the actor. Such change happens because the entrepreneur is “alert” to new possibilities for action. If the entrepreneur were not alert, he would never adopt a new ends-means framework, and change in economic life would be impossible. As a result, alertness is a necessary feature of all human action. Under the umbrella of Kirzner’s work on entrepreneurship, it is possible to address, from a variety of angles, the questions of why, when, and how opportunities arise, and why, when, and how some individuals become entrepreneurs while others do not. Furthermore, Kirzner’s view allows the investigation of the connection between individual actions and market dynamics. Thus, it allows questions about how firm can behave entrepreneurially and about the strategic implications and the macroeconomic consequences of entrepreneurial activity. To summarize, Kirzner’s work provides the soundest theoretical framework for a comprehensive theory of entrepreneurship and, therefore, it is used as the theoretical umbrella for this paper. Throughout the paper, I move in logical sequence from microeconomic to macroeconomic topics, and discuss recent contributions about entrepreneurship and entrepreneurial behavior. Section 2 reviews works about who entrepreneurs are and what they do. Section 3 reviews contributions related to the socio-economic context within which entrepreneurial decisions are made. Section 4 reviews the relationship between entrepreneurship and organizations, and the strategic implications of entrepreneurial behavior. Section 5 reviews the links between entrepreneurial activity and the economy. Finally, Section 6 summarizes the discussion, identifie strengths and weaknesses in the existing literature and suggests directions for further research.

2. ENTREPRENEURS AND NEW VENTURE CREATION A crucial question in entrepreneurship asks who the entrepreneur is and in what ways and why he is different from other individuals. An increasing number of scholars agree that opportunity recognition represents the most distinctive and fundamental entrepreneurial behavior (Stevenson & Jarillo, 1990; Venkataraman, 1997). In fact, there is wide agreement that entrepreneurs are individuals who are more likely than others to be “alert” to the identificatio and exploitation of profi opportunities (Kirzner, 1973; Low & MacMillan, 1988; Schumpeter, 1934; Shane & Venkataraman, 2000). As a result, understanding the opportunity

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recognition process represents one of the crucial questions for the domain of entrepreneurship. Kirzner (1973, 1985) define alertness as the entrepreneurial element in people’s actions responsible for our understanding of action as active, creative, and human rather than as passive, automatic and mechanical. In particular, in his discussion of alertness, Kirzner argues that the difference between alert and non-alert individuals lay in the different decisions they make about their circumstances. Non-alert individuals fail to take advantage of entrepreneurial opportunities because they misinterpret their market environment and the behaviors appropriate for their environment. Building upon Kirzner’s theory, Gaglio and Katz (2001) take a cognitive psychology approach and suggest the existence of a “schema” of entrepreneurial alertness. They argue that “schema are dynamic, evolving mental models that represent an individual’s knowledge and beliefs about how physical and social worlds work” (p. 97). These mental models help direct attention and guide information processing and reasoning for any specifi event. The schema content and complexity, however, vary among individuals. Thus, perceptions and interpretations of the world vary among individuals too. Schema theory assumes that individuals engage in a sort of matching game between contextual motivations and the content stored in the activated schema (Fiske & Taylor, 1991; Mitchell & Beach, 1990). Gaglio and Katz (2001) explain that if the match is sufficientl good, alertness turns into action. If the match is not good, the collection of additional information is required. In this case, when contextual motivations are perceived as being unusual or unpredictable, many individuals never follow the activation of the schema with actions. Under the same circumstances, however, some individuals do integrate the new information in their existing schema and, as a result, create new subcategories and causal links. Alert individuals are those who update their schema to accommodate non-matching information. Non-alert individuals, instead, only switch the informational content of their schema. For alert individuals, the enriched complexity and richness of their schema leads to action even in unusual or unpredictable situations (Fiske & Taylor, 1991; Sherman et al., 1989). Alert individuals have more complex schema about change than non-alert individuals. Their ability to construct and use more complex patterns as a single unit of information is the mechanism that produces opportunity identificatio and, more important, the ability to act upon them. To summarize, according to Gaglio and Katz (2001), alert individuals possess the ability to adapt to changing contextual cues and realize that the appropriate behavior at that moment requires a re-evaluation of their environment. This argument is consistent with Kirzner’s claim that alert individuals are especially sensitive to signals of market disequilibrium.

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In general, in cognitive psychology, perceptions and interpretations are said to vary as a result of the schema activated in response to a particular event. Chase and Simon (1973) and Chi et al. (1982), for example, suggest that differences in decisions and performances between creative and non-creative individuals can be traced back to differences in schema content. Differences in activated schema produce different actions. Individuals possessing more accurate schema do a better job at projecting expected changes and are able to better tailor their actions to the changing environment. Along similar lines, Koppl (2002a, b) adds a more subjective and internal perspective to the study of entrepreneurial behavior by bringing in the phenomenological psychology of Alfred Schutz. In Schutz’s system, human knowledge is a system of typifications a system of stereotypes and recipes that guide individuals through our daily activities (Schutz, 1951). The entrepreneur’s knowledge, for example, is such a structure. According to Koppl, the entrepreneur organizes his collection of typification through a system of relevancies. This system of relevancies guides the entrepreneur and influence the sorts of discoveries he can make. Any act of entrepreneurship has its meaning for the entrepreneur within his system of relevancy even as it transforms that system. From the previous discussion, entrepreneurs emerge as alert and innovative individuals. Alert is what they are like. There is also general agreement that entrepreneurship is seizing an opportunity by taking innovative actions. Innovate is what entrepreneurs do. Alertness leads to the discovery of new opportunities. If the opportunity discovered is a real one, the entrepreneur acts on it. Thus, alertness necessarily leads to innovative actions such as the founding of a new venture. After having analyzed what prompt alertness, the issue becomes why certain individuals start new businesses while others do not. A variety of causes has been indicated as the reasons why some individuals become entrepreneurs. Often, researchers have focused on differences caused by the resources at one’s disposal. For example, Schumpeter (1934) and Kirzner (1973) discuss the importance of people’s expectations about the value of available resources. Evans and Jovanovic (1989), Evans and Leighton (1989), and Kihlstrom and Laffont (1979) discuss the importance of financia resources. Amit, Mueller and Cockburn (1995), and Minniti (forthcoming) focus on individuals’ opportunity costs while choosing between alternative income producing activities. Cooper, Woo and Dunkelberg (1989), Leazar (2002) and Otani (1996) concentrate on prior experience in determining employment status choices. Finally, Begley and Boyd (1987) and Minniti (2001) discuss individuals’ tolerance toward ambiguity. In general, the question of why certain individuals start new businesses while others under similar circumstances do not has been related, in both the psychology and economics literature, to the issue of intentionality and locus of control. Clearly,

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starting a business is an intentional act that involves repeated attempts to exercise control over the process in order to achieve the desired outcome. Although, in some cases, the environment’s contribution to success may exceed the contribution of the individual, the act of business creation is clearly intentional. Attribution theory has been used effectively to address this issue (Shaver et al., 2001). In general, attribution theory is a tool used by psychologists to account for the way in which people explain their own actions and the actions of others (Heider, 1958). If the event to be explained consists in performing a task, such as starting a new business, attribution theory concentrates on the individual’s ability, the individual’s effort, the difficult of the task, and the presence of luck in the performing of the task. An individual is able to perform a task successfully if his ability exceeds the task difficult . In addition to the previous four explanatory factors, attribution theory takes into account the degree to which the individual intends to produce the event and whether the individual has enough control over the situation to make the event happen. If an individual imagines a price discrepancy, thus the opportunity for entrepreneurial arbitrage, but does not act upon it, whatever the reason, it means that the price discrepancy does not correspond to an opportunity for him. In other words, that there is not imagined change in plans that the individual really prefers to his pre-existing course of action. If the individual does not act upon a perceived opportunity, it means that there is no opportunity for him. Starting a business is clearly an intentional act requiring internal control (Shaver et al., 2001). In attribution theory, the criterion used in making the locus of causality judgment consists in asking if, under the same circumstances, all individuals would behave in the same way. If the answer is yes, the cause of action is external to the individual, and there is no need for internal control. If the answer is no, the cause of action is internal to the individual, and the latter possess internal control. In the case of new business creation, the answer is clearly no. The process necessary for the creation of a new business is multi-layered, complex, and requiring a significan amount of internal control. The more an event appears to be the product of an internal cause and under internal control, the more the individual can be held accountable for that event (Shaver et al., 2001). Of course, the choice to undertake the steps necessary to the creation of a new venture implies that such actions are most likely to be acted upon when individuals believe that they will be able to perform them successfully. Both individual factors and contextual variables enter into the individual’s judgments. Judgments may be affected by perceptions of one’s own skills and abilities, generalizations from past entrepreneurial experiences, the perceived difficult of the task, or the amount of effort required (Katzell & Thompson, 1990). Judgments may be also affected by perceptions of contextual constraints, such as the availability of capital, network contacts, and potential market demand for the product or service.

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Overall, the psychology literature and, in particular, Shaver’s attribution argument complement Harper’s claim that entrepreneurs tend to have an internal locus of control (Harper, 1998). Harper draws on Gilad (1982) to argue that an individual’s “locus of control” influence his degree of alertness. An individual with an internal locus of control tends to believe that events are “contingent upon his own behavior or his own relatively permanent characteristics” (Rotter, 1966, p. 1 as cited in Harper, 1998, p. 248). People with external locus of control tend to see their actions as less effective in producing outcomes. They see events “as under the control of powerful others, or as unpredictable because of the great complexity of the forces surrounding them” (Rotter, 1966, p. 1 as cited in Harper, 1998, p. 249). In Harper’s theory, an internal locus of control increases entrepreneurial alertness. This increased alertness leads to more learning and, therefore, to more entrepreneurship. The locus of control literature draws attention to the fact that the entrepreneurial process is a multi-layered, complex phenomenon requiring a significan amount of internal control. Within this context, an additional contribution to our understanding of new venture creation comes from sociologists who have focused on the distinction between “nascent entrepreneurs” and “entrepreneurial cycles” (Reynolds & White, 1997). A nascent entrepreneur is define as someone who initiates activities that are intended to culminate in a viable business start-up. A nascent entrepreneur is the alert individual who discovers the opportunity and acts upon it. The “entrepreneurial cycle,” instead, is a sequence of four stages. The four stages include conception, gestation, infancy and adolescence, and account for the transition from an individual with a business idea to an individual entrepreneur, to an infant firm and, finall , to an established new fir (Reynolds, 1994). Since entrepreneurship is clearly a process involving many stages of action, the entrepreneurial cycle concept allows the study of the many different decisions required of an entrepreneur. If we look at the process from a sufficientl distant and abstract perspective the particulars fall out of view. This perspective is the one Kirzner has adopted. In his theory, the stages of the discovery process fall out of view. But if we look closely, we notice separate stages occurring at different times. Kirzner’s lack of interest in the stages of the entrepreneurial discovery process does not imply that they do not exist or that his theory denies their existence. Thus, the distinction between nascent entrepreneur and the entrepreneurial cycle is important because it allows researchers to consider new firm as just one possible outcome, and indeed not the most common, of the entrepreneurial process (Aldrich & Martinez, 2001). Entrepreneurs are alert to new opportunities. When one is found, Kirzner says, the entrepreneur has discovered it. Whether the opportunity the entrepreneur acts upon was already out there, or the entrepreneur creates it,

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the opportunity must fi reality and it must conform to its external context and constraints. Understanding the sequence of actions required by the entrepreneurial process and the nature of their outcomes is, to a large extent, contingent upon the context in which they are taken.

3. THE ENTREPRENEURIAL CONTEXT Entrepreneurs do not act in a vacuum and entrepreneurial actions take place in well-define contexts. Thus, understanding the entrepreneurial process requires that we consider the context in which entrepreneurs develop their efforts. For any individual, the entrepreneurial context consists of the knowledge required by the individual and of the set of more or less binding constraints that are a function of his social and economic circumstances. Sue Birley, for example, argues that “there is no dichotomy between entrepreneurs and non-entrepreneurs; with the right stimulus, the most unexpected people can become entrepreneurs” (Wright, 2001, pp. 37–38). As a result, understanding the entrepreneurial context requires the understanding of what socio-economic variables provide incentives for individuals to become entrepreneurs, whether or not certain conditions are more conducive to entrepreneurial success than others, and, most important, what knowledge potential entrepreneurs possess of their environment. Much of the literature on entrepreneurial knowledge is consistent with the literature discussing internal control and with the methodological subjectivism and process orientation of the Austrian approach. Different people know different things. Knowledge is contextual. Thus, the knowledge that guides economic decision-making is dispersed among many independently acting agents (Yates, 2000). The knowledge of what to produce, how to produce it, and so on is scattered across many different economic actors. The Austrian knowledge problem is that of coordinating this dispersed knowledge. Entrepreneurial knowledge is just a specifi case of the Austrian knowledge problem. Hayek recognized that the division of labor produces a division of knowledge and showed how the market process solves the knowledge problem through decentralized decision-making (Hayek, 1948). If the market is a spontaneous order in Hayek’s sense, then market participants have only partial understandings of it. Because of this knowledge asymmetry, alert individuals in the market can always profi from the discovery of new opportunities within the system. This is why Hayek was led to describe the market competition as a “discovery procedure” (Hayek, 1978). Hayek’s theory of the market as a discovery procedure forms an essential part of Kirzner’s notion of entrepreneurial discovery.

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In Kirzner’s theory of entrepreneurship, discovery is not only possible in the market; it is necessary. Those who discover new techniques enjoy profits Those sticking to the old ways of doing things suffer losses. The idea of entrepreneurial discovery is important for understanding the acquisition of knowledge for entrepreneurial activities. In the case of entrepreneurship, the knowledge required is often knowledge about opportunities created by the environment or by the possibility of a new product or process. The founding of a new business often requires entrepreneurs to improvise. Because of the trial and error period characteristic of any improvisation, the entrepreneurial process is a non-institutionalized form of acquiring knowledge. “Their heuristic-based logic gives entrepreneurs a competitive advantage in quickly learning about new changes and what the implication of those changes are for the development of specifi discoveries” (Aldrich & Martinez, 2001, p. 50). Along complementary lines, Choi (1993a, b) argues that, in society, people have the possibility of acquiring knowledge from others’ practices. Trial and error processes in society generate conventions. That is, people identify mutually compatible “paradigms.” These conventions make social life possible. Their stability, however, makes innovation difficult Social and economic practices, therefore, tend to continue through time, even as experiences of different individuals might suggest to some that by adopting alternative paradigms, profi is possible. The entrepreneur discovers the neglected opportunities and tries to capture them. In the process, the prevailing practices are transformed. Choi calls the process of entrepreneurial discoveries and their eventual adoption by the rest of the society a social learning process. When studying the context of entrepreneurial decisions, in addition to issues related to knowledge, Low and MacMillan (1988) stress the importance of studying entrepreneurship in a contextual and process-oriented way. In particular, they view entrepreneurship as either the result of strategic adaptation, or as emerging from the ecology of a given population. The strategic adaptation perspective emphasizes the pro-active behavior of individuals whom, after having identifie opportunities, gather the resources necessary to exploit these opportunities and create the strategies required for their exploitation. The crucial issue in this line of research is entrepreneurial knowledge. The population ecology approach, instead, emphasizes external factors such as the sources of opportunities and the mechanisms used for selecting specifi sets of actions necessary to increase the likelihood of exploiting successfully any particular opportunity. The underlying assumption of this line of research is that the environment of entrepreneurial decisions is formed, among other things, by the characteristics of other organizations in the population. The crucial issue in this line of research is social capital.

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Social capital is important because it allows individuals to obtain resources that are otherwise unavailable to them (Aldrich, 1999; Davidsson & Honig, 2002). Transforming an idea into a new organization requires entrepreneurs to acquire a variety of resources and to allocate attention among multiple tasks (Greene & Brown, 1997). In this context, social capital is important because actions involving innovation and multiple tasks present ambiguous environments (March & Olsen, 1976). In the case of entrepreneurship, for example, the individual may lack knowledge about the subsidiary activities necessary to the working of the venture. When the business environment is not transparent, the set of necessary tasks and their characteristics is fuzzy and the entrepreneur cannot be assumed to know the true structure of his decision-making model. If an entrepreneur is willing to act on a perceived opportunity, it is because he believes to possess a comparative advantage in that specifi market. But he does not have a comparative advantage in coping with ambiguity. Thus, he focuses his attention on his specifi talent while coping with ambiguity by leveraging cues and information provided by the behavior of other entrepreneurs. Everything else being the same, the larger the number of entrepreneurs he observes, the lower the ambiguity he experiences (Minniti, 2001). By observing others, our potential entrepreneur acquires information and skills. He meets other individuals who have similar or complementary expertise. Throughout this process his social environment becomes important and the access to a certain amount of broadly define social capital helps him to defin the set of his entrepreneurial tasks. The existence of a significan number of entrepreneurs also legitimizes his activity and enables him to exploit a number of established routines. In fact, researchers have shown that when choosing in an ambiguous environment, agents tend to base their decisions on social cues (Aldrich, 1999). Aldrich and Zimmer (1986), in particular, have shown that participation in social networks is a crucial element for entrepreneurs. Saxenian (1990) has argued that much of the success of Silicon Valley is to be attributed to its availability of social capital. The role played by social capital in entrepreneurial decisions is best understood in the context of the literature on embeddedness (Jack & Anderson, 2002), and the literature on social networks (Aldrich, 1999; Aldrich & Fiol, 1994). Embeddedness define as the nature, depth, and extent of an individual’s ties into the environment, has recently been indicated as one of the relevant elements of the market process (Dacin et al., 1999; Jack & Anderson, 2002; Uzzi, 1997). Individuals are viewed as being embedded in ongoing systems of social relations (Granovetter, 1985). In the context of entrepreneurship Carsrud and Johnson (1989) argue that the exploitation of business opportunities is strongly influ enced by interdependencies that mold the patterns of social interactions among

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individuals. Embeddedness is relevant to entrepreneurship because it helps the entrepreneur to identify resources and constraints when committing to founding a new organization. Jack and Anderson (2002) argue that entrepreneurship is not merely an economic process but draws from the social context which shapes and forms entrepreneurial outcomes. According to their analysis, embedding is the mechanism whereby an entrepreneur becomes part of the local structure and learns how to draw upon and use the resources provided by available social capital. Much research about embeddedness exploits Giddens’ view of structuration as a theoretical framework to explore the link between the entrepreneur and his social context (Giddens, 1979, 1984). Applying structuration to the study of entrepreneurship enables sociologists to recognize how social structures affect and encourage entrepreneurial activity, particularly in terms of resource availability or constraint (Jack & Anderson, 2002). As a result, this approach contributes directly to our understanding of what external conditions are more conducive to entrepreneurial behavior and, possibly, entrepreneurial success. In fact, some researchers claim that embedding enables entrepreneurs to recognize and realize opportunities that fi the specifi needs of a local situation and, under certain conditions, endows entrepreneurs with a competitive advantage. Chell and Baines (2000), for example, fin that the information and resources gathered by being embedded compensated for environmental constraints and, as a result, facilitate the entrepreneurial process. In her work in development, Emily Chamlee-Wright takes an Austrian view of entrepreneurship and explains how cultural meanings influenc entrepreneurs (Chamlee-Wright, 1997). Her ethnographic approach complements and supports the embeddedness view. Among other things, Chamlee-Wright provides useful case studies illustrating the importance of trust, reputation, and personal relationships in regulating the supposedly anonymous forces of the market. Each culture and each market has its own mechanisms for producing trust. Thus, Chamlee-Wright shows that entrepreneurs are cultural figures One the one hand, entrepreneurs’ actions reflec the cultural environment in which they act. On the other hand, their actions are an important influenc on the culture in which they operate. Development theory should take account of the role of entrepreneurs as cultural figures The embedding process embraces the cultural structure of a community and consists in understanding the nature of the structure and the perpetuation of the structure while enriching its complexity (Johannisson, 1988; Weick, 1969). The networks, ties and relationships of the entrepreneur determine the level of his embeddedness in the environment. Thus, social networks provide the mechanism for becoming embedded.

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The contribution of the literature on social networks to our understanding of the entrepreneurial process lies in its illustration of how entrepreneurs embed as a mechanism to pursue and exploit opportunities. The social network approach illustrates how opportunity recognition and realization are conditioned by the dynamics of the entrepreneur and the social structure (Aldrich & Martinez, 2001). If entrepreneurship is embedded in a social context, then it must build upon society. The implicit argument is that when studying the entrepreneur, the context has to be taken into account because the social environment is more than simply the sum of its individual components (Minniti, 2001). A network of social relationships is important to an entrepreneur because it gives him access to the resources possessed by others in the community or industry. The location of the entrepreneur within the larger community is important because it affects his ability to acquire resources. Finally, the strength of the relationship with contacts is important because it determines the entrepreneur’s ability to exploit the resources provided by his community. In fact, entrepreneurial actions are conditioned by ongoing structures of social relations (Jack & Anderson, 2002). Aldrich and Zimmer (1986), for example, argue that entrepreneurship is embedded in a social context. Also, Carsrud and Johnson (1989) claim that entrepreneurial activity is encouraged or inhibited by individuals’ positions in a social network and that entrepreneurs are dependent upon the information and resources provided by social networks. In the context of social networks, population density and relational density have been shown to affect the survival of new businesses too (Baum & Mezias, 1992; Hannan & Carroll, 1992; Hannan & Freeman, 1989). Individuals trying to create new ventures in populations with high density fin more opportunities to learn effective knowledge and create extensive social networks, but they also encounter more intense competition (Baum & Oliver, 1992; Delacroix & Rao, 1994). Relational density, by increasing the legitimacy of a whole population, protects new entrepreneurs from potential constraints from other social forces (Zucker, 1989). Clearly, other contextual variables are relevant for entrepreneurship. In addition to knowledge and social capital, several economic circumstances are crucial to entrepreneurial behavior. Variables relating to external conditions such as the availability of financing labor markets, and quality of existing infrastructure, in other words, issues related to the economy, have all been shown to be important. Most of the work in those areas has been conducted by economists who study these topics in finance labor economics and industrial organization. Although an extended review of this literature is beyond the scope of this survey, it is worth listing some of the contributions that, in various fields deal directly with entrepreneurs and entrepreneurship as discussed in the two previous sections

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of this paper. Among others, Evans and Jovanovic (1989), Evans and Leighton (1989), and Kihlstrom and Laffont (1979) discuss the importance of financia resources and constraints on entrepreneurial decisions. Gifford (1998) and Murphy et al. (1991) discuss the optimal allocation of human resources. Gromb and Scharfstein (2002) and Hamilton (2000) discuss the interdependence between entrepreneurial decisions and conditions in the labor market. Leazar (2002) argues that entrepreneurs are jacks-of-all-trades who may not excel at any one skill but are competent in many, and links entrepreneurial decisions to the previous work experiences of the entrepreneur. Gompers and Lerner (2001), Kortum and Lerner (2001), and Lerner and Gompers (2001) discuss entrepreneurship and venture capital. Finally Gompers and Lerner (forthcoming) discuss initial private offerings. In line with neoclassical methodology, most of these studies use representative agent models and focus on issues of scarcity and allocational efficien y rather than on the behavioral attributes of the individual.

4. ENTREPRENEURIAL FIRMS AND STRATEGIC DECISIONS The discussion of the discovery and exploitation of opportunities expands often from individuals’ actions to the actions of firm and organizations. Gartner (1985, 1990) argues that entrepreneurship is about “organizing” and that the entrepreneurial process is more likely to be understood through the study of firms behavior. Thus, research on the characteristics, context and actions of the individual entrepreneur leads to research into the nature, antecedents and effects of firm-l vel entrepreneurial activities. The identificatio of entrepreneurial behavior at the fir level is a difficul task though some consensus exists around the idea that entrepreneurship is a resource for the fir and, when properly exploited, contributes to the firm s profitabilit and competitive position. In recent years, the literature in industrial organization, strategy, and organization theory has moved from discussing how to re-engineer firm to how to “re-invent” them, a process in which firm are continuously refocused as they search for new opportunities (Oster, 1999). In this area, entrepreneurship becomes a strategic capability of the fir and the integration between entrepreneurship, industrial organization and strategy occurs naturally (McGrath & MacMillan, 2000). Along similar lines, Barney (2002) define the fiel of strategy as the study of firms theories about how to gain competitive advantages. Indeed, one way for firm to earn economic profit is to see and seize new lucrative opportunities before entry has accomplished its profi leveling function in the industry. Firms exhibiting this ability are entrepreneurial firms In

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particular, entrepreneurial firm may be described as those exhibiting openness to new ideas, the willingness to commit resources to the exploitation of these ideas, and the ability to match opportunities to their core competencies (Oster, 1999). The bulk of this research belongs in the realm of organization theory and of the theory of the firm Although strong links exist, a review of works in these areas is beyond the scope of a survey on entrepreneurship studies. An exception, however, must be made for recent studies on corporate entrepreneurship. Research on corporate entrepreneurship tries to identify organizational and environmental factors that affect a company’s entrepreneurial activities (Peterson & Berger, 1972; Zahra, 1991). Earlier researchers in this area give special attention to the process by which established firm venture into new business field and discuss the factors that influenc the success of corporate ventures (Burgelman, 1983a, b, c). More recently, however, researchers have begun examining the linkages between environmental, strategic, and organizational variables, and a company’s entrepreneurial activities (Miller, 1983). Stopford and Baden-Fuller (1994) summarize how the strategy literature identifie three types of corporate entrepreneurship. The firs type is the creation of new ventures within an existing organization. The second type is the broader activity associated with transforming the structure of an existing firm The third type is found when a fir is able to change the competitive environment of its industry, for example, by introducing a significan innovation in product or process. Finally, additional works distinguish between entrepreneurial disposition (Covin & Slevin, 1988; Miller, 1983), orientation (Lumpkin & Dess, 1996) and actions (Zahra, 1995) in the context of corporate competitive behavior. Clearly, it is not easy for a fir to behave “entrepreneurially.” Organizations, especially large ones, tend to be characterized by significan inertia. It is a human tendency to shape expectations about the future on the basis of the past and, as a result, to create incentives that promote an entrepreneurial attitude at the level of organization is difficult To behave entrepreneurially, in addition to a f exible organizational structure, firm need a variety of tangible and intangible assets. Stevenson and Jarillo (1990), for example, focus on the principal-agent issues related to the fact that, for a fir to behave entrepreneurially, management is dependent on other individuals and groups within the fir and discuss to the importance of fir culture. Guth and Ginsberg (1990) develop a more specifi argument and claim that firm-l vel entrepreneurship embodies the two key components of innovation and new venture creation. Among other things, firm need the ability to match perceived opportunities with their core competencies and the willingness and ability to commit resources to the exploitation of those opportunities. On the latter point, the literature in strategy and organization theory has become increasingly aware of the importance of heterogeneous fir assets in achieving a

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firm s sustainable competitive advantage. In particular, the role of entrepreneurship as one of the heterogeneous assets available to the fir has been addressed in the context of the resource-based and transaction costs views of the fir (Alvarez, 2003). Barney (1986) and Dierickx and Cool (1989) were the firs to draw attention to the importance of tacit, socially complex, assets, and to argue that the behavior of the entrepreneurial fir is best understood using the resource-based and the transactions cost views of the fir (Alvarez, 2003). The resource-based approach to fir behavior suggests that the returns earned by firm are largely attributable to the resources they held. Specificall , the resource-based view implies that fir resources, capabilities, and competencies facilitate the development of sustainable competitive advantages (Barney, 1986, 1991; Hitt & Ireland, 1985; Rumelt, 1991). The intuition is that strategic behavior is contingent and dependent upon the specifi resources available to a fir and that competitive advantages are achieved when firm are successful in leveraging the resources. Winter has argued that an organization’s knowledge, for example, is a profitabl strategic asset if meets three criteria: (1) the knowledge is tacit rather than articulate; (2) the knowledge is not observable in use; and (3) the knowledge is complex rather than simple (Winter, 1987). But if it is true that a firm s competitive position is define by its unique resources and their continuous adjustment over time in response to competitive pressures, then entrepreneurship and resource heterogeneity become complementary (Alvarez, 2003). Kirzner (1997) too argues that heterogeneous resources are a necessary condition for entrepreneurial behavior to exist. In addition, entrepreneurial opportunities exist if, and only if, individuals perceive resources as having different values, and if individuals with high perceived values are willing and capable of mobilizing the unexploited potential (Casson, 1982; Kirzner, 1979). While the resource-based view of the fir focuses on the role played by heterogeneous resources on entrepreneurial behavior, the transaction costs approach to the fir provides a way to analyze the relationship between entrepreneurial behavior and fir profitabilit . Both Kirzner (1979) and Schumpeter (1934) describe the entrepreneur as an individual capable of improving upon the current allocation of resources by directing inputs into certain processes rather than others. In this context, the role of the entrepreneur is to use his knowledge to redistribute undervalued resources thereby improving allocative and productive efficien y. The transactions cost approach addresses the production and organizational activities of the fir as unique coordination activities in which entrepreneurial actions result in superior fir performance and a potential source of competitive advantage. Coase (1937) suggests that as a firm s size increases, the costs of organizing additional internal transactions rise and, as a result, the returns to entrepreneurial

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behavior decrease. Thus, Coase (1937) attributes to the entrepreneur the role of coordinator of production within the firm The need for coordination arises from the fact that the internal allocation of resources is not subject to the discipline imposed by the market. The transaction cost view illustrates how, as the size of the fir increases, the critical role played by the entrepreneur is lost because the knowledge the entrepreneur possesses about the resource structure within the fir is diluted. Williamson (1975, 1985) develops this point further and argues that a primary role of the fir is to economize on transaction costs and that, as a result, innovation is more likely to occur in smaller than larger firm though larger firm are more effective at manufacturing and distributing innovations (Oster, 1999). Unfortunately, no general agreement exists on what makes a fir entrepreneurial. Even more, no general agreement exists on the role played by entrepreneurship on fir profitabilit . Jennings and Seaman (1994), for example, argue that there may be no performance differences between entrepreneurial and conservative firms Although it is easy to see that first-m ver firm that incur the greatest risk and expenditure on innovative activities are often rewarded in the marketplace, it is also true that firm may enjoy greater long-term benefit from imitation strategies than from high levels of innovation (Nelson & Winter, 1982). As the discussion about entrepreneurship progresses and moves from the individual to the fir level, the question of the potential aggregate effects of entrepreneurial behavior arises. Is more entrepreneurship desirable? Is there a relationship between entrepreneurial behavior and economic growth? Recent empirical studies have shown that economic activity in the 1980s shifted from large firm to small firm (Acs & Audretsch, 1993; Carlsson, 1992) and that the amount of entrepreneurial activity differs significantl across countries and across different regions of the same country (Reynolds et al., 2001).

5. ENTREPRENEURSHIP AND MACROECONOMIC ACTIVITY Since Schumpeter’s 1934 classic work, the study of possible linkages between entrepreneurship and economic growth has remained the domain of economists. The topic, however, has been largely ignored for a long time as neo-classical growth theory concentrated mainly on the contribution of labor and capital to the growth process (Denison, 1985; Solow, 1970). Since it did not fi in standard neo-classical systems, theorists working with analytical models neglected entrepreneurship and simply treated it as part of the residuals that cannot be attributed to any measurable productive input (Baumol, 1983, 1993a). Only recently, new growth theory has

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provided ways to endogenize the long-run rate of economic growth and, as a result, entrepreneurship has been considered explicitly as a form of human capital accumulation usually linked to the long run size of the fir (Bates, 1990; Iyigun & Owen, 1998; Otani, 1996; Schmitz, 1989) or as the engine for innovation and productivity increases (Aghion & Howitt, 1992; Calvo & Wellisz, 1980). Baumol (1983, 1990, 1993b) provides a comprehensive approach to the study of entrepreneurship and its relationship to economic growth. Baumol’s theory unites entrepreneurs in their common motivation, but segregates them based on their contribution to society. In particular, Baumol (1990) classifie entrepreneurs into the three distinct groups of productive, unproductive and destructive. When linking entrepreneurship to economic growth, Baumol relies on productive entrepreneurs and identifie the two main contributions of entrepreneurship to economic activity as the productions of new entry and of innovation. Also, Baumol (1993a) convincingly argues that, as a result of entry and innovativeness, the channel through which entrepreneurship influence growth is productivity. He identifie entrepreneurship, investment in innovation, and technology transfers, together with contextual variables such as capital investment and education, as the endogenous variables in an iterative process in which the firs group of variables affect productivity, which, in turn, influence the contextual variables after some lag. In the wake of the new growth theory literature, a few complementary models have been proposed for the study of entrepreneurship and its impact on macroeconomic variables. Iyigun and Owen (1998) propose variations of endogenous growth models in which entrepreneurship appears as a special form of human capital. Aghion and Howitt (1992), instead, build directly on Romer’s (1990) classic model of endogenous growth and focus on the role played by the R&D sector in providing new production techniques. In their view, a producer adopting an innovation is rewarded with economic profit until a new technique is found which replaces his innovation. The intermediate variable of innovativeness, because of its ability to produce change, is shown to be an engine of growth. To some extent, Aghion and Howitt capture the substance of Schumpeter’s idea of creative destruction. In other words, the fact that economic change results from the actions of profit-seekin entrepreneurs, whose quest for monopoly rents produces innovation, new products, and, indirectly, economic growth (Wennekers & Thurik, 1999). Since Aghion and Howitt, much of this literature has come to identify entrepreneurship with the engine behind innovation. Lumpkin and Dess (1996) argue that a key dimension of an entrepreneurial orientation is an emphasis on innovation. Wennekers and Thurik (1999) claim that the ability to produce innovation is the main contribution of entrepreneurship to macroeconomic

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dynamics. Finally, Acs (1992) identifie the entrepreneurial sector with small firm and argues that the latter play an important role in the economy because of their ability and propensity to innovate, their contribution to employment, and their ability to stimulate industry evolution. Unlike previous neoclassical models, the endogenous growth literature allows the study of entrepreneurial behavior because of its ability to move beyond representative agent models and to include issues related to increasing returns, spillovers and multiple equilibria. The introduction of increasing returns and spillovers allows the construction of formal models that can account for entrepreneurial learning and for the role of social capital on entrepreneurial decisions. The possibility of multiple equilibria, instead, allows the construction of formal models in which entrepreneurial behavior and the resulting level of entrepreneurial activity emerge as the unintended and unpredictable consequences of the norms and history of a community. Combined, these features allow economics models to incorporate insights from sociology and evolutionary psychology into the study of entrepreneurship. In fact, increasing returns and multiple equilibria have both been used to study the relationship between entrepreneurship and economic growth in alternative approaches that complement the neoclassical view. Minniti (1999, 2001, forthcoming) links complexity theory to the study of entrepreneurship. Her work provides a model of the relationship between entrepreneurial behavior and aggregate entrepreneurial activity in which increasing returns to local knowledge and social capital spillovers create non-pecuniary externalities that reduce ambiguity and encourage entrepreneurship. These dimensions are consistent with Hayek’s notion of spontaneous order in the sense that, as in many complex phenomena, the aggregate outcome “cannot be reduced to the regularities of the parts” (Hayek, 1967, p. 74). In particular, Minniti (forthcoming) shows that, when information is evenly distributed, the number of entrepreneurs remains low even when agents are highly alert, whereas, when information is asymmetrically distributed, entrepreneurship increases and concentrates geographically. Her results are consistent with observed clustering of entrepreneurial activity in otherwise similar regions. Minniti (2001) also shows that if the entrepreneur is a catalyst of further economic activity then entrepreneurship breeds entrepreneurship, the aggregate level of entrepreneurial activity within an economy is uncertain, and that the level of entrepreneurship is determined through a path dependent process. Along similar lines, Holcombe (1998, 2003) argues that every time an entrepreneur seizes a new opportunity, the possibility for new markets is created. When an entrepreneur fill a niche in his market, resources are mobilized, the possibility of complementary products or services is created and, as a result, new entrepreneurial opportunities exist. Thus, the entrepreneur is an equilibrator

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within his market and, simultaneously, a catalyst of activity for the economy as a whole. An additional framework helpful when analyzing the relationship between entrepreneurship and the macroeconomy is the evolutionary approach developed by Nelson and Winter. Nelson and Winter (1982) argue that technical change is the driving force of long-run growth and that, in order to understand their interdependence, it is necessary to consider the variety of behavior and performance of individual firms as well as the dynamics of the competitive process. Although they do not consider entrepreneurship explicitly, Nelson and Winter’s argument relies on Schumpeter’s (1934) view of economic development and Simon’s (1991) explanations of human and organizational behavior. Instead of the standard neo-classical concept of equilibrium and optimization, they take an evolutionary approach and use the concepts of tendencies and decision rules. Nelson and Winter borrow from biology and view firm as possessing a genetic endowment of technical routines and procedures that, over time, evolve and adapt. In the end, the competitive process at the sector level selects the most successful routines and weeds out the routines, which are no longer suitable. So innovation and selection are the engines of growth. The process of allocating resources and their distribution through the entry and exit of firm constitutes the mechanism of competitive selection among different business ideas and projects. The evolutionary approach of Nelson and Winter is complementary to Audretsch and Thurik’s (1997) argument that economic growth results from the straggle of the managed and the entrepreneurial sectors. Audretsch and Thurik (1997) is just an example of a small but significan body of recent literature addressing explicitly the relationship between the small business sector and economic growth (Acs & Audretsch, 1993; Acs et al., 1999; Carree et al., 2000; Thurik, 1996; Wennekers & Thurik, 1999). Like Acs (1992), these works identify entrepreneurship with the small business sector and study industry dynamics and the contribution to GDP growth of various groups of firm classifie by size. These works take an economic approach and contribute significantl to our understanding of the dynamic of business ownership and its impact on development, of the relationship between employment, self-employment and development, and of firm-siz distribution and economic growth. Finally, when discussing the relationship, if any, between entrepreneurship and macroeconomic activity, it is important to consider the role paid by government regulation and public policy. In addition to the cultural norms discussed in Section 3, governments and political activity in general also influenc the context within which individuals make entrepreneurial decisions. Government actions and political events create new institutional structures for entrepreneurial action, encouraging some activities and discouraging others (Dobbin & Dowd, 1997).

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Public policy shapes the rules of competition and creates niches where investment and entrepreneurial activities may be perceived as being more or less attractive. Harper (1998) argues explicitly that the nature of our political and economic institutions influence alertness. Those institutions and policies that improve transparency and entitlement tend to increase the subjective perception of the link between actions and outcome. They increase, therefore, the number of individuals who have an internal locus of control. Harper’s central argument is that “an environment of freedom is more likely than other environments to generate internal locus of control beliefs and acute entrepreneurial alertness” (1998, p. 253). Government regulation also affects the fate of individual organizations and entire industries as well, for example, by disrupting established ties between organizations and resources (Carroll, Delacroix & Goodstein, 1988; Stinchcombe, 1965). Finally, Baumol (1990) argues that institutional arrangements affect the quantity and type of entrepreneurial efforts and that “. . . the exercise of entrepreneurship can sometimes be unproductive or even destructive, and that whether it takes one of these directions or one that is more benign depends heavily on the structure of payoffs in the economy – the rules of the game” (Baumol, 1990, pp. 898–899). In general, the legal and institutional framework is crucial in determining the quantity and quality of entrepreneurial behavior. Legal incentives for entrepreneurship are mainly rooted in the fisca regime and in the laws concerning bankruptcy, they also influenc individuals’ perceptions of legal transparency and entitlement. Competition rules, instead, address the regulation of entry, trade barriers and anti-trust policy. Overall, the institutional framework define the incentives for individuals to transform perceived opportunities into actions, and contribute significantl to determine to what extent the external environment is supportive of and conducive to entrepreneurial behavior.

6. CONCLUSION Using Kirzner’s theory as the starting point and unifying theme, this paper provides a survey of the literature on entrepreneurship in various disciplines. Who is the entrepreneur? According to Kirzner, the entrepreneur is an alert individual. Entrepreneurship is a change in the ends-means framework of this individual. Such change happens because the potential entrepreneur is “alert” to new possibilities for action. Kirzner argues that the differences between alert and non-alert individuals lay in the alternative evaluations they make about their circumstances. Similarly, cognitive psychology suggests the existence of schema. That is, evolving mental models of entrepreneurial alertness. Alert individuals

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have more complex schema about change than non-alert individuals. The phenomenological psychology view is consistent with this interpretation and adds systems of typificatio and relevancy. Any act of entrepreneurship has its meaning for the entrepreneur within his system of relevancy. Systems of typificatio and schema differ across individuals and, in some cases, prompt alertness. Why do systems of typificatio and entrepreneurial schema vary across individuals? This question is addressed, in both the psychology and economics literature, by looking at intentionality and locus of control. Individuals with an internal locus of control believe that events are contingent upon their own behavior. Thus, an internal locus of control increases entrepreneurial alertness and, as a result, leads to more entrepreneurship. The locus of control literature draws attention to the fact that the entrepreneurial process is a multi-layered and complex phenomenon. What does the entrepreneur do? The entrepreneur innovates and, by doing so, creates new ventures of some sort. The sociology literature addresses this issue by distinguishing between nascent entrepreneurs and entrepreneurial cycles. The entrepreneurial cycle is the sequence of stages necessary for the transition from an individual with an opportunity to an established new firm The establishment of a new venture requires the choice and the commitment to a specifi set of actions. What determines the specifi sequence of entrepreneurial actions selected by the entrepreneur? The actions required by the entrepreneurial cycle are contingent upon the context in which they are taken. Understanding the entrepreneurial context requires the understanding of what socio-economic variables provide incentives for individuals to become entrepreneurs, and, most important, what knowledge entrepreneurs possess of their environment. The Austrian literature suggests that the knowledge problem is that of coordinating dispersed knowledge. Entrepreneurial knowledge is just a specifi case of the Austrian knowledge problem. To complement the Austrian view, the strategic adaptation literature emphasizes the pro-active behavior of individuals whom, after having identifie opportunities, gather the resources necessary to exploit these opportunities. The population ecology approach, instead, emphasizes external factors such as the sources of opportunities and the availability of social capital. Is social capital relevant to entrepreneurial decisions? The sociology literature stresses that social capital is important because it allows individuals to obtain resources that are otherwise unavailable to them. The role played by social capital in entrepreneurial decisions is best understood in the context of embeddedness and social networks. Embeddedness is relevant to entrepreneurship because it helps the entrepreneur to identify resources and constraints when committing to founding a new organization. Social networks, instead, improve the entreprenur’s ability to pursue and exploit commercial opportunities.

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But what happens after the initial stages of the entrepreneurial process have taken place? Does entrepreneurship cease to exist or does it become irrelevant? The study of the entrepreneurial context leads organically to research into firm-l vel entrepreneurial activities. In this context, the literature on strategy and corporate entrepreneurship identifie organizational and environmental factors that affect a firm s entrepreneurial behavior. For example, the resource-based approach views entrepreneurship as one of the possible resources upon which the competitive advantage of the fir is built. The transaction costs approach, instead, analyzes the relationship between entrepreneurial behavior and fir profitabilit and identifie entrepreneurial actions as the source of coordination activities that result in superior performance. As the discussion about entrepreneurship progresses and moves from the individual to the fir level, the question of the aggregate effects of entrepreneurial behavior arises. Is more entrepreneurship desirable? Is there a relationship between entrepreneurial behavior and economic growth? Recent empirical studies show that the amount of entrepreneurial activity differs significantl across countries and across different regions of the same country with potentially significan effects on business activity and development. The neo-classical economics approach argues that, as a result of entry and innovativeness, the channel through which entrepreneurship influence growth is productivity. Complementary models exploit the insight of complexity and evolutionary theory to add social and cultural circumstances to the allocational and distributional issues raised by endogenous growth studies. Finally, is there a connection between entrepreneurship, governments, and institutions? Government actions and political events certainly create institutional structures that may encourage or thwart entrepreneurial action. Those institutions and policies that improve transparency and entitlement tend to increase the subjective perception of the link between actions and outcome. This is so because they ultimately increase the number of individuals who have an internal locus of control. Overall, and in spite of so many different approaches, there seems to be a movement towards agreeing that entrepreneurship is about emergence. Low and MacMillan (1988) suggest that research on entrepreneurship should focus on new fir creation and its role in promoting economic progress. Shane and Venkataraman (2000), on the other hand, suggest that the fiel of entrepreneurship should study the discovery and exploitation of entrepreneurial opportunities, the individuals involved, and the modes of action used to exploit the opportunities. Both views focus on the creation of new economic activity. In contrast, Gartner (1985, 1990, 2001) takes the position that entrepreneurship is about organizing and that it has a greater likelihood of being understood through the study

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of fir creation. Importantly, both Low and MacMillan (1988) and Shane and Venkataraman (2000) also include in the stated purpose of entrepreneurship a clear interest in societal-level outcomes. Aldrich and Martinez (2001), while applying a view similar to Gartner’s on entrepreneurship as “the creation of new organizations,” start from the more aggregate-level interest of sociology and hence fin it natural for entrepreneurship to consider societal-level outcomes. The review of topic and approaches presented in this paper shows clearly that entrepreneurship is a multi-faceted phenomenon. Further research is needed in all areas to understand the motivations and logic behind entrepreneurial behavior and its impact on individuals, firms and macroeconomic activity. If we take entrepreneurship seriously, we recognize its complexity. The rules and practices of the entrepreneurial processes are complex. They are embedded in the socioeconomic environment of the entrepreneur and include past experiences, culture and institutions, and random accidents. Hopefully, we are on our way to studying better entrepreneurial behavior and to fin new ways to understand the complex.

ACKNOWLEDGMENTS Financial support from the W. F. Glavin Center for Global Management is gratefully acknowledged. Many thanks go to Roger Koppl and an anonymous referee for helpful comments and suggestions. All errors are mine.

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ENTREPRENEURSHIP, INDUSTRY EVOLUTION AND ECONOMIC GROWTH David B. Audretsch and A. Roy Thurik ABSTRACT The purpose of this paper is to provide a link between entrepreneurial activity on the one hand, and industry evolution and economic growth on the other. The role that entrepreneurship plays in innovative activity is explained. The link between entrepreneurship and industry evolution through the spillover of knowledge in generating entrepreneurial activity is analyzed. This implies that the relationship between entrepreneurship and growth is identified. In particular, this paper finds that entrepreneurship generates a positive pulse in the evolution of industries in such a way that fosters economic growth.

1. INTRODUCTION Explanations for economic growth have generally been restricted to the realm of macroeconomics (Krugman, 1991; Romer, 1990). However, a different scholarly tradition linking growth to industrial organization dates back at least to Schumpeter (1934). In his 1911 classic treatise, Theorie der wirtschaftlichen Entwicklung, Schumpeter proposed a theory of creative destruction, where new firm with entrepreneurial spirit displace the tired old incumbents, ultimately leading to a higher degree of economic growth. Even in his 1942 classic, Capitalism, Socialism Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 39–56 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06003-4

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and Democracy, Schumpeter (1942, p. 13) still argued that entrenched large corporations tend to resist change, forcing entrepreneurs to start new firm in order to pursue innovative activity, “The function of entrepreneurs is to reform or revolutionize the pattern of production by exploring an invention, or more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way . . . To undertake such new things is difficul and constitutes a distinct economic function, firs because they lie outside of the routine tasks which everybody understands, and secondly, because the environment resists in many ways.” The purpose of this paper is to provide a link between entrepreneurial activity on the one hand, and industry evolution and economic growth on the other. In Section 2 of this paper, the role that entrepreneurship plays in innovative activity is explained. The link between entrepreneurship and industry evolution is the focus of Section 3. In Section 4, the spillover of knowledge in generating entrepreneurial activity is analyzed. In Section 5, the relationship between entrepreneurship and growth is identified Finally, in Section 6 conclusions are presented. In particular, this paper find that entrepreneurship generates a positive pulse in the evolution of industries in such a way that fosters economic growth.

2. INNOVATION AND ENTREPRENEURSHIP The increased importance of knowledge as a source of competitiveness for OECD countries suggests that the organization of industries most conducive to innovative activity will be linked to higher growth rates (Audretsch & Thurik, 2000, 2001). The starting point for most theories of innovation is the firm In such theories the firm are exogenous and their performance in generating technological change is endogenous. For example, in the most prevalent model found in the literature of technological change, the model of the knowledge production function, formalized by Griliches (1979), firm exist exogenously and then engage in the pursuit of new economic knowledge as an input into the process of generating innovative activity. The most decisive input in the knowledge production function is new economic knowledge. And as Cohen and Klepper (1991, 1992) conclude, the greatest source generating new economic knowledge is generally considered to be R&D. Certainly a large body of empirical work has found a strong and positive relationship between knowledge inputs, such as R&D, on the one hand, and innovative outputs on the other hand. The knowledge production function has been found to hold most strongly at broader levels of aggregation. The most innovative countries are those with the

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greatest investments to R&D. Little innovative output is associated with less developed countries, which are characterized by a paucity of production of new economic knowledge. Similarly, the most innovative industries, also tend to be characterized by considerable investments in R&D and new economic knowledge. Not only are industries such as computers, pharmaceuticals and instruments high in R&D inputs that generate new economic knowledge, but also in terms of innovative outputs (Audretsch, 1995). By contrast, industries with little R&D, such as wood products, textiles and paper, also tend to produce only a negligible amount of innovative output. Thus, the knowledge production model linking knowledge generating inputs to outputs certainly holds at the more aggregated levels of economic activity. Where the relationship becomes less compelling is at the disaggregated microeconomic level of the enterprise, establishment, or even line of business. For example, while Acs and Audretsch (1990) found that the simple correlation between R&D inputs and innovative output was 0.84 for four-digit standard industrial classificatio (SIC) manufacturing industries in the United States, it was only about half, 0.40 among the largest U.S. corporations. The model of the knowledge production function becomes even less compelling in view of the recent wave of studies revealing that small enterprises serve as the engine of innovative activity in certain industries. These results are startling, because as Scherer (1991) observes, the bulk of industrial R&D is undertaken in the largest corporations; small enterprises account only for a minor share of R&D inputs. Thus the knowledge production function seemingly implies that, as the Schumpeterian Hypothesis predicts, innovative activity favors those organizations with access to knowledge-producing inputs – the large incumbent organization. The more recent evidence identifying the strong innovative activity raises the question, “Where do new and small firm get the innovation producing inputs, that is the knowledge?” One answer, proposed by Audretsch (1995), is that, although the model of the knowledge production function may still be valid, the implicitly assumed unit of observation – at the level of the fir – may be less valid. The reason why the knowledge production function holds more closely for more aggregated degrees of observation may be that investment in R&D and other sources of new knowledge spills over for economic exploitation by third-party firms This spillover can occur in various ways: social interaction, change of employer and, the main focus of this paper, the exploitation of that knowledge in a new organization. Stinchcombe (1965) distinguishes fi e conditions under which people will be motivated to form an organization. First of all, they know a better way of doing things that are not easily done within the existing organization. Second, they believe that the new organization will be profitabl enough to pay

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for the trouble of building it. Third, they will receive some of the benefits Fourth, they can lay hold of the resources and, finall , they can defeat, or at least avoid being defeated by their opponents. Concerning the second condition, a large literature has emerged focusing on what has become known as the appropriability problem. The underlying issue revolves around how firm that invest in the creation of new economic knowledge can best appropriate the economic returns from that knowledge (Arrow, 1962). Audretsch (1995) proposes shifting the unit of observation away from exogenously assumed firm to individuals – agents with endowments of new economic knowledge. But when the lens is shifted away from focusing upon the fir as the relevant unit of observation to individuals, the relevant question becomes, How can economic agents with a given endowment of new knowledge best appropriate the returns from that knowledge? The appropriability problem confronting the individual may converge with that confronting the firm Economic agents can and do work for firms and even if they do not, they can potentially be employed by an incumbent firm In fact, in a model of perfect information with no agency costs, any positive economies of scale or scope will ensure that the appropriability problems of the fir and individual converge. If an agent has an idea for doing something different than is currently being practiced by the incumbent enterprises – both in terms of a new product or process and in terms of organization – the idea, which can be termed as an innovation, will be presented to the incumbent enterprise. Because of the assumption of perfect knowledge, both the fir and the agent would agree upon the expected value of the innovation. But to the degree that any economies of scale or scope exist, the expected value of implementing the innovation within the incumbent enterprise will exceed that of taking the innovation outside of the incumbent fir to start a new enterprise. Thus, the incumbent fir and the inventor of the idea would be expected to reach a bargain splitting the value added to the fir contributed by the innovation. The payment to the inventor – either in terms of a higher wage or some other means of remuneration – would be bounded between the expected value of the innovation if it implemented by the incumbent enterprise on the upper end, and by the return that the agent could expect to earn if he used it to launch a new enterprise on the lower end. Thus, each economic agent would choose how to best appropriate the value of his endowment of economic knowledge by comparing the wage he would earn if he remains employed by an incumbent enterprise, w, to the expected net present discounted value of the profit accruing from starting a new firm ␲. If these two values are relatively close, the probability that he would choose to appropriate the value of his knowledge through an external mechanism such as starting a new firm Pr(e), would be relatively low. On the other hand, as the gap between w and ␲ becomes larger, the likelihood of an agent choosing to appropriate

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the value of his knowledge externally through starting a new enterprise becomes greater, or Pr(e) = f (␲ − w)

(1)

This model refocuses the unit of observation away from firm deciding whether to increase their output from a level of zero to some positive amount in a new industry, to individual agents in possession of new knowledge that, due to uncertainty, may or may not have some positive economic value. Once one drops the assumption of perfect information, both fir and economic agent are confronted with uncertainty. It is this uncertainty inherent in new economic knowledge, combined with asymmetries between the agent possessing that knowledge and the decision making vertical hierarchy of the incumbent organization with respect to its expected value, that potentially leads to a gap between the valuation of that knowledge. How the economic agent chooses to appropriate the value of his knowledge, that is either within an incumbent fir or by starting or joining a new enterprise will be shaped by the knowledge conditions underlying the industry. Under what Nelson and Winter (1982) term as the routinized technological regime the knowledge conditions will be favorable to innovation by established firms Secrecy, patent protection or difficultie to imitate will tend the agent to appropriate the value of his new ideas within the boundaries of incumbent firms Thus, the propensity for new firm to be started should be relatively low in industries characterized by the routinized technological regime. By contrast, under the entrepreneurial regime the agent will tend to appropriate the value of his new ideas outside of the boundaries of incumbent firm by starting a new enterprise. Thus, the propensity for new firm to enter should be relatively high in industries characterized by the entrepreneurial regime. Audretsch (1995) suggests that divergences in the expected value regarding new knowledge will, under certain conditions, lead an agent to exercise what Albert O. Hirschman (1970) has termed as exit rather than voice, and depart from an incumbent enterprise to launch a new firm But who is right, the departing agents or those agents remaining in the organizational decision making hierarchy who, by assigning the new idea a relatively low value, have effectively driven the agent with the potential innovation away? Ex post the answer may not be too difficult But given the uncertainty inherent in new knowledge, the answer is anything but trivial a priori. Thus, when a new fir is launched, its prospects are shrouded in uncertainty. If the new fir is built around a new idea, i.e. potential innovation, it is uncertain whether there is sufficien demand for the new idea or if some competitor will have the same or even a superior idea. Even if the new fir is formed to be an exact replica of a successful incumbent enterprise, it is uncertain whether sufficien

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demand for a new clone, or even for the existing incumbent, will prevail in the future. Tastes can change, and new ideas emerging from other firm will certainty influenc those tastes. Finally, an additional layer of uncertainty pervades a new enterprise. Stinchcombe (1965) named four conditions that make up his “liability of newness”; social conditions that affect the survival rate of new organizations. These conditions are: the ease of obtaining skills; the degree of initiative and responsibility within the workforce; the trustworthiness of strangers; and finall , the strength of the ties between customers and established firms In our modern society, with extensive law and emancipated customers, the third and fourth condition are such that they usually do not affect the survival rate in a negative way. But the firs two conditions still remain. It is not known how competent the new fir really is, in terms of management, organization, and workforce. At least incumbent enterprises know something about their underlying competencies from past experience. Which is to say that a new enterprise is burdened with uncertainty as to whether it can produce and market the intended product as well as sell it. In both cases the degree of uncertainty will typically exceed that confronting incumbent enterprises.

3. INDUSTRY EVOLUTION This initial condition of not just uncertainty, but greater degree of uncertainty vis-`a-vis incumbent enterprises in the industry is captured in the theory of fir selection and industry evolution proposed by Boyan Jovanovic (1982). Jovanovic presents a model in which the new firms which he terms entrepreneurs, face costs that are not only random but also differ across firms A central feature of the model is that a new fir does not know what its cost function is, that is its relative efficien y, but rather discovers this through the process of learning from its actual post-entry performance. In particular, Jovanovic (1982) assumes that entrepreneurs are unsure about their ability to manage a new-fir startup and therefore their prospects for success. Although entrepreneurs may launch a new fir based on a vague sense of expected post-entry performance, they only discover their true ability – in terms of managerial competence and of having based the fir on an idea that is viable on the market – once their business is established. Those entrepreneurs who discover that their ability exceeds their expectations expand the scale of their business, whereas those discovering that their post-entry performance is less than commensurate with their expectations will contact the scale of output and possibly exit from the industry. Thus, Jovanovic’s model is a theory of noisy selection, where efficien firm grow and survive and inefficien firm decline and fail.

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The theory of fir selection is particularly appealing in view of the rather startling size of most new firms For example, the mean size of more than 11,000 new-fir startups in the manufacturing sector in the United States was found to be fewer than eight workers per fir (Audretsch, 1995). While the minimum efficien scale (MES) varies substantially across industries, and even to some degree across various product classes within any given industry, the observed size of most new firm is sufficientl small to ensure that the bulk of new firm will be operating at a suboptimal scale of output. Why would an entrepreneur start a new fir that would immediately be confronted by scale disadvantages? An implication of the theory of fir selection is that new firm may begin at a small, even suboptimal, scale of output, and then if merited by subsequent performance expand. Those new firm that are successful will grow, whereas those that are not successful will remain small and may ultimately be forced to exit from the industry if they are operating at a suboptimal scale of output. See Audretsch, van Leeuwen, Menkveld and Thurik (2001). An important implication of the dynamic process of fir selection and industry evolution is that new firm are more likely to be operating at a suboptimal scale of output if the underlying technological conditions are such that there is a greater chance of making an innovation, that is under the entrepreneurial regime. If new firm successfully learn and adapt, or are just plain lucky, they grow into viably sized enterprises. If not, they stagnate and may ultimately exit from the industry. This suggests, that entry and the startup of new firm may not be greatly deterred in the presence of scale economies. As long as entrepreneurs perceive that there is some prospect for growth and ultimately survival, such entry will occur. Thus, in industries where the MES is high, it follows from the observed general small size of new-fir startups that the growth rate of the surviving firm would presumably be relatively high. At the same time, those new firm not able to grow and attain the MES level of output would presumably be forced to exit from the industry, resulting in a relatively low likelihood of survival. In industries characterized by a low MES, neither the need for growth, nor the consequences of its absence are as severe, so that relatively lower growth rates but higher survival rates would be expected. Similarly, in industries where the probability of innovating is greater, more entrepreneurs may actually take a chance that they will succeed by growing into a viably sized enterprise. In such industries, one would expect that the growth of successful enterprises would be greater, but that the likelihood of survival would be correspondingly lower. How are the new firms many of which operate at a suboptimal scale of output, able to exist? The answer according to the studies on post-entry survival and growth is that they cannot – at least not indefinitel . Rather, they must growth to at least approach the MES level of output. An alternative answer is provided by

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recent studies focusing on the relationship between fir size, age and employee compensation (Audretsch, 1995). By deploying a strategy of compensating factor differentials, where factor inputs are both deployed and remunerated differently than they are by the larger incumbent enterprises, suboptimal scale enterprises are to some extent able to offset their size-related cost disadvantages. Just as it has been found that the gap between the MES and fir size lowers the likelihood of survival, there is evidence suggesting that factors of production, and in particular labor, tend to be used more intensively (that is, in terms of hours worked) and remunerated at lower levels (in terms of employee compensation). Taken together, the empirical evidence on survival and growth combined with that on wages and fir size suggests how it is that small, suboptimal scale enterprises are able to exist in the short run. In the initial period of learning, during which time the entrepreneur discovers whether he has the right stuff and whether he is able to adapt to market conditions, new firm are apparently able to reduce the cost of production in order to compensate for their small scale of production. In the current debate on the relationship between employment and wages it is typically argued that the existence of small firm which are sub-optimal within the organization of an industry represents a loss in economic efficien y. This argument is based on a static analysis, however. When viewed through a dynamic lens a different conclusion emerges. One of the most striking results is the findin of a positive impact of fir age on productivity and employee compensation, even after controlling for the size of the firm Given the strongly confirme stylized fact linking both fir size and age to a negative rate of growth (that is the smaller and younger a firm that faster it will grow but the lower is its likelihood of survival), this new findin linking fir age to employee compensation and productivity suggests that not only will some of the small and sub-optimal firm of today become the large and optimal firm of tomorrow, but there is at least a tendency for the low productivity and wage of today to become the high productivity and wage of tomorrow. What emerges from the new theories and empirical evidence on innovation and industry evolution is that markets are in motion, with many firm entering the industry and a large number of firm exiting from the industry. But is this motion horizontal, in that the bulk of firm exiting are comprised of firm that had entered relatively recently, or vertical, in that a significan share of the exiting firm had been established incumbents that were displaced by younger firms In trying to shed some light on this question, Audretsch (1995) proposes two different models of the evolutionary process of industries over time. Some industries can be best characterized by the model of the conical revolving door, where new businesses enter, but where there is a high propensity to subsequently exit from the market. Other industries may be better characterized by the metaphor

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of the forest, where incumbent establishments are displaced by new entrants. Which view is more applicable apparently depends on three major factors – the underlying technological conditions, scale economies, and demand. Where scale economies play an important role, the model of the revolving door seems to be more applicable. While the rather starting result discussed above that the startup and entry of new businesses is apparently not deterred by the presence of high scale economies, a process of fir selection analogous to a revolving door ensures that only those establishments successful enough to grow will be able to survive beyond more than a few years. Thus, the bulk of new entrants that are not so successful ultimately exit within a few years subsequent to entry. There is at least some evidence also suggesting that the underlying technological regime influence the process of fir selection and therefore the type of fir with a higher propensity to exit. Under the entrepreneurial regime new entrants have a greater likelihood of making an innovation. Thus, they are less likely to decide to exit from the industry, even in the face of negative profits By contrast, under the routinized regime the incumbent businesses tend to have the innovative advantage, so that a higher portion of exiting businesses tend to be new entrants. Thus, the model of the revolving door is more applicable under technological conditions consistent with the routinized regime, and the metaphor of the forest, where the new entrants displace the incumbents – is more applicable to the entrepreneurial regime. Why is the general shape of the firm-siz distribution not only strikingly similar across virtually every industry – that is, skewed with only a few large enterprises and numerous small ones – but has persisted with tenacity not only across developed countries but even over a long period of time? The evolutionary view of the process of industry evolution is that new firm typically start at a very small scale of output. They are motivated by the desire to appropriate the expected value of new economic knowledge. But, depending upon the extent of scale economies in the industry, the fir may not be able to remain viable indefinitel at its startup size. Rather, if scale economies are anything other than negligible, the new fir is likely to have to grow to survival. The temporary survival of new firm is presumably supported through the deployment of a strategy of compensating factor differentials that enables the fir to discover whether or not it has a viable product. The empirical evidence supports such an evolutionary view of the role of new firm in manufacturing, because the post-entry growth of firm that survive tends to be spurred by the extent to which there is a gap between the MES level of output and the size of the firm However, the likelihood of any particular new fir surviving tends to decrease as this gap increases. Such new suboptimal scale firm are apparently engaged in the selection process. Only those firm

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offering a viable product that can be produced efficientl will grow and ultimately approach or attain the MES level of output. The remainder will stagnate, and depending upon the severity of the other selection mechanism – the extent of scale economies – may ultimately be forced to exit out of the industry. Thus, the persistence of an asymmetric firm-siz distribution biased towards small-scale enterprise reflect the continuing process of the entry of new firm into industries and not necessarily the permanence of such small and sub-optimal enterprises over the long run. Although the skewed size distribution of firm persists with remarkable stability over long periods of time, a constant set of small and suboptimal scale firm does not appear to be responsible for this skewed distribution.

4. KNOWLEDGE SPILLOVERS The recent wave of studies revealing that small enterprises serve as the engine of innovative activity in certain industries (Acs & Audretsch, 1988, 1990; Audretsch, 1995) is particularly startling, because the bulk of industrial R&D is undertaken in the largest corporations; small enterprises account for only a minor share of R&D inputs (Cohen & Klepper, 1992; Scherer, 1992). Thus, the model of the knowledge production function seemingly implies that innovative activity favors those organizations with access to knowledge-producing inputs – large organizations. The more recent evidence identifying the role of small firm as a source of innovative activity raises the question, Where do entrepreneurial small firms get the innovation producing inputs, that is the knowledge? One suggested answer is that although the model of the knowledge production function may certainly be valid, the implicitly assumed unit of observation which links the knowledge inputs with the innovative outputs – at the level of the establishment or fir – may be less valid. Instead, a new literature suggests that knowledge spills over from the fir or research institute producing it to a different fir commercializing that knowledge (Griliches, 1992). This view is supported by theoretical models which have focused on the role that spillovers of knowledge across firm play in generating increasing returns and ultimately economic growth (Krugman, 1991; Romer, 1986). An important theoretical development is that geography may provide a relevant unit of observation within which knowledge spillovers occur. The theory of localization suggests that because geographic proximity is needed to transmit knowledge and especially tacit knowledge, knowledge spillovers tend to be localized within a geographic region. The importance of geographic proximity for knowledge spillovers has been supported in a wave of recent empirical studies by Jaffe

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(1989), Jaffe, Trajtenberg and Henderson (1993), Acs, Audretsch and Feldman (1992, 1994), Audretsch and Feldman (1996) and Audretsch and Stephan (1996). That knowledge spills over is barely disputed. In disputing the importance of knowledge externalities in explaining the geographic concentration of economic activity, Krugman (1991) and others do not question the existence or importance of such knowledge spillovers. In fact, they argue that such knowledge externalities are so important and forceful that there is no compelling reason for a geographic boundary to limit the spatial extent of the spillover. According to this line of thinking, the concern is not that knowledge does not spill over but that it should stop spilling over just because it hits a geographic border, such as a city limit, state line, or national boundary. The claim that geographic location is important to the process linking knowledge spillovers to innovative activity in a world of e-mail, fax machines and cyberspace may seem surprising and even paradoxical. The resolution to the paradox posed by the localization of knowledge spillovers in an era where the telecommunications revolution has drastically reduced the cost of communication lies in a distinction between knowledge and information. Information, such as the price of gold on the New York Stock Exchange, or the value of the Yen in London, can be easily codifie and has a singular meaning and interpretation. By contrast, knowledge is vague, difficul to codify and often only serendipitously recognized. While the marginal cost of transmitting information across geographic space has been rendered invariant by the telecommunications revolution, the marginal cost of transmitting knowledge, and especially tacit knowledge, rises with distance. Von Hipple (1994) demonstrates that high context, uncertain knowledge, or what he terms as sticky knowledge, is best transmitted via face-to-face interaction and through frequent and repeated contact. Geographic proximity matters in transmitting knowledge, because as Kenneth Arrow (1962) pointed out some three decades ago, such tacit knowledge is inherently non-rival in nature, and knowledge developed for any particular application can easily spill over and have economic value in very different applications. As Glaeser, Kallal, Scheinkman and Shleifer (1992, p. 1126) have observed, “intellectual breakthroughs must cross hallways and streets more easily than oceans and continents.” The importance of local proximity for the transmission of knowledge spillovers has been observed in many different contexts. It has been pointed out that, “business is a social activity, and you have to be where important work is taking place.”1 A survey of nearly one thousand executives located in America’s sixty largest metropolitan areas ranked Raleigh/Durham as the best city for knowledge workers and for innovative activity.2 The reason is that “A lot of brainy types who made their way to Raleigh/Durham were drawn by three top research universities . . . U.S. businesses, especially those whose success depends on staying at the top of new technologies

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and processes, increasingly want to be where hot new ideas are percolating. A presence in brain-power centers like Raleigh/Durham pays off in new products and new ways of doing business. Dozens of small biotechnology and software operations are starting up each year and growing like kudzu in the fertile climate.”3 Almeida (1996) shows that foreign firm use local plants to tap in to local knowledge. Not only did Krugman (1991, p. 53) doubt that knowledge spillovers are not geographically constrained but he also argued that they were impossible to measure because “knowledge fl ws are invisible, they leave no paper trail by which they may be measured and tracked.” However, an emerging literature (Jaffe, Trajtenberg & Henderson, 1993) has overcome data constraints to measure the extent of knowledge spillovers and link them to the geography of innovative activity. Jaffe (1989), Feldman (1994) and Audretsch and Feldman (1996) modifie the model of the knowledge production function to include an explicit specificatio for both the spatial and product dimensions. Jaffe (1989) used the number of inventions registered with the United States patent offic as a measure of innovative activity. By contrast, Audretsch and Feldman (1996) and Acs, Audretsch and Feldman (1992) developed a direct measure of innovative output consisting of new product introductions. The consistent empirical evidence supports the notion knowledge spills over for third-party use from university research laboratories as well as industry R&D laboratories. This empirical evidence suggests that location and proximity clearly matter in exploiting knowledge spillovers. Not only have Jaffe, Trajtenberg and Henderson (1993) found that patent citations tend to occur more frequently within the state in which they were patented than outside of that state, but Audretsch and Feldman (1996) found that the propensity of innovative activity to cluster geographically tends to be greater in industries where new economic knowledge plays a more important role. Prevezer (1997) and Zucker, Darby and Armstrong (1994) show that in biotechnology, which is an industry based almost exclusively on new knowledge, the firm tend to cluster together in just a handful of locations. This findin is supported by Audretsch and Stephan (1996) who examine the geographic relationships of scientists working with biotechnology firms The importance of geographic proximity is clearly shaped by the role played by the scientist. The scientist is more likely to be located in the same region as the fir when the relationship involves the transfer of new economic knowledge. However, when the scientist is providing a service to the company that does not involve knowledge transfer, local proximity becomes much less important. Zucker, Darby and Armstrong (1998) show that the most productive scientists in the California biotechnology are connected to firm through employment or ownership. Spillovers occur in this industry for the scientist to financiall exploit his knowledge. There is reason to believe that knowledge spillovers are not homogeneous across firms In analyzing the role of spillovers for large and small enterprises separately,

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Acs, Audretsch and Feldman (1994) provide some insight into the puzzle posed by the recent wave of studies identifying vigorous innovative activity emanating from small firm in certain industries. How are these small, and frequently new, firm able to generate innovative output while undertaking generally negligible amounts of investment into knowledge generating inputs, such as R&D? The answer appears to be through exploiting knowledge created by expenditures on research in universities and on R&D in large corporations. Their finding suggest that the innovative output of all firm rises along with an increase in the amount of R&D inputs, both in private corporations as well as in university laboratories. However, R&D expenditures made by private companies play a particularly important role in providing knowledge inputs to the innovative activity of large firms while expenditures on research made by universities serve as an especially key input for generating innovative activity in small enterprises. Apparently large firm are more adept at exploiting knowledge created in their own laboratories, while their smaller counterparts have a comparative advantage at exploiting spillovers from university laboratories. In addressing the questions how and why knowledge spills over, an assumption implicit to the model of the knowledge production function is challenged – that firm exist exogenously and then endogenously seek out and apply knowledge inputs to generate innovative output. Although this may be valid some, if not most of the time, the evidence from biotechnology suggests that, at least in some cases, it is the knowledge in the possession of economic agents that is exogenous. In an effort to appropriate the returns from that knowledge, the scientist then endogenously creates a new firm Thus, the spillover of knowledge from the source creating it, such as a university, research institute, or industrial corporation, to a new-fir startup facilitates the appropriation of knowledge for the individual scientist(s) but not necessarily for the organization creating that new knowledge in the firs place (Audretsch & Stephan, 1996). While Romer (1990, 1994) and Krugman (1991) identifie the role that knowledge spillovers and externalities play in generating endogenous growth, they are less precise about the actual mechanism by which knowledge spills over. Entrepreneurial small firm are one such mechanism transmitting the spillover of knowledge. Thus, an increase in the role of entrepreneurship activity may facilitate such knowledge spillovers and therefore subsequent growth.

5. ECONOMIC GROWTH There is a considerable gap of research linking entrepreneurship to economic growth. The reasons for this void in the state of knowledge about the impact

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of entrepreneurship on economic growth may be attributable to a paucity of theoretical frameworks linking entrepreneurship to growth as well as severe constraints in measuring entrepreneurship, let alone entrepreneurship within a cross-national context. See Audretsch and Thurik (2000) and Carree and Thurik (2003) for an extensive review to the literature. The last two decades have seen an explosion in studies analyzing the determinants of entrepreneurship. While some of these studies are theoretical (Holmes & Schmitz, 1990), others are empirical (Evans & Jovanovic, 1989; Evans & Leighton, 1990; Reynolds, 1997) or eclectic (Audretsch & Thurik, 2001; Audretsch, Thurik, Verheul & Wennekers, 2002). What they have in common is to pose the questions, “Why do people start firm and what determines who becomes an entrepreneur?” The consequences of entrepreneurship, in terms of economic performance, have also generated a large literature. However, this literature has been restricted to two units of observations – at the level of the establishment or enterprise, and for regions. Noticeably absent are studies linking the impact of entrepreneurship on performance for the unit of observation of the country (Audretsch, Carree & Thurik, 2001). In fact, a large literature has emerged analyzing the impact of entrepreneurship on economic performance at the level of the fir or establishment. These studies typically measure economic performance in terms of enterprise growth and survival (Audretsch, 1995; Caves, 1998; Sutton, 1997). The compelling stylized facts that have emerged from this literature is that entrepreneurial activity, measured in terms of fir size and age, is positively related to growth. The growth of new firm and small firm is systematically greater than for large and established incumbents. These finding hold across OECD countries and across time periods. The link between entrepreneurship and performance has also been extended beyond the unit of observation of the fir to include a geographic region. A rich literature exists linking measures of entrepreneurial activity for regions to the economic performance of those regions (Audretsch & Fritsch, 2002; Reynolds, Miller & Maki, 1995; Reynolds, Storey & Westhead, 1994). While Reynolds, Miller and Maki (1995) fin that the degree of entrepreneurship has a positive impact on regional economic growth in the U.S., Audretsch and Fritsch (2002) fin that for Germany the relationship shifted from negative in the 1980s to positive in the 1990s. However, when it comes to linking entrepreneurship to growth at the national level, only a few studies exist. Audretsch et al. (2002) and Carree and Thurik (1999) offer two distinct approaches, based on two different measures of entrepreneurship – the relative share of economic activity accounted for by small firms and the selfemployment rate. In addition, two different measures of performance of economic activity are also analyzed – economic growth and reduction of unemployment – to

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link changes in entrepreneurship to changes in economic performance. Different samples including OECD countries over different time periods reach consistent results – increases in entrepreneurial activity tends to result in higher subsequent growth rates and a reduction of unemployment. Audretsch et al. (2001) provide empirical evidence for a panel of OECD countries, which suggests that those countries that have experienced an increase in entrepreneurial activity have also enjoyed higher rates of growth and greater reductions in unemployment. By contrast, those countries that have not increased the degree of entrepreneurial activity have had less growth and less reductions in unemployment. Entrepreneurship generates growth because it serves as a vehicle for innovation and change, and therefore as a conduit for knowledge spillovers. Thus, in a regime of increased globalization, where the comparative advantage of the leading developed countries is shifting towards knowledge-based economic activity, not only does entrepreneurship play a more important role, but the impact of that entrepreneurship is to generate growth.

6. CONCLUSIONS While economic growth has traditionally remained in the analytic domain of macroeconomics, the lens of evolutionary economics provides linkages across multiple units of observation, spanning the individual, the firm the industry, and ultimately macroeconomic growth. Entrepreneurship plays a central role in the growth process, because it is the assessment of ideas that leads not just to change and growth, but also does this through the mechanism of starting a new firm Higher rates of entrepreneurship tend to generate a greater degree of turbulence within industries. Not only do more firm enter industries, but the exit rates are also greater, reflectin a greater degree of search activity relative to routinized activity. The positive relationships found between entrepreneurship and industry turbulence do not necessarily imply a superior economic performance. However, an emerging body of empirical evidence clearly suggests a positive link between entrepreneurship and growth that holds not just for firms but also for geographic units of observation, including the city, region and even country. Those regions and countries that have a greater degree of entrepreneurial activity also enjoy higher rates of growth. A question still to be answered is from where does the new knowledge originate. Is it the R&D activities within the young firm synergies within networks of small firms spillovers from universities or from larger incumbent firms A follow-up question is why and how these spillovers occur and how they can be stimulated.

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The eclectic framework of the determinants of entrepreneurship as presented in Audretsch, Thurik, Verheul and Wennekers (2002) may be a starting point for investigating the mechanisms and stimulation of these spillovers.

NOTES 1. “The Best Cities for Knowledge Workers,” Fortune, 15 November, 1993, p. 44. 2. The survey was carried out in 1993 by the management consulting fir of Moran, Stahl and Boyer of New York City. 3. “The Best Cities for Knowledge Workers,” Fortune, 15 November, 1993, p. 44.

ACKNOWLEDGMENTS This paper is the result of a series of visits by David Audretsch as a Visiting Research Fellow at the Tinbergen Institute and by Roy Thurik as the Ameritech Research Scholar at the Institute for Development Strategies, Indiana University. We would like to thank Candice Henriquez, Hidde Wiersma and an anonymous referee for their helpful comments and suggestions.

REFERENCES Acs, Z. J., & Audretsch, D. B. (1988). Innovation in large and small firms An empirical analysis. The American Economic Review, 78(4), 678–690. Acs, Z. J., & Audretsch, D. B. (1990). Innovation and small firms. Cambridge, MA: MIT Press. Acs, Z. J., Audretsch, D. B., & Feldman, M. P. (1992). Real effects of university research: A comment. American Economic Review, 82(1), 363–367. Acs, Z. J., Audretsch, D. B., & Feldman, M. P. (1994). R&D spillovers and recipient fir size. Review of Economic and Statistics, 76(2), 336–340. Almeida, P. (1996). Knowledge sourcing by foreign multinationals: Patent citation analysis in the U.S. semiconductor industry. Strategic Management Journal, 17 (Special issue: Knowledge and the firm) 155–165. Arrow, K. (1962). Economic welfare and the allocation of resources for invention. In: R. Nelson (Ed.), The Rate and Direction of Inventive Activity (pp. 609–625). Princeton: Princeton University Press. Audretsch, D. B. (1995). Innovation and industry evolution. Cambridge, MA: MIT Press. Audretsch, D. B., Carree, M. A., Van Stel, A. J., & Thurik, A. R. (2002). Impeded industrial restructuring: The growth penalty. Kyklos, 55(1), 81–97. Audretsch, D. B., Carree, M. A., & Thurik, A. R. (2001). Entrepreneurship and unemployment. Institute for Development Strategies Discussion Paper, Indiana University. Audretsch, D. B., & Feldman, M. (1996). R&D spillovers and the geography of innovation and production. American Economic Review, 86(3), 630–640.

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Audretsch, D. B., & Fritsch, M. (2002). Growth regimes over time and space. Regional Studies, 36, 113–124. Audretsch, D. B., Van Leeuwen, G., Menkveld, B., & Thurik, A. R. (2001). Market dynamics in the Netherlands: Competition policy and the role of small firms International Journal of Industrial Organization, 19(5), 795–821. Audretsch, D. B., & Stephan, P. (1996). Company-scientist locational links: The case of biotechnology. American Economic Review, 86(3), 641–652. Audretsch, D. B., & Thurik, A. R. (2000). Capitalism and democracy in the 21st century: From the managed to the entrepreneurial economy. Journal of Evolutionary Economics, 10, 17–34. Audretsch, D. B., & Thurik, A. R. (2001). What is new about the new economy: Sources of growth in the managed and entrepreneurial economies. Industrial and Corporate Change, 10, 267–315. Audretsch, D. B., Verheul, I., Thurik, A. R., & Wennekers, S. (Eds) (2002). Entrepreneurship: Determinants and policy in a European-U.S. comparison. Boston/Dordrecht: Kluwer Academic Publishers. Carree, M. A., & Thurik, A. R. (1999). Industrial structure and economic growth. In: D. B. Audretsch & A. R. Thurik (Eds), Innovation, Industry Evolution and Employment (pp. 86–110). Cambridge: Cambridge University Press. Carree, M. A., & Thurik, A. R. (2003). The impact of entrepreneurship on economic growth. In: D. B. Audretsch & Z. J. Acs (Eds), Handbook of Entrepreneurship. Boston/Dordrecht: Kluwer Academic Publishers. Caves, R. E. (1998). Industrial organization and new finding on the turnover and mobility of firms Journal of Economic Literature, 36(4), 1947–1982. Cohen, W. M., & Klepper, S. (1991). A reprise of size and R&D. Mimeo, Carnegie Mellon University. Cohen, W. M., & Klepper, S. (1992). The trade-off between fir size and diversity in the pursuit of technological progress. Small Business Economics, 4(1), 1–14. Evans, D. S., & Jovanovic, B. (1989). An estimated model of entrepreneurial choice under liquidity constraints. Journal of Political Economy, 97(4), 808–827. Evans, D. S., & Leighton, L. S. (1990). Small business formation by unemployed and employed workers. Small Business Economics, 2(4), 319–330. Feldman, M. (1994). The geography of innovation. Boston: Kluwer Academic Publishers. Glaeser, E., Kallal, H., Scheinkman, J., & Shleifer, A. (1992). Growth in cities. Journal of Political Economy, 100(6), 1126–1152. Griliches, Z. (1979). Issues in assessing the contribution of R&D to productivity growth. Bell Journal of Economics, 10(1), 92–116. Griliches, Z. (1992). The search for R&D spill-overs. Scandinavian Journal of Economics, 94, 29–47. Hirschman, A. O. (1970). Exit, voice and loyalty: Responses to decline in firms, organizations and states. Cambridge, MA: Harvard University Press. Holmes, T. J., & Schmitz, J. A., Jr. (1990). A theory of entrepreneurship and its application to the study of business transfers. Journal of Political Economy, 98(2), 265–294. Jaffe, A. (1989). Real effects of academic research. American Economic Review, 79(5), 957–970. Jaffe, A., Trajtenberg, M., & Henderson, R. (1993). Geographic localization of knowledge spillovers as evidenced by patent citations. Quarterly Journal of Economics, 108(3), 577–598. Jovanovic, B. (1982). Selection and evolution of industry. Econometrica, 50(3), 649–670. Krugman, P. (1991). Geography and trade. Cambridge: MIT Press. Nelson, R. R., & Winter, S. G. (1982). An evolutionary theory of economic change. Cambridge, MA: Harvard University Press.

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Prevezer, M. (1997). The dynamics of industrial clustering in biotechnology. Small Business Economics, 9(3), 255–271. Reynolds, P. D. (1997). Who starts new firms – Preliminary explorations of firms-in-gestation Small Business Economics, 9(5), 449–462. Reynolds, P. D., Miller, B., & Maki, W. R. (1995). Explaining regional variation in business births and deaths: U.S. 1976–1988. Small Business Economics, 7(5), 389–407. Reynolds, P. D., Storey, D. J., & Westhead, P. (1994). Cross national comparison of the variation in the new fir formation rates. Regional Studies, 28(4), 443–456. Romer, P. M. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94(5), 1002–1037. Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5), 71–101. Romer, P. M. (1994). The origins of endogenous growth. Journal of Economic Perspectives, 8(1), 3–22. Scherer, F. M. (1991). Changing perspectives on the fir size problem. In: Z. J. Acs & D. B. Audretsch (Eds), Innovation and Technological Change: An International Comparison (pp. 24–38). Ann Arbor: University of Michigan Press. Scherer, F. M. (1992). Schumpeter and plausible capitalism. Journal of Economic Literature, 30(3), 1416–1433. Schumpeter, J. A. (1934). The theory of economic development. Cambridge, MA: Harvard University Press. Schumpeter, J. A. (1942). Capitalism, socialism and democracy. New York: Harper and Row. Sutton, J. (1997). Gibrat’s legacy. Journal of Economic Literature, 35(1), 40–59. Stinchcombe, A. L. (1965). Social structure and organizations. In: J. G. March (Ed.), Handbook of Organizations (pp. 153–193). Chicago: Rand McNally. Von Hipple, E. (1994). Sticky information and the locus of problem solving: Implications for innovation. Management Science, 40(4), 429–439. Zucker, L. G., Darby, M. R., & Armstrong, J. (1994). Intellectual capital and the firm The technology of geographically localized knowledge spillovers. National Bureau of Economic Research, Working Paper No: 9496, Cambridge MA. Zucker, L. G., Darby, M. R., & Armstrong, J. (1998). Geographically localized knowledge: Spillovers or markets? Economic Inquiry, 36(1), 65–86.

ON AUSTRIAN ANALYSIS OF ENTREPRENEURSHIP AND MY OWN William J. Baumol ABSTRACT All of economics recognizes the importance of entrepreneurship, but until the work of the Austrians, little was done about it. Neoclassical economics could not deal with it in its models, because formal optimization is largely irrelevant and because the entrepreneur’s innovation is, by definition, purely heterogeneous. The Austrians, with their flexibility of method, were able to break through, following Schumpeter’s great contribution. My own work on the subject solved the method problem by discussing not what activities the entrepreneurs undertake, but how their services are allocated between such things as contributions to production and rent seeking.

INTRODUCTION It is not accidental that what the literature has produced on the theory of entrepreneurship is largely attributable to the Austrian economists, including in this group their successors in other countries. In contrast, one can say of the role of the entrepreneur in the mainstream mathematical writings of the fir much what Mark Twain said of the weather – everyone talks about the subject but no one does anything about it. Every economist surely must be prepared to concede that entrepreneurs are (even if for reasons not fully specified of great importance. But in standard microtheory they are completely invisible. Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 57–66 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06004-6

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First, let me recall the two senses in which the term is used and indicate why neither of them permits it a role in the standard models. Sometimes, as in the writings of Sharon Gifford (see particularly 1998), or the teachings in the business schools, the entrepreneur is the organizer of new firms whether or not the enterprises are novel in operation or organization, and that is surely the meaning of the French or the German terms for the activity. But for other writers, following Schumpeter (as I usually do) the entrepreneur is an innovator, who is always engaged in doing something that was never done before, and not just founding yet another business entity of a sort often in existence before. Now there are two reasons why neither entrepreneur fit comfortably and perhaps does not fi at all into the current mainstream formulation of the firm First, the product of the entrepreneur’s activity is markedly heterogeneous. It is, perhaps, even the ultimate extreme among the products that are not identical. Indeed, as I have argued, it is mere tautology that tells us the output of Schumpeter’s entrepreneur must be a heterogeneous product. Though mainstream theorists have recently begun to fin ways to incorporate imperfect substitutes even into their general equilibrium models, here the differentiation of the products is so fundamental as to resist the standard mathematical treatments of the firm Even more critical is the orientation of the mathematical models to optimization and maximization, which certainly fit in well with routine business decisions. Gifford has shown in her book that even such an approach can cast valuable light on the structure of entrepreneurial decisions. But the fact remains that much of entrepreneurial decision making has little or nothing to do with optimization (or even with Herbert Simon’s “satisficing” so that the writers in the arena under discussion are forced to conclude that, though the entrepreneur is almost all-important, they have nothing to say on the subject. Austrian economics, because it is not so tightly constrained by unswerving allegiance to any particular analytical method or such a method’s peculiar strengths and limitations, can, in contrast, provide significan insights on this important but highly elusive subject. The classic Schumpeterian model in which the entrepreneur find he can earn profit only by innovating, and can obtain an enduring fl w of profit only by constantly innovating, is the prime example. And it is an example important for the discussion here because it is so clearly not the end of the story. That is, it can be used to make clear that Austrian analysis is not designed to terminate examination of any phenomenon such as entrepreneurship, but is rather calculated to invite further investigation in search of additional insights.

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THE ENTREPRENEUR AS EQUILIBRIUM AND DISEQUILIBRIUM CREATOR The approach of Israel Kirzner (1979, 1997) brings this out very clearly. It does not only go beyond Schumpeter and provide novel avenues of analysis and novel insights. It actually provides a critical result that, in one sense, contradicts a Schumpeterian conclusion, but basically is complementary with the latter. In Kirzner’s work, what distinguishes the entrepreneur is superior alertness to business opportunities. The successful entrepreneur is the one who is firs to spot such opportunities and to take advantage of them. The prototype case is an opportunity for profitabl arbitrage. But arbitrage has a close relation to equilibrium. An arbitrage opportunity can occur only in the absence of equilibrium because, by definition in equilibrium all avenues for enhancement of earnings through change must have been employed to exhaustion. Moreover, arbitrage is a process that is constructed so as to move matters toward equilibrium. In other words, the side of entrepreneurship on which Kirzner focuses entails unrelenting pressure moving matters toward equilibration whenever the state of affairs is not an equilibrium. The alert entrepreneur observes a state of disequilibrium that constitutes an opportunity for profitabl arbitrage, and then quickly inaugurates measures that, by taking advantage of the opportunity, work toward elimination of the disequilibrium. The disequilibrium may or may not be eliminated entirely, but the entrepreneur’s standard activities certainly work toward reduction of its severity and toward bringing it to an end. But in a significan sense, this is the reverse of Schumpeter’s story, though it is important to recognize that there is no conflic between the two. Rather, it is only when we consider the two analyses together that we become aware of the two crucial sides of the story. In Kirzner, the entrepreneur’s activities cannot abide continuation of disequilibrium, and can be relied upon to work toward its elimination. In contrast, Schumpeter’s entrepreneur constitutionally cannot abide continuation of an equilibrium. He is driven to search constantly for innovation opportunities, but an innovation, by its very nature, upsets any equilibrium that provided the opportunity for the novel product or process that the entrepreneur introduces. Thus, we have the Kirzner entrepreneur who cannot abide disequilibrium, and Schumpeter’s entrepreneur who cannot abide its absence. But the two, seemingly conflicting observations only together enable us understand what is going on. In sum, the entrepreneur is the agent of change, no matter what the situation. It is the status quo, whatever it may be, that he is impelled to disturb. From these two parts of the story we end up not only with a better understanding of the role of the

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entrepreneur, but also of the pertinence of the concept of equilibrium itself for the behavior of the economy in reality.

PRODUCTIVE AND UNPRODUCTIVE ENTREPRENEURSHIP In my own work I have taken off from such Austrian analyses and concepts and have sought to extract further insights on the subject. Here I will summarize two of my attempts to analyze the role of the entrepreneur: firs the notion that societies can experience apparently autonomous outbursts of entrepreneurship and equally independent declines and near disappearance of this individual whose activities are so critical for growth. Is there an economic explanation for such developments that can perhaps enable us to do something about them, or must they be treated as fundamentally fortuitous and inexplicable events? Second, I will discuss Schumpeter’s observation in his later writings that the innovation process is undergoing routinization. The questions to which this view gives rise are whether it is in fact true and, if so, where it leaves the entrepreneur, whether it threatens to deprive him of his role. I begin with the firs of these issues (summarizing the analysis in my book on the subject, 1993). In my view the perception that entrepreneurship has a disturbing tendency to dry up unexpectedly or to spring forth unexpectedly like Athena from the head of Zeus, stems from a basic misunderstanding. The source of this misunderstanding is a propensity to equate entrepreneurship with virtuous behavior. Because we recognize that it can bring innovation and growth, we are misled into thinking that it must always contribute to economic abundance and expansion. But there is no reason why this must be so, and it patently is not true in reality. First, one must recognize that the class of individuals who constitute the economy’s entrepreneurs are not selected to be, uniformly, a collection of archangels. Like professors or lawyers or doctors, the strength of their dedication to morality will vary from one such individual to another. It is, indeed, a plausible hypothesis that the typical entrepreneur has a tendency toward amorality in his professional activities, neither accepting major sacrifice on behalf of the general welfare nor deliberately seeking to damage it. The entrepreneur’s goal is acquisition and accumulation of wealth, power and prestige, and he uses innovation as his primary weapon in pursuit of those objectives. If his innovations happen to yield social benefits so much the better. But if those benefit are questionable, that need not put a stop to his activities. The point is that entrepreneurship, like any other input in the economy, is an allocable resource, and pursuit of profi – the profi motive – will determine where

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it will be allocated. Now one can be innovative and enterprising in a variety of ways. The gangster godfather who invents a new instrument for extortion and the warlord who invents a new military tactic to tighten his grip on his domain are surely being entrepreneurial. These extreme examples are chosen deliberately, to show how far the conventional notion of entrepreneurship invites extension. It is, of course, true that the U.S. economy has no warlords, though it does have its godfathers. But consider what would happen if something were to change the situation to one resembling that of the central Middle Ages. Then, as we know, the entrepreneur innovators were the unruly barons, who not only conducted continual warfare with one another, but even with their kings, as in England in the reigns of Stephen and Matilda, John, Henry III, Richard II, Henry VI and Richard III. The point is that society’s most enterprising individuals were in these societies driven by their ambition to innovative aggression rather than to production. The class of entrepreneurs did not vanish. Rather, they were induced to go where the most promising opportunities for enrichment and acquisition of power were to be found. All of this may (or may not) seem convincing but largely irrelevant for the most pressing economic issues facing today’s society. But that is only because of the extreme examples on which I have focused to dramatize my point. Today, criminal activity aside, the primary type of effort that competes with production as an attraction to entrepreneurs is something far less dramatic than military violence, but nevertheless important. This alternative is rent seeking, the pursuit of earnings primarily through redistribution in one’s own favor, rather than in return for productive accomplishment. The lawsuit is a prime example of such an activity, and the number of firm that participate in such activities is hardly negligible. Vast resources are devoted to representatives of the fir in the courts, the regulatory agencies and other such instrumentalities, whose job it is to seek special economic advantages such as court-imposed protection from disturbingly vigorous competition and direct enrichment through vast court-ordered damage payments. Such activities can and often are carried out in an innovative manner with full exercise of entrepreneurial vigor. And it is easy to provide examples of firm that participate in both types of activity – production and litigation. But where the damage payment being sought in a lawsuit is (as I have more than once experienced) equal to something like a decade of the firm s usual profits it is easy to imagine where primary attention is given by the firm s decision makers. As is well recognized, rent seeking takes many forms beyond litigative activity. There is, for example, pursuit of an exclusive license to operate a public utility, lobbying in Congress, efforts to extend the life of patents by means of inventions whose primary purpose is to exclude competition and many additional variants,

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all of which are pursued entrepreneurially, with constant alertness for innovation opportunities. The central point here is that the rules of the game – the structure of the economy’s payoffs – can and do change. And when they change they can confidentl be expected to modify the allocation of the economy’s entrepreneurs between production and rent seeking. History readily provides striking examples. Thus, during the reigns of the last Plantagenets and the early Tudors, service to the King was a primary source of income, privilege and perhaps most critical, landed property. As a result, the evidence indicates, economic activity by leading subjects was focused in this direction, with productive investment by the magnates a very new phenomenon, following the innovative example of Edward IV. And during the reign of the Stuarts, when Parliament succeeded in circumscribing the rent-granting powers of the monarch, it is arguable that the economy’s entrepreneurs’ activities were redirected toward commerce and production, thereby providing part of the explanation for the subsequent British economic success in the European economy of the early 19th century. What was true on those occasions remains true now. Entrepreneurs can still be tempted to redirect their efforts by changes in the structure of payoffs. This indicates the importance of avoidance of governmental forms of intervention that end up providing significan opportunities for rent seeking, and for the benefit of foreclosure of rent seeking opportunities that derive from other sources. Thus, I maintain that the analysis that takes entrepreneurship as another allocable resource not only possesses explanatory power, but also can be helpful for design of policy. The analysis also helps us to see why free market economies are characterized by so much greater an abundance of productive entrepreneurship than was found in earlier societies. The rule of law, along with rights of property and its protection from arbitrary confiscation the enforceability of contracts and a variety of other protections have made productive activities less risky and more effective avenues to wealth than they were before. This along with some closing down of rent-seeking opportunities and opportunities for respectable wealth acquisition though organized violence have reallocated entrepreneurial effort in directions that contribute to prosperity and growth. Entrepreneurship in the free market was not created by mysterious means, by spontaneous generation – it was merely redirected from what it had previously been doing.

ROUTINIZATION OF INNOVATION AND THE ENTREPRENEUR’S CONTINUING ROLE My research on entrepreneurship has continued since the preceding ideas were firs formulated, and the resulting later observations are contained in my most recent

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book (2002). The central topic of that book is the extraordinary growth record of the free market economies, and the reasons why no other form of economic organization has come close to its productive and innovative accomplishments over any protracted period of time. The relevance to the discussion here should already be clear from my previous observations on the attributes of the free market economy that apparently have contributed so substantially to the volume of activity in productive entrepreneurship. But there is much more to the story, in particular in the drive toward routinization of innovation and its implications for entrepreneurship. The story here, in brief, is that in the market economies the most visible and active forms of competition are found in oligopolistic industries, where rivals’ surveillance of one another’s activities is direct and where the actions of any one enterprise in a market can be expected to elicit rivalrous responses from the others. Directly relevant to the discussion here is the important subsector of the group of oligopolistic industries that are characterized as “high-tech” and that are responsible for the bulk of innovative activities that take place within established firms For many of such firm innovation is not only important, it can be a matter of life and death. The resulting pressures have led those enterprises to take whatever measures they can to minimize their risk of falling behind rivals in the innovation “arms race” that encompasses the industry. To do so, they have, as far as they could, taken the innovative activities on which they depend out of the hands of the independent inventors and entrepreneurs, and brought them inside the firm into business operated and controlled R&D facilities. This is the sense in which innovation activity has indeed grown more routine and, according to government statistics, some 70% of R&D activity is now conducted in this way in the United States. The activity as carried out by private business has become routine in many ways. Its budget is determined centrally, in competition with the firm s expenditures on all of its other major activities such as advertising and plant construction. The firm s management may select its R&D subsidiary’s organization structure, decide on its facilities and even, in a surprising number of cases, it will decide what should be invented. As this is being written, for example, it has been announced by Microsoft that its R&D is about to be redirected from the addition of new working features to increases of the users’ security from invasion of viruses as well as the confidentialit of what is written and saved on the computer. This presumably will be a centrally directed reorientation of the activities of the firm s R&D personnel, and it is a pattern that is to be encountered throughout industrial research. This is a far cry from the inspired and heterodox efforts of legend, toiling in attic and basement to come up with a working version of an invention that exists initially only in the inventor’s mind, and the work of the entrepreneur whose alertness enables him to observe the existence or prospect of

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this invention and whose efforts are designed to see it to completion, all the way to the marketplace. Yet the routinization story by itself is surely an exaggeration. Neither the independent innovator nor the independent entrepreneur has vanished from the face of the earth. On the contrary, they are alive and well and appear to be as active and productive as ever. There are lists of the important innovative breakthroughs of the 20th century and a substantial number of them if not the majority are derived from these sources rather than from the laboratories of business enterprises. Of course, once they become successful, the individuals involved typically organize themselves into business firm such as Xerox, Polaroid and Microsoft, and those firm in turn often turn to routinization of their innovation activities. But they, in turn, are followed by still other entrepreneurs and inventors, and the process goes on, bringing ever more new products and new processes to the economy. These developments have evolved in a way that appears to fall into a pattern. Rather than serving primarily as substitutes, the continuing activities of the entrepreneurs and inventor have followed a direction rather different from the routinized activities of the firm s innovating personnel. The most obvious direction has been that of the business firms whose routinized innovation tended to follow relatively routine directions. They have been slanted toward incremental improvements rather than revolutionary breakthroughs. User friendliness, increased reliability, marginal additions to application, expansions of capacity, f exibility in design, these and many other types of improvement have come out of the industrial R&D facilities, with impressive consistency, year after year, and often pre-announced and pre-advertised. In contrast, if one takes any of the lists of the primary conceptual breakthroughs of the century that has just come to an end, the great leaps forward in unanticipated directions, an impressive proportion is seen to have stemmed from the independent innovators’ sector, as has just been said. It is the unaffiliate inventors and entrepreneurs who have tended to be the suppliers of the dramatic breakthroughs, the ones that deservedly receive the most attention and are most widely recognized and remembered. One is tempted to draw from this description the conclusion that the lone inventors and the entrepreneurs are the clear winners as prime contributors to economic growth and standards of living, but this is by no means an open and shut case. Without in any way seeking to denigrate the entrepreneurs’ enormous contribution, it is nevertheless appropriate to reconsider what the routine innovative activities of the large firm have accomplished. And indeed, it is possible to argue that though their outputs have usually been less dramatic and less spectacular, taking the incremental contributions together and summing their accomplishments, one comes away with the judgment that their accomplishment is not compara-

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tively minuscule. Indeed, there are many cases where the summed incremental contributions plainly outperform the contribution of the original breakthrough. A very clear example is the electronic computer. The firs computer obviously constituted a revolutionary breakthrough in concept. But, as has often been done, we can easily compare its speed, computing capacity and memory with what is available today in instruments with tiny fractions of the earliest instruments’ bulk and weight and a spectacular reduction in cost. We realize quickly that a fairly low-end personal computer today can outperform the original in each of these attributes by a vast multiple, and with far greater reliability, user friendliness and range of applications. Accordingly, the bulk of the speed, computing power and memory capacity of today’s computers is probably attributable to the combined increment additions made by routine research activities in corporate facilities. Other careful observers have extended such examples, and have concluded that incremental and routinized innovation activities have been responsible for a very respectable share of the contribution of innovation to economic growth in the 20th century. Yet there is something misleading about such a comparison, because it casts the innovative activity in the large firm and that of the independent innovative in the role of rivals, as producers of substitute products, each vying for victory over the other. But it seems clear that this is not generally what has happened. Rather, there has tended to be specialization, with the outputs of the two groups tending to complementarity rather than rivalry. More than that, there is a tendency toward serendipity between the two, with each facilitating and supplementing the work of the other. The nature of the specialization is suggested by the preceding discussion. The independent inventor and his entrepreneur partner have tended to be those who produced the radical departures from what were then current products and processes. The big novel idea, the unprecedented way of thinking, the heterodox approach, has been disproportionately in their hands. But with such breakthroughs as raw materials, the groups specializing in routinized innovation have taken over and gone on with the task of transforming the breakthrough models into more easily usable, more powerful and more marketable products, raising them from infancy into mature products with substantial markets and massive outputs. Thus, the result has arguably been super-additive, with the total contribution to the economy’s productive powers greater than the sum of the contributions for which each was individually responsible. The firms takeover of the original inventions from the unaffiliate inventors and entrepreneurs have contributed compensation to the latter, thereby encouraging their activity. Moreover, the inventors have often learned from the less spectacular discoveries in the industrial labs and this has aided them in their subsequent work. The other side of the matter is the fact that the initial breakthrough has so often

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served as the vital ingredient in the work of improvement that was subsequently undertaken by routinized innovation activity. Thus, albeit not perfectly clean-cut, there has been specialization, with considerable benefit to both parties, and the economy has been better off as a result. More than that, it follows that the growth of routinization in the innovation process has not threatened the entrepreneur with obsolescence. He seems in no danger of disappearance or of being deprived of a market for his activities. In this respect, Schumpeter’s remark on the growth of routinization, while not incorrect, may be somewhat misleading.

CONCLUDING COMMENT One of the hallmarks of Austrian economics has been its unwillingness to be tied down to any dogma on method, and certainly has resisted pressures for rigid formalism in analysis. It is this that has enabled it to begin to shed light on subjects such as entrepreneurship, that are ill-suited to formalistic treatment, for reasons I have already suggested. And this is of critical importance, because entrepreneurship is widely accepted as a vital activity, one without understanding of which the market economy’s workings really cannot be comprehended. On this, let me not be misunderstood. I believe that formal analysis has accomplished much and will continue to contribute both understanding and powerful analytic methods. But in an arena such as economics there is no one set of methods that is the right approach everywhere, and this, too, Austrian analysis has demonstrated. Here, I have tried to go one step further, and show how someone not raised in the Austrian tradition can nevertheless build on the Austrian approaches and accomplishments and perhaps even add something more to the insights they have provided.

REFERENCES Baumol, W. J. (1993). Entrepreneurship, management and the structure of payoffs. Cambridge, MA: MIT Press. Baumol, W. J. (2002). The free-market innovation machine: Analyzing the growth miracle of capitalism. Princeton, NJ: Princeton University Press. Gifford, S. (1998). The allocation of limited entrepreneurial attention. Boston, MA: Kluwer Academic Publishers. Kirzner, I. (1979). Perception, opportunity and profit. Chicago, IL: University of Chicago Press. Kirzner, I. (1997). Entrepreneurial discovery and the market process: An Austrian approach. Journal of Economic Literature, 35, 60–85.

ENTREPRENEURSHIP AND DEVELOPMENT: CAUSE OR CONSEQUENCE? Peter J. Boettke and Christopher J. Coyne ABSTRACT This paper discusses the inherent tension in the notion of entrepreneurship as developed by Ludwig von Mises and Israel Kirzner. Given that entrepreneurship is an omnipresent aspect of human action, it cannot also be the “cause” of economic development. Rather, for economic development to take place, certain institutions must be present in order for the entrepreneurial aspect of human action to flourish. After further developing this theoretical insight, an in-depth analysis of the institutions necessary for entrepreneurship is considered. Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things. All governments which thwart this natural course, which force things into another channel or which endeavor to arrest this progress of society at a particular point, are unnatural, and to support themselves are obliged to be oppressive and tyrannical. Adam Smith (1776, p. xliii)

1. INTRODUCTION The question of why some nations are rich and others are poor has been at the center of economic debate for over two centuries. While the post-WWII Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 67–87 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06005-8

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Keynesian-dominated discussion of economic development focused on and emphasized the importance of such factors as foreign aid and government planning, it is now widely agreed that the entrepreneur is the prime driver of economic progress (Kasper & Streit, 1998, pp. 1–23; Leff, 1979). It is also accepted that the institutions that economic agents (including entrepreneurs) operate in – political, legal and cultural – directly influenc their activity and hence economic development (Baumol, 1990; Olson, 1996). Institutions, or the rules of the game, provide a framework which guides activity, removes uncertainty and makes the actions of others predictable. In short, institutions serve to reduce the costs of action and facilitate the coordination of knowledge dispersed throughout society. Economists associated with the Austrian school of economics have long focused their attention on the study of entrepreneurship and the economic analysis of institutions, providing a robust literature emphasizing the importance of these areas (Boettke, 1994, 2001, pp. 234–247; Foss, 1997; Wubben, 1997). In contrast to other schools of economic thought, the Austrians have not only realized the importance of institutions, but have attempted to provide a connection between the market process and an economic understanding of institutions. Moreover, Austrians stress that entrepreneurship does not describe a distinct group of individuals, but rather, is an omnipresent aspect of human action. As Mises wrote: In any real and living economy, every actor is always an entrepreneur and speculator . . . Economics, in speaking of entrepreneurs, has in view not men, but a definit function. This function is not the particular feature of a particular special group or class of men; it is inherent in every action and burdens every actor . . . The term entrepreneur as used in catallactic theory means: acting man exclusively seen from the aspect of the uncertainty inherent in every action (1949, pp. 252–253).

Economic decision makers do not simply react to given data and allocate their scarce means to realize given ends. The entrepreneurial element in human action entails the discovery of new data and information; discovering anew each day not only the appropriate means, but the ends that are to be pursued (Kirzner, 1973, pp. 30–87). Moreover, the ability to spot changes in information is not limited to a selective group of agents – all agents posses the capacity to do so. Herein lies the dilemma in the literature on entrepreneurship and economic development. Given the Austrian insight that entrepreneurship is omnipresent, entrepreneurship cannot also be claimed to be the “cause” of economic development. There are countries that have not achieved a level of economic development consistent with their endowment, the state of technology, and the level of human capital investment in the country, yet economic actors are still coping with uncertainty and striving to be alert to hitherto unrecognized opportunities for gain. Obviously,

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a narrow reading of entrepreneurship cannot help us explain why some nations are rich and other nations languish in poverty. To explore the causal relationship between entrepreneurship and economic growth, we must think more broadly. Entrepreneurship manifests itself differently across alternative institutional regimes and some of these manifestations are consistent with economic development, while others are not. The realization of the role that the rules of the game play in guiding action provides an analytical framework in which we can consider the link between economic progress and entrepreneurship. That is, we must consider the institutions that comprise the societal organizational environment and consider how they serve to channel entrepreneurial activity in one direction or another. The question that motivates us is one that has motivated economists at least since the time of Adam Smith – Why are some nations rich while others are poor? Olson (1996) highlighted an interesting dilemma, namely that there are huge opportunities for mutual gain that continue to go unrealized in the less developed areas of the world. In considering why such opportunities are not exploited in terms of the previously mentioned analytical framework, we must look at the rules of the game which provide incentives to economic actors as entrepreneurs. Simply put, economic growth, driven by entrepreneurship, cannot be explained without reference to institutions. In this paper, we will argue that entrepreneurship cannot be the cause of development, but rather, that the type of entrepreneurship associated with economic development is a consequence of it. That is, development is caused by the adoption of certain institutions, which in turn channel and encourage the entrepreneurial aspect of human action in a direction that spurs economic growth. Given our thesis, in those countries where opportunities are left unexploited, we would expect to fin either a lack of institutions or an institutional structure that discourages certain types of entrepreneurship. Likewise, in those developed countries where opportunities for mutual gain are exploited, we would expect to see an institutional environment that encourages entrepreneurial discovery of the type that generates greater gains from exchange. Entrepreneurship comes in the form of either arbitrage or innovative action, but some arbitrage and innovative actions are limited in scope, while other steps in the arbitrage or innovative direction are transformative in terms of economic development. Section 2 of this paper will serve as an overview of the varying notions of the entrepreneur and his role in economic development. Focus will be placed on the implications of the rules of the game on each particular concept of entrepreneurship. Section 3 will address the mechanics of economic development. We will discuss the neoclassical growth model with particular focus on the critical role that institutions play in economic development. The shortcomings of the model in capturing these critical elements will be discussed. Section 4 will consider

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empirical studies of the various institutions that are the causes of entrepreneurship. Finally, in Section 5, we summarize our finding and provide concluding remarks.

2. ENTREPRENEURSHIP IN THE LITERATURE In this section we will provide an overview of the three main views of the notion of the entrepreneurial process: Schumpeter’s view of the entrepreneur as innovator, Kirzner’s notion of entrepreneurship as arbitrage and the view of entrepreneurship in history as one of betting on ideas.1 In considering each of these views, we will pay particular attention to the implications of the institutional environment on the particular notion of entrepreneurship.2 Before considering Schumpeter’s notion of entrepreneurship and economic development, it is important to clarify his view of the market and his understanding of the capitalist system – his characterization of capitalism is directly tied to the role the entrepreneur occupies within it. While rejecting the widely accepted view of the market as a perfectly competitive construct, Schumpeter couched his analysis in an initial state of general equilibrium.3 He viewed the market process as a dynamic process driven by creative destruction: “It [referring to the market process] must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it . . .” (1950, p. 83). Schumpeter linked the market process of creative destruction – which he associated with “new combinations” – and therefore economic development and progress, to innovation and distinguished the entrepreneur as the prime innovator.4 In addition to being an innovator, the entrepreneur is a leader. His actions channel the means of production into previously unexploited markets and other producers follow him into these new markets (1961, p. 89). Perhaps Kirzner best described the market impact of Schumpeter’s entrepreneur when he wrote: “. . . for Schumpeter the essence of entrepreneurship is the ability to break away from routine, to destroy existing structures, to move the system away from the even, circular fl w of equilibrium” (1973, p. 127). Although not the emphasis of his analysis, Schumpeter recognized that the entrepreneur (in addition to all economic actors) would have to adapt to his surrounding institutional environment: . . . the fiel of individual choice is always, though in very different ways and very different degrees, fenced in by social habits or conventions and the likes: it still remains broadly true that, within the circular fl w, everyone adapts himself to his environment so as to best satisfy given wants . . . as best he can (1960, p. 91).

Moreover, Schumpeter realized the necessity of private property in providing financia motives for entrepreneurial action and hence economic development.5

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The entrepreneur, working within the societal institutional framework will adjust and adopt his actions based on the incentive structure he faces. Without a conducive framework in which he can pursue the activities of innovation and leadership, Schumpeter’s entrepreneur will fail to carry out his function. While there are similarities between Schumpeter’s and Kirzner’s notion of entrepreneurship, there is a foundational juxtaposition between each author’s understanding of the market process which leads to differing views of the role of the entrepreneur.6 As compared to Schumpeter’s characterization of the market process as creative destruction, Kirzner emphasized that markets “tend continually . . . towards equilibrium, as the consequence of continually-stimulated entrepreneurial discoveries” (1999, p. 6). The key concept in Kirzner’s notion of entrepreneurship is the alertness to opportunities – i.e. the discovery of knowledge previously unknown (1973, p. 35, 1979, p. 139). Entrepreneurial discoveries are realizations of ex-post errors made by market participants which either caused them to be, ex-ante, over or under pessimistic in their expectations (1999, p. 6). The existence of error provides scope for profi opportunities that actors can realize if they move in a direction less erroneous than before.7 For Kirzner, alertness, and therefore discovery, is characterized as “knowing where to look for knowledge” (1973, pp. 66–68). While both Schumpeter’s and Kirzner’s notions of entrepreneurship grounded in the exploitation of profi opportunities, the greatest difference is that the former shifts the market away from equilibrium while the latter serves to continually move the market toward equilibrium.8 While Schumpeter’s entrepreneur is an innovator who destroys the current structure, Kirzner’s entrepreneur is alert to arbitrage opportunities based on past errors and serves to exploit and correct those errors, and in doing so, directs the market towards equilibrium. Kirzner recognized the role that the entrepreneur would play in economic development. “In economic development, too, the entrepreneur is to be seen as responding to opportunities rather then creating them; as capturing profi opportunities rather then generating them . . . Without entrepreneurship, without alertness to the new possibility, the long-term benefit may remain untapped” (1973, p. 74). For Kirzner, the competitive market and entrepreneurship are inseparable – the competitive process is in essence entrepreneurial (1973, pp. 15–16). The consideration of economic progress and the institutions that facilitate that development through entrepreneurship occurs here on two levels. First, given that competition and entrepreneurship are inseparable, we must evaluate if the institutional framework provides a structure for competition. Second, we must consider if the institutional framework provides the incentive structure for the entrepreneur to: (1) exercise his subconscious alertness; and (2) act on his alertness to exploit arbitrage opportunities.

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According to Kirzner, competition exists as long as there are no arbitrary barriers to entry (1973, p. 97; 1985, pp. 130, 142). The competitive process necessarily must allow those who are able and willing to provide a potential offer the ability to do so. Only when barriers have been erected to prevent potential competitors from entering the market and offering a more attractive deal will competition be retarded. Furthermore, there can be only two possible restrictions to entry – the lack of resources needed for an activity or government-imposed restrictions. Entrepreneurial activity, according to Kirzner, does not require any initial resources so the only means of restricting the competitive process is the latter – government-imposed restrictions (1973, pp. 99–100). If we are looking for the connection between economic development and the entrepreneur and accept Kirzner’s notion, then one institution we must consider is the presence of barriers to entry. If Kirzner’s notion of entrepreneurship and competition is accurate, we would expect to see countries with high barriers to entry less economically developed than those where the competitive process is largely uninhibited. As discussed, alertness is the key element of Kirzner’s entrepreneur: “. . . the market performs a crucial function in discovering knowledge nobody knows exists . . .” (1979, p. 139). Kirzner also realized that the institutional structure could influenc this aspect of human action: “it must appear highly desirable to choose among alternative social institutional arrangements those modes of organization that generate the greatest volume of spontaneous, undeliberate learning” (ibid., p. 147). If the goal is to encourage the entrepreneurial aspect of human action, the best institutions are those that promote alertness to previously unknown knowledge. For Kirzner, entrepreneurship does not just involve alertness, but also the exploitation of the opportunity realized through alertness: It follows, then, that for opportunities for social improvement to be more rapidly discovered and exploited, these opportunities must be translated into opportunities that are not merely encountered . . . but into opportunities that are to the advantage of these potential entrepreneurs, and that most effectively excite their interest and alertness . . . (ibid., p. 149).

Given such, we must also consider the societal institutional environment in terms of the incentives it provides the entrepreneur in exploiting potential arbitrage opportunities. Here we can make a connection with the motives of Schumpeter’s entrepreneur in terms of the necessity of private property. However, we must be careful to avoid distorting Kirzner’s notion of entrepreneurship. It is critical to remember that Kirzner’s entrepreneur need not own any resources to fulfil his function: 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 . . . It is not yielded by

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exchanging something the entrepreneur values less for something he values more highly. It comes from discovering sellers and buyers of something for which the latter will pay more that the former demand. The discovery of a profi opportunity means the discovery of something obtainable for nothing at all. No investment is required; the free ten-dollar bill is discovered to already be within one’s grasp (1973, p. 48).

However, as Harper (1998) has pointed out, although the ownership of property is not a necessary condition for alertness, it would be extremely difficul for entrepreneurs to execute on the opportunities they have observed without it (in Kirzner’s example the “sellers” and “buyers” involved in the transaction did not have known control of the related resources). Moreover, although the entrepreneur need not start with any assets, it is quite possible that he will own some of the capital necessary to execute on his plan (Kirzner, 1973, p. 49, 1985). The third view that we will consider is the notion of entrepreneurship in history as one of “betting on ideas” (Brenner, 1985; Mokyr, 1990). Historians, in an attempt to explain the economic advancement of developed countries, often use this notion of entrepreneurship. Its main focus is on the uncertainty of innovation as well as the risks and gambles involved in changing a known production process, or introducing a new product. Through historical analysis of economic development, this notion concludes that a number of institutions facilitated entrepreneurs in their role as risk takers and innovators. That is, the rules of the game provided the stability and incentive for individuals to take risks. Examples include the creation of firm to diversify risk (Mokyr, 1990), a stable monetary policy (Brenner, 1985), a predictable rule of law, the introduction of bills of exchange, insurance, private property, a standardized accounting methodology, the development of a widely understood business ethic and a regular and systematic code of government taxation (Birdzell & Rosenberg, 1986, pp. 29–30, 113–139). These institutions served to facilitate innovative behavior due to decreased uncertainty and therefore decreased risks. Prior to the development of these institutions, the gamble of undertaking potentially innovative activities was in many cases too high. With these institutions in place, prospective entrepreneurs were able to shed a portion of the risk and participate in such activities. This notion of entrepreneurship provides insight into the impact of various institutions on the risk/reward tradeoff that economic agents, acting within them, face. Despite differences in the notion of entrepreneurship, each of the notions emphasizes the dual role of entrepreneurship in the economic process – this is represented in Fig. 1. The entrepreneur, in discovering previously unexploited profi opportunities, pushes the economy from an economically (and technologically) inefficien point (A) towards the economically (and technologically) efficien production point (B). Moreover, in discovering new technology and new production processes, which use resources in a more efficien manner, the

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Fig. 1.

entrepreneurial process shifts the entire production possibility curve out from “pp 1” to “pp 2” (Kirzner, 1985).9 This shift represents the essence of economic growth – an increase in real output due to increases in real productivity. Additionally, we can fin further parallels that tie the varying concepts of entrepreneurship together – specificall the institutions or environment that are necessary for the entrepreneur to fulfil his function. We have already discussed the importance of private property for all three notions of entrepreneurship. Moreover, we can put forth several other general categories of institutions which apply to all three views of entrepreneurship: a notion of freedom, a rule of law which is certain, general and equally applicable to all, freedom of choice, and the ability to freely contract with others (Birdzell & Rosenberg, 1986; Brenner, 1994; Harper, 1998; Mokyr, 1990; North, 1994; Olson, 1996).10 We will return to a discussion of the institutions that encourage entrepreneurship in Section 5 of this paper when we consider empirical studies on the topic.

3. MECHANICS OF ECONOMIC DEVELOPMENT We have established that the entrepreneurial aspect of human action is the prime catalyst of economic growth. Moreover, we have discussed several notions of the entrepreneurial function and the role that institutions play in encouraging or discouraging that aspect of human action. We now turn to a discussion

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of neoclassical growth economics and the role – or lack thereof – that the entrepreneur and institutional organization play in that framework. Neoclassical growth theory has long overlooked the importance that institutions play in economic growth (Kirzner, 1985; North, 1994). Simply put, for Neoclassical economists, institutions did not matter. Instead, they focused on calculating equilibrium as well as the relevant prices, variables and outputs for arriving at that end state. It was not until the postwar period that economists began to realize the importance of the entrepreneur as the driver of economic progress. Several decades later (1960s–1970s), economists began to focus on institutions in their analysis of economic growth (Kasper & Streit, 1998). As Stiglitz writes: The neoclassical view prevailed until 30–40 years ago, when people became convinced that the laws of supply and demand did not explain everything about economic equilibria . . . The breakthrough came when people began to recognize that economic theory ought to be able to explain the reason for institutions in a society, the functions they serve and the forms they take (2000, pp. 2–3).

The standard neoclassical growth model is define as: Y = K, L, Tech, SK, NR, ST Capital (K) was originally deemed important for long-term growth since it was assumed that growth was positively correlated to the accumulation of capital, which in turn is a function of savings and net investment. Soon thereafter, economists began focusing on the relationship between capital, labor (L) and technology (Tech). An increase in labor was seen as having a positive influenc on growth. Likewise, technological advances shifted the production function out, allowing for increased levels of output. Growth theory was further refine when economists realized the importance of human capital. Increases in the skills and knowledge (SK) of the labor force had a positive correlation with increases in productivity. Moreover, natural resources (NR) were included as an important determinant in economic growth. This was a logical inclusion because natural resources, like all other factors, are scarce and there was rising concern in the late 1960s that the supply of some natural resources might soon become exhausted. Finally, in the 1970s some studies indicated that the structural organization of economic activity changes (ST) as income changes, or that macroeconomic growth was an extension of microeconomic foundations. While not denying the importance of the factors mentioned above, the neo-classical growth model suffers from its inability to incorporate the relationship between time and the institutional structure.11 In short, the neoclassical model fails to ask the pertinent questions why? and what? Why is there capital accumulation through forgone consumption and investment or a lack thereof? Why are there

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new technological advances in some countries and not others? Why is existing technology used more efficientl in some places as compared to others? What causes laborers to invest in their own development and what causes employers to invest in their employees? Why are natural resources used in different ways in different countries and why are the same resources used more efficientl in some countries as compared to others? What are the incentives that economic actors face and why do they act as they do? These questions can only be answered in the institutional context. If some countries have higher capital accumulation than others, or faster and more innovative technological advances, or a more highly skilled labor force, we can conclude that there are incentives in place to encourage this behavior. The neoclassical growth paradigm is incapable of capturing this information and therefore is unable to accurately predict economic development.12 As North writes: Neoclassical theory is simply an inappropriate tool to analyze and prescribe policies that will induce development. It is concerned with the operation of markets, not with how markets develop . . . When applied to economic history and development it . . . ignored the incentive structure embodied in institutions . . . In the analysis of economic performance through time it contained two erroneous assumptions: (i) that institutions do not matter; and (ii) that time does not matter (1994, p. 359).

The emptiness of growth theory is present not only in its inability to consider the rules of the game and the incentives that those rules provide, but also in its failure to understand the growth process itself. An economic analysis lacking institutional considerations has led many economists to offer misguided policy advice. For an example of this, one need only look at the fall of the Soviet empire and the inability of western economists to both predict its occurrence and to offer pertinent development advice directly after the fact. Human interaction in an economy relies on regular, expected patterns of behavior. The rules of the game facilitate interaction and reduce the coordination costs of undertaking economic activities by making actions more predictable. In addition, the institutions that arise provide an incentive structure that influence the actions that economic agents, including entrepreneurs, will take. Given that the entrepreneur is the catalyst of economic growth, any theory of economic development must consider the deeper issues that effect the entrepreneurial aspect of human action. These issues include a broad range of institutions including political, legal and sociological considerations such as culture, ideology, values and preferences.13 Additionally, in order to arrive at more robust results, economic growth theorists must recognize that development is the result of a mixture of formal and informal rules and that the same rules will have different consequences when applied to different economies. Moreover, political regimes directly influ ence development through both the intended and unintended consequences of their

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involvement in the institutional environment. Finally, adaptive institutions, which are able to change and evolve over time, are more likely to lead to faster economic development as compared to institutions that are infl xible (North, 1994). In order to continue to develop an understanding of economic growth, one constructive endeavor for both Austrians and Neoclassicals to undertake is the development of an analytical framework which can be used to judge the effectiveness of various institutions. There is a great opportunity for the further development of this analytical construct. Initially, some measurement must be developed to identify “good” institutions from “bad” institutions. Stiglitz (2000) has suggested a basic benchmark of a good institution as one that fulfill its function. This, of course, is a very general benchmark which would need clarificatio to be effective. Additionally, this point of reference only considers the stated goals versus the performance. Other considerations include the allocation of resources or services due to the operation of the institution – that is, does the institution grant favors or special privilege to some while excluding others? If it is agreed that the entrepreneur is the driver of economic progress, economists should also continue to develop measurements to determine the impact of certain institutions on that function of entrepreneurship. Creating an analytical framework with which economists can study the rules of the game will only help in better understanding economic development.

4. INSTITUTIONS AS CAUSE, ENTREPRENEURSHIP AS CONSEQUENCE Having concluded that the entrepreneur is indeed the prime driver of economic progress within a certain institutional framework, we now turn to a survey of the literature on entrepreneurship in the developing market context. In these contexts, the institutions within which economic actors transact are undergoing a process of transformation. As discussed, it is widely agreed that the incentive structure influence the action of economic agents. This allows us to rule out such considerations as the availability of technological knowledge, the population level, migration, etc. as factors which can serve to explain the differences in wealth across countries (Olson, 1996). Instead, we can focus on the institutional environment and consider its influenc on economic activity.14 The two most important “core” institutions for encouraging entrepreneurship are well-define property rights and the rule of law. It is well established that those countries where these core institutions are developed have a record of strong economic growth (Boettke & Subrick, forthcoming; Gwartney, Holcombe & Lawson, 1998, 1999; Scully, 1988). Moreover, a majority of the other institutions

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that are correlated with economic growth are grounded in these two institutions. In a study of fi e post-communist countries, it was found that the two countries (Russia and Ukraine) placed in the “backward group” diverged from the others largely due to differences in protection of property. The study also confirme that these countries had the weakest rule of law. Courts were used less and the cost of interacting with government was higher in these countries (Johnson, McMillan & Woodruff, 2000). In addition to property and the rule of law, the previously mentioned survey also considered fir performance (growth, contraction and start-ups) and the development of market infrastructure – which are directly linked to the core institutions. One is able to further realize the importance of the core institutions by analyzing the “unofficia economy.” We normally see an underground economy in those countries where property rights and the rule of law do not exist or are poorly define or enforced. Extralegal activities evolve in order to circumvent the current institutional structure which prevents or retards key economic activities. This usually occurs through the prohibition of certain transactions, or the failure to enforce transactions due to poorly define property rights or rule of law. Examples of institutions that stunt economic growth include government, police and/or court corruption, excessive taxation and/or regulation, unstable and/or inconsistent monetary and fisca policy (Frye & Shleifer, 1997; Gwartney, Holcombe & Lawson, 1998, 1999; Johnson, Kaufmann & Zoido-Lobaton, 1998; Johnson, McMillan & Woodruff, 1999, 2000; Schleifer, 1997; Schleifer & Vishney, 1993, 1994; de Soto, 1989, 2000). There have been several studies which attempt to measure the unofficia economy and the variables that cause its existence (Enste & Schneider, 2000; Johnson, Kaufmann & Shleifer, 1997; Johnson, Kaufmann & Zoido-Lobaton, 1998). The finding of these studies serve to highlight the institutional structure – or lack thereof – which encourages underground activity. These studies have identifie several general relationships between the institutional structure and underground economic activity. First, there is high correlation between the percentage of total GDP comprised by the unofficia economy and the level of regulation – the unofficia economy comprises a large share of GDP in those countries with stringent and excessive regulations. Second, higher taxes on businesses lead to higher levels of unofficia economic activity. Third, higher levels of corruption – government, police, and courts – lead to higher levels of unofficia economic activity. The study of fi e post-communist countries discussed above supports these findings Russia scored a 4 out of 5 in terms of regulation (the higher the score the worse the regulations for business) and scored last in regulatory discretion and lax enforcement of rules (Johnson, McMillan & Woodruff, 2000). Furthermore, in a separate but related study, Ukraine scored last in terms of tax structures that helped business

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with Russia not far behind. Both countries also scored extremely low in terms of rule of law (Johnson, Kaufmann & Zoido-Lobaton, 1998). Clearly the lack of institutions in these countries is highly correlated with their lack of economic growth. Capital fligh is yet another indicator which highlights the influenc of the institutional environment on entrepreneurship and hence, economic growth. Again, the issue of capital fligh is directly linked to the core institutions – private property and the rule of law. It has been established that foreign capital only matters after private property has been established. Even with capital at the entrepreneur’s disposal, there will be little incentive for him to invest it without property rights (Johnson, McMillan & Woodruff, 2000).15 Additionally, as discussed in Section 2, the notion of entrepreneurship – especially for Kirzner – does not require the ownership of any resources to undertake entrepreneurial activities. However, as indicated, it is often the case that the entrepreneur does own resources that are used in the execution of his plan. Furthermore, even if the entrepreneur does not own or contribute any of his own capital, it is a safe assumption that capital will be needed from some source to accomplish his plan. It is in this aspect that we can make the connection between the importance of well-define property rights and the notion of capital. Property rights, while critical in encouraging capital fl w into a country, are not the only influencin factors. Other variables that play a key role in attracting capital are the stability and certainty of the tax structure, macroeconomic stability (including controlled inflatio and stable monetary policy), trade rules and regulations and the ability of agents to develop their own businesses and firm which in turn allows for the development of investor confidenc (Bhattacharya, 1999; Sheets, 1996; Wintrobe, 1998). Hernando de Soto has identifie the following “effects” that have allowed the West to develop capital: (1) definin the economic potential of assets through securities, title, contract, etc.; (2) integrating legal information into one system; (3) making people accountable through the legal system; (4) making assets fungible by representing them in some standard form facilitating interaction and exchange; (5) forming a network of people which allows assets to move between agents; and (6) protecting transactions via the rule of law (2000, pp. 49–62). Recalling that the role of institutions is to remove uncertainty and facilitate social interaction, the effects identifie by de Soto make logical sense. In those countries where the environment is characterized by uncertainty and riskiness, there is great potential for a lack of capital which makes it difficul for entrepreneurs to carry their plans to fruition.

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In discussing overall economic development as well as capital flight one of the key factors is the ability of agents to form firms 16 The fir is important to economic development for several reasons. As discussed in Section 2, the fir allows for the diversificatio of risk and encourages research, development and innovation. Moreover, the fir enables workers to specialize and allows for different individuals with varying skills, knowledge and ideas to interact, potentially spurring innovation. Given this, we can learn much about an institutional structure by considering its effect on startups and spin-offs.17 This indicator is closely tied to the previously discussed notion of capital. The ability to attract capital, in part, relies on how capable firm are in attracting investors. However, to grow and become more stable, firm need capital to fund their expansion. There is a circularity here that can lead to continued difficult and economic stagnation if it is not remedied. If there is a shortage of capital, firm may have a difficul time expanding operations and gaining stability which in turn, may sour investor confidenc to supply capital. Much depends on how institutions are implemented and the signals that those institutions send to foreign investors. Returning to the study of fi e post-communist countries, startups and spin-offs were “stagnant” in the “backward group” while the other three countries considered (Poland, Slovakia, and Romania) were much more “dynamic” (Johnson, McMillan & Woodruff, 2000). Again, this is in line with our conclusion that those countries with well-define property rights and the rule of law develop at a faster rate than their counterparts. Having concluded that the core institutions for economic development are welldefine property rights and the rule of law, we must address the issue of transition. There is much literature on this topic but we will limit ourselves here to a discussion of some of the issues that a country faces when attempting to implement these institutions. Institutional change is often met with many barriers – new rules and institutions often clash with their longer-established counterparts. Additionally, there is often corruption, rent seeking and power grabbing by government official and those who seek privilege from them. Finally, even with institutional change, the underlying values and culture of a country may be slow to change and prohibit the new institutions from being effective. Regarding privatization and deregulation, there are many issues that must be decided including the valuation and sale of public assets, distribution of sale proceeds, the speed and sequence of privatization, what sectors or industries to privatize and how much of the economy to privatize, as well as the many political and bureaucratic barriers that are sure to arise. Establishing a rule of law that is conducive to economic growth suffers from the problems discussed above as well as coordination with privatization and deregulation. Historically, those countries that have well-define property rights and a strong rule of law also have a high growth rate. In considering developing countries,

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those that have adopted these core institutions as well as others that stem from it – freedom of choice, predictable government activity, rules conducive to market and fir development, freedom of contract and exchange, etc. – have also grown at a faster rate as compared to their counterparts which have adopted different institutions. The adoption of these institutions has provided an incentive structure which encourages the entrepreneurial aspect of human action, and hence continued economic progress.

5. CONCLUSION While economists have a difficul time arriving at unanimous agreement, there are a few general principles where the profession is able to fin common ground. It is agreed that incentives matter and that the institutional environment in which the economic agent acts serves as an incentive structure which guides and influence action. Moreover, it is widely agreed that the entrepreneur is the catalyst of economic progress. The Austrians have long realized the importance of the entrepreneur and the need for economic analysis of the institutional organization that influence economic actors. For the Austrians, the entrepreneurs are not a separate class of individuals who fulfil an entrepreneurial function. Rather, entrepreneurship is an omnipresent aspect of human action such that all individuals are entrepreneurs. Given this, entrepreneurship cannot be the cause of economic development. Instead, we must look at the rules of the game and determine the behaviors which those incentives encourage and discourage. We have demonstrated that entrepreneurship is a consequence of a country’s development – specificall the adoption and development of institutions that encourage the entrepreneurial aspect of human action. Stimulating entrepreneurial action will in turn spur economic development and growth. Therefore, if economic growth is the goal, attention should be paid to achieving the institutional mix that encourages the entrepreneurial aspect of human action. Neoclassical growth theory is ill equipped to deal with the time and institutional aspects that are critical for a fir understanding of economic development. The formalized models overlook the deeper issues – institutional evolution, political, legal and sociological – that influenc entrepreneurship. There is a robust research program for Austrians and Neoclassicals alike in determining an analytical framework by which we are able to evaluate the effectiveness of institutions on growth and development. We determined that the two core institutions necessary for achieving the goal of encouraging entrepreneurship are private property and the rule of law. While these are not the only institutions that influenc entrepreneurship, the impact of all

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other institutions stems from the adoption of these core institutions. Determining the institutions which encourage entrepreneurship and implementing them are very different endeavors. There are many barriers to transition including political, bureaucratic, and resistance to change. Institutions which are effective in one country may fail to have the same impact in other countries. This is due to the fact that institutions operate in a moral and cultural context, which in some cases may hamper the workings of the market. This is not a result of the market as such, but rather how agents decide to act within it.

NOTES 1. For further discussion on entrepreneurship in the literature (see Kirzner, 1973, pp. 75–84). For a discussion of the historical role of the entrepreneur in economic theory (see Blaug, 1998; Soltow, 1968). For a discussion of the development of entrepreneurship in the Austrian school (see Kirzner, 1994). 2. Baumol (1990) makes the distinction between “productive” and “unproductive” entrepreneurship. If anything, his analysis further highlights the simple fact that institutions matter. Our analysis of the institutional structure dovetails nicely with Baumol’s thesis in that we realize that the societal organization channels the entrepreneurial aspect of human action towards certain activities. However, while Baumol focuses on productive (i.e. innovation, etc.) versus unproductive (i.e. rent seeking and organized crime) entrepreneurship we focus on this aspect of human action as being transformative or not. Transformative entrepreneurship requires alertness to hitherto unknown opportunities. An example of this is the recent trend of drug dealers in Baltimore lowering the age of their distributors and providing them with mopeds. This entrepreneurial activity (in the sense that it reflecte alertness to a previously unknown opportunity) lowers the cost of getting caught and raises the cost of the police catching the distributors. Furthermore, this activity is neither productive nor unproductive in the sense that Baumol uses these terms. 3. For a further discussion of Schumpeter’s analysis of entrepreneurship grounded in Walrasian general equilibrium (see Rothbard, 1997). 4. Schumpeter was careful to distinguish between “innovation” and “invention”: This function does not essentially consist in either inventing anything or otherwise creating the conditions which the enterprise exploits. It consists in getting things done (1950, p. 132).

And further juxtaposing the role of inventor with the entrepreneurial role of innovation: As long as they are not carried into practice, inventions are economically irrelevant. And to carry any improvement into effect is a task entirely different from the inventing of it . . . Although entrepreneurs of course may be inventors . . . they are inventors not by nature of their function but by coincidence and vice versa (1960, pp. 88–89).

Innovation on the other hand can be characterized as the introduction of a new good(s), introducing new production or technical method(s), opening a new market, new sources of raw materials or new forms of industry organization (1960, p. 66).

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5. In his analysis of the entrepreneur, Schumpeter attempted to consider the various motives that may drive his efforts. In doing so, he put forth three groups of motives: power and independence, to succeed simply for the intrinsic value of success (i.e. for success’ sake), and the joy of creating and achieving. Schumpeter postulated that only the firs group of motives required the institution of private property. He also realized that discarding this motive would retard development: “These and other peculiarities incident to the mechanism of ‘acquisitive’ society make it very difficul to replace it as a motor of industrial development . . .” (1960, pp. 93–94). 6. It is well known that the differing views of the two authors on the notion of entrepreneurship has led to continued debate and a great deal of literature. Kirzner has recently put forth a reconsideration of both his and Schumpeter’s entrepreneur. In so doing, he has drawn several new connections between both notions of entrepreneurship and responded to a number of the criticisms of his earlier work on this topic (see Kirzner, 1999). 7. On a theoretical level, the importance of Kirzner’s insight should not be understated because his work provides us with the disequilibrium foundations for the equilibrium economics that underlies standard price theory. Without these disequilibrium foundations, as Franklin Fisher (1983) has argued, our intellectual confidenc in the teachings of standard microeconomics would have to fade away. 8. It must be made clear that for Schumpeter, innovation in technology is the only source of change. Since he started from a Walrasian general equilibrium, tastes and resources could not be the source of change. 9. Another relevant point here is the “spillover” effect of entrepreneurship. When entrepreneurs exploit profi opportunities, they simultaneously create new entrepreneurial opportunities for others to exploit (Holcombe, 1998). The entrepreneurial process is reliant on an incentive structure which encourages the entrepreneurial aspect of human action. Additionally, the entrepreneurial aspect of human action is, in a sense, self-sustaining since it creates an environment of further discovery. 10. This is hardly a complete list of the freedoms sufficien or necessary for entrepreneurship. (See Harper, 1998 for a more complete list.) 11. In the neo-classical effort to develop a mathematically formal model, this exclusion makes logical sense. The other variables in the growth model are for the most part easily quantifiabl while the institutional structure and its evolution over time are difficul if not impossible to capture in mathematical form. 12. It must be noted that there have been some attempts to incorporate rule of law and private property indexes in studies of economic growth (Barro, 1997). However, these attempts still suffer from the fact that that these indexes fail to capture the institutional process – i.e. the development of institutions over time. At best, these studies are able to compare two sets of historical data to observe the changes at two distinct points in time. 13. Olson found that differences in personal culture explain only a small part of differences in per capita income between the rich and poor countries (1996, p. 19). However, culture and ideology do have an important influenc on the development of entrepreneurship (Boettke, 2001, pp. 248–265). Culture plays a key role in encouraging certain characteristics and values – independence, risk-taking, innovation, competitive aggressiveness (Lee & Peterson, 2000) – which will influenc the impact that institutions have. 14. A findin in the literature on development is that foreign aid tends to be ineffective in countries that lack good governance, but effective in countries that have good governance. The trouble with this conclusion is that countries that have good governance tend to be

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countries that do not need foreign aid. Our argument about entrepreneurship and the institutional environment is simply a variant of this empirical claim – entrepreneurship generates economic growth within the right institutional environment. Entrepreneurial activity outside of that institutional environment will not be effective in generating economic growth. Our argument leads us back to the quote from Adam Smith that is at the beginning of this paper – if you get the right basic institutions, all else takes care of itself in the natural course of individuals realizing the mutual gains from exchange. 15. Another point to consider is that weak financia markets may not prohibit economic growth if companies are able to reinvest their own profits see Johnson, McMillan and Woodruff (2000). 16. There is some empirical literature linking entrepreneurship to economic growth in the industrial organization context. While these studies do not focus on entrepreneurship as an omnipresent aspect of human action, they do realize the importance of the formation of firm as a key element in manifesting entrepreneurial activity and hence, economic growth. This literature serves as an extension of the underlying Austrian insight regarding entrepreneurship. See Audretsch, Leeuwen, Menkveld and Thurik (2001); Audretsch, Carree, Stel and Thurik (2002); Reynolds, Miller and Maki (1995); and Reynolds, Storey and Westhead (1994) for work in this area. 17. For a study of regulation barriers to establishing businesses, see Djankov, La Porta, Silanes and Shleifer (2000) and Parente and Prescott (1994). See Sautet (2000) for a discussion of the necessity of firm for the exploitation of discovered profi opportunities.

ACKNOWLEDGMENTS We acknowledge the financia assistance of the J. M. Kaplan Fund to support our research. The usual caveat applies.

REFERENCES Audretsch, D. B., Caree, M. A., van Stel, A. J., & Thurik, A. R. (2002). Impeded industrial restructuring: The growth penalty. KYKLOS, 55, 81–98. Audretsch, D. B., van Leeuwen, G., Menkveld, B., & Thurik, A. R. (2001). Market dynamics in the Netherlands: Competition policy and the role of small firms International Journal of Industrial Organization, 19, 611–862. Barro, R. J. (1997). Determinants of economic growth: A cross-country empirical study. Massachusetts: MIT Press. Baumol, W. J. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political Economy, 98, 893–921. Bhattacharya, R. (1999). Capital fligh under uncertainty about domestic taxation and trade liberalization. Journal of Development Economics, 59, 365–387. Birdzell, L. E., & Rosenberg, N. (1986). How the west grew rich: The economic transformation of the industrial world. New York: Basic Books.

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Blaug, M. (1998). Entrepreneurship in the history of economic thought. In: P. J. Boettke, I. M. Kirzner & M. J. Rizzo (Eds), Advances in Austrian Economics (Vol. 5, pp. 217–239). Connecticut: JAI Press. Boettke, P. J. (1994). Alternative paths forward for Austrian economics. In: P. J. Boettke (Ed.), The Elgar Companion to Austrian Economics (pp. 601–615). UK: Edward Elgar Publishing. Boettke, P. J. (2001). Calculation and coordination: Essays on socialism and transitional political economy. London & New York: Routledge. Boettke, P. J., & Subrick, J. R. (forthcoming). Rule of law, development and human capabilities. Supreme Court Economic Review. Brenner, R. (1985). Betting on ideas: Wars, inventions, inflation. Chicago: University of Chicago Press. Brenner, R. (1994). Labyrinths of prosperity: Economic follies, democratic remedies. Michigan: University of Michigan Press. Djankov, S., La Porta, R., de Silanes, F. L., & Shleifer, A. (2001). The regulation of entry. National Bureau of Economic Research, Working Paper 7892. Available at: www.nber.org Enste, S., & Schneider, F. (2000). Shadow economies around the world: Size, causes and consequences. International Monetary Fund Working Paper: WP/00/26. Fisher, F. (1983). The disequilibrium foundations of equilibrium economics. New York: Cambridge University Press. Foss, N. J. (1997). On Austrian economics and neo-institutionalist economics. In: W. Keizer, B. Tieben & R. van Zijp (Eds), Austrian Economics in Debate. New York: Routledge. Frye, T., & Shleifer, A. (1997). The invisible hand and the grabbing hand. American Economic Review, Papers and Proceedings, 87, 354–358. Gwartney, J., Holcombe, R., & Lawson, R. (1998). The scope of government and the wealth of nations. Cato Journal, 18, 163–190. Gwartney, J., Holcombe, R., & Lawson, R. (1999). Economic freedom and the environment for economic growth. Journal of Institutional and Theoretical Economics, 155, 643–663. Harper, D. A. (1998). Institutional conditions for entrepreneurship. In: P. J. Boettke, I. M. Kirzner & M. J. Rizzo (Eds), Advances in Austrian Economics (Vol. 5, pp. 241–275). Connecticut: JAI Press. Holcombe, R. (1998). Entrepreneurship and economic growth. The Quarterly Journal of Austrian Economics, 1, 45–62. Johnson, S., Kaufmann, D., & Shleifer, A. (1997). The unofficia economy in transition. Brookings Papers on Economic Activity, 2, 159–221. Johnson, S., Kaufmann, D., & Zoido-Lobaton, P. (1998). Government in transition: Regulatory discretion and the unofficia economy. The American Economic Review, 88, 387–392. Johnson, S., McMillan, J., & Woodruff, C. (1999). Why do firm hide? Bribes and unofficia activity after communism. Working Paper: Centre for Economic Policy Research Discussion Paper: 2105. Johnson, S., McMillan, J., & Woodruff, C. (2000). Entrepreneurs and the ordering of institutional reform: Poland, Slovakia, Romania, Russia and the Ukraine compared. Economics of Transition, 8, 1–36. Kasper, W., & Streit, M. E. (1998). Institutional economics: Social order and public policy. UK: Edward Elgar Publishing. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1979). Perception, opportunity, and profit: Studies in the theory of entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1985). Discovery and the capitalist process. Chicago: University of Chicago Press.

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Kirzner, I. M. (1994). Entrepreneurship. In: P. J. Boettke (Ed.), The Elgar Companion to Austrian Economics (pp. 103–110). UK: Edward Elgar Publishing. Kirzner, I. M. (1999). Creativity and/or alertness: A reconsideration of the Schumpeterian entrepreneur. The Review of Austrian Economics, 11, 5–17. Lee, S., & Peterson, S. (2000). Culture, entrepreneurial orientation, and global competitiveness. Journal of World Business, 35, 401–416. Leff, N. A. (1979). Entrepreneurship and economic development: The problem revisited. Journal of Economic Literature, 17, 46–64. Mises, L. von [1949] (1996). Human action: A treatise on economics. San Francisco: Fox & Wilkes. Mokyr, J. (1990). The lever of riches: Technological creativity and economic progress. New York: Oxford University Press. North, D. C. (1994). Economic performance through time. The American Economic Review, 84, 359–368. Olson, M. (1996). Big bills left on the sidewalk: Why some nations are rich and others poor. Journal of Economic Perspectives, 10, 3–24. Parente, S. L., & Prescott, E. C. (1994). Barriers to technology adoption and development. The Journal of Political Economy, 102, 298–321. Reynolds, P. D., Miller, B., & Maki, W. R. (1995). Explaining regional variation in business births and deaths: U.S. 1976–1988. Small Business Economics, 7, 389–407. Reynolds, P. D., Storey, D. J., & Westhead, P. (1994). Cross national comparison of the variation on the new fir formation rates. Regional Studies, 28(4), 443–456. Rothbard, M. N. (1997). Breaking out of the Walrasian box: Schumpeter and Hansen. Printed in: The Logic of Action Two: Applications and Criticism from the Austrian School. UK: Edward Elgar Publishing. Sautet, F. E. (2000). An entrepreneurial theory of the firm. New York: Routledge. Schleifer, A. (1997). Schumpeter lecture: Government in transition. European Economic Review, 41, 385–410. Schleifer, A., & Vishney, R. W. (1993). Corruption. Quarterly Journal of Economics, 108, 599–617. Schleifer, A., & Vishney, R. W. (1994). Politicians and firms Quarterly Journal of Economics, 109, 995–1025. Schumpeter, J. A. (1950). Capitalism, socialism and democracy. New York: Harper & Brothers Publishers. Schumpeter, J. A. (1961). The theory of economic development. New York: Oxford University Press. Scully, G. W. (1988). The institutional framework and economic development. Journal of Political Economy, 96, 652–662. Sheets, N. (1996). Capital fligh from countries in transition: Some empirical evidence. Journal of Policy Reform, 1, 259–277. Smith, A. (1776) [1991]. The wealth of nations. New York: Prometheus Books. Soltow, J. H. (1968). The entrepreneur in economic history. The American Economic Review, 58, 84–92. de Soto, H. (1989). The other path: The invisible revolution in the third world. New York: Harper & Row Publishers. de Soto, H. (2000). The mystery of capital: Why capitalism triumphs in the west and fails everywhere else. New York: Basic Books. Stiglitz, J. E. (2000). Challenges in the analysis of the role of institutions in economic development. Keynote address at the Villa Borsig Workshop Series – The Institutional Foundations of a Market Economy. Available at: http://www.dse.de/ef/instn/stiglitz.htm

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Wintrobe, R. (1998). Privatization, the market for corporate control, and capital fligh from Russia. University of Western Ontario Department of Economics Research Reports/TERF Reports: 9804. Available at: http://ideas.uqam.ca/ideas/data/Papers/uwouwowop9804.html Wubben, E. F. M. (1997). Entrepreneurship, interdependency and institutions: The comparative advantages of the Austrian and post-Keynesian styles of thought. In: W. Keizer, B. Tieben & R. van Zijp (Eds), Austrian Economics in Debate (pp. 192–219). New York: Routledge.

DIFFERENTIATION AND CONTINUITY IN THE MARKET ECONOMY G. B. Richardson ABSTRACT The effective working of market economies is dependent, for reasons not fully recognised, on the existence, and on the relative stability, of differences in the capabilities of individual firms. General equilibrium theory abstracts from these circumstances and is therefore unable to explain how economic adjustment actually takes place; a proper appreciation of the role played by differentiation and continuity enables to do this and to assess the scope and limitations of the process. It is in the tradition of the Austrian School to seek to explain economic phenomena in terms of the consequences of individual actions, and to recognise that these actions are taken on the basis of subjective beliefs about both technical possibilities and what other relevant people in the system – consumers, suppliers and competitors – are likely to do. This being so, it is obviously appropriate to enquire as to what particular features of a market economy would make it easier or more difficul for business men to form beliefs which will prove to be justifie in the event. On the face of it, this is a reasonable question to ask, but one which is ruled out of consideration by theory which focuses on the pure logic of decision-taking on the basis of a full specificatio of the relevant information. It is characteristic of the Austrian approach, however, to keep the epistemology, as well as the logic, of Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 89–95 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06006-X

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decision taking in the foreground – a circumstance of which I firs became aware when I read, as a student, the famous article, Economics and Knowledge, which Hayek published in Economica in 1937. In addressing the question to which I have referred, perhaps I could claim to situate myself broadly within the Austrian tradition.1 In this paper I shall argue that the effective working of market economies is dependent, for reasons not fully recognised, on the existence, and on the relative stability, of differences in the capabilities of individual firms A proper appreciation of the role of these differences, I shall maintain, enables us to understand the scope and limitations of the processes that promote an efficien use of resources. It may be thought that these processes are already well understood, an account of them having been given in broad terms by Adam Smith over two centuries ago, and subsequently refine by a succession of writers since that time. Over one century ago, Walras developed a general equilibrium model, which purported to identify a configuratio of prices and outputs towards which, given perfect competition, all prices and outputs throughout the economy would tend to move. Pareto demonstrated its normative properties. Then half a century later, Arrow and Debreu published a fully developed mathematical theory of general equilibrium that, by some if not all economists, came to be regarded as a fina apotheosis. Whatever else they may have established, I do not believe that Arrow and Debreu, any more than Walras, provide an explanation of how economic order in fact does, or ever could, come about spontaneously in the world we know. Walras sought to illustrate the attainment of general equilibrium by means of a special kind of auction in which a process of tentative bidding, on the basis of provisional prices, caused these prices to be varied until demand and supply came into balance in all markets. Arrow and Debreu extended this approach by presupposing the establishment of a complete system of contracts related to an unlimited number of goods distinguished not only be their physical characteristics, but also by their place and date of delivery and the state of the world at that time. Now it is clear beyond any argument that economic order in the real world does not come about as a result of the complex contracting procedures, the postulation of which can be justifie only as a heuristic device. General equilibrium theory tells us nothing about the processes of adjustment in the real world; indeed, as we shall see, it abstracts from circumstances that make such adjustment possible. Whatever value the theory may have, we are not entitled to draw from it any conclusions about how economic order could be realised, or about the institutional arrangements, the market structures, and the distribution of knowledge and skills that would have to be in place. General equilibrium theory is associated with a complete set of contracts, which ensure “clearance” in all markets. In the world as we know it, contracting certainly

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does play an important role in the process of resource allocation. No economic activity can be said to be profitabl or useful taken by itself, but only within an appropriate context of related activities. A fir contemplating the production of a good will therefore want to know that the required inputs will be available and that a sufficien demand for the good can be depended upon. In order to ensure this, contracts may be entered into with suppliers and, if possible, orders for the product sought in advance. In this way cooperation enters into the process of resource allocation, parties being said to cooperate when each of them does something on the understanding that the others will likewise do what is expected of them. Cooperation takes many different forms. A very important one is the organised cooperation that takes place within a firm it being distinguished by contracts according to which all employees undertake, within the limits of their actual or implied job descriptions, what management asks of them. Cooperation also takes place among firms in a wide variety of forms, whenever their differing capabilities have to be harnessed to a common purpose. Cooperation co-exists and inter-acts with competition, as the latter regulates the terms on which the parties to the former come together. I am inclined to think that, in providing accounts of how resources come to be allocated, cooperation has not enjoyed its fair share of the limelight. (And also, perhaps, that the human dispositions favouring cooperation rather than competition have been undervalued.) Common observation tells us, however, that the role of cooperation in furthering economic order is nevertheless limited. The limits are reached when, at the margin, the reduction in uncertainty that is provided by contracts costs too much in terms of reducing the freedom of action needed to deal with the uncertainties that will remain. A fir wishing to secure needed inputs, for example, may be reluctant to enter into a long-term contract for their supply when it is not sure of its likely future requirements. It will similarly be reluctant to undertake itself the production of the needed inputs, even if possessing the capability to do so, in that it will widen the range of its investments associated with the same risk. Consumers will likewise rarely wish to commit themselves in advance to a pattern of purchasing when they do not know what future opportunities may be and how their own needs and preferences may develop. Contracting, in any case, does not provide perfect assurance as the parties to it, for good or bad reason, may default. It is by no means surprising, therefore, that in real world market economies, contracting does not, as in the general equilibrium models, take over the whole burden of coordination. A consumer will, without thinking, take the risk of being able to buy a pair of shoes when he wants them; a producer will enter into longterm arrangements only for the supply of such inputs as are so specifi to his own needs as to be not readily available on the market.

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We must conclude, therefore, that although uncertainty about what other people will do can be reduced by reciprocal undertakings, their effectiveness is limited by the residual uncertainty, particularly about tastes and technology that inevitably remains. Nevertheless, the world goes round, as the institutions, structures, laws and practices of market economies have evolved in adaptation to this circumstance. In order to understand how market economies work, we have to ask ourselves how effective business planning is possible despite the fact that reciprocal undertakings cannot provide full assurance that related activities essential to a contemplated investment, whether complementary or competitive, will also be undertaken. General equilibrium models, by presuming that all business decisions are based on the existence of a complete set of contracts, provide no answer to that question and may mislead us as to where an answer can be found. This paper is concerned with two circumstances, familiar to us in real life, which do not feature in general equilibrium theory, nor indeed in most economic model building. These circumstances are differentiation and continuity. Individual people obviously exhibit differences in their ability to perceive and to respond to particular opportunities, differences attributable to their innate talents, their situation and their experience. And these differences are relatively persistent; they usually change only gradually over time. Systems of organised cooperation, such as firms likewise exhibit differentiation and continuity. They have, in other words, particular capabilities which fi them for some lines of activity better than for others, differences attributable in part, of course, to differences in the talents and experience of those working within them, but also to differences in organisation, experience, market connections, goodwill and reputation. Firms will also differ, as do individuals, in how much expansion they can safely undertake at any particular time. Again as do individuals, they will differ also – and importantly – in what may perhaps best, if ponderously, be termed “the structure of their awareness,” it being upon this that will depend the nature of the profi opportunities they are likely to perceive.2 And all these capabilities, although subject to development, will exhibit a degree of continuity. There is likely to be a relationship, through this continuity of capability, between the changing activities that a fir undertakes over time; and the rate of change will obviously also tend to be limited by the durability of fi ed equipment. These two circumstances, differentiation and continuity, will naturally favour some division of labour both among individuals and among the firm in within which they are organised. This consideration weighed heavily with Adam Smith both in his account of the increasing productivity of individuals and in his very important account of how specialisation among enterprises both brings about, and is brought about by, increasing total output. “The Division of Labour.” as he famously put it, “is limited by the Extent of the Market.” Later theorists responsible

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for the model of perfect competition, so influentia since its development a century after Smith, in effect rejected this famous principle by assuming the existence of many firm doing the same thing. There seems little doubt that, in the endeavour to develop from the contributions of Smith and earlier writers a more accurate and more formalised theory of the determination of prices and outputs, important ideas were lost from sight. It might be argued that neo-classical theory was entitled to abstract from differences in the comparative advantage between firm on the ground that these were not relevant to the matter in hand – that of identifying an equilibrium configuratio of prices and outputs towards which they system would move. In fact, however, the opposite is the case. Differentiation and continuity can be shown to be conditions necessary for the achievement of economic order. Were all firm to be equally able to perceive and evaluate a profi opportunity, then it would in effect be open to none of them; it is differences in firms perceptions of an opportunity, in their evaluation of it and in their ability to respond, that can narrow the fiel sufficientl to offer individual firm a chance of success. And just as differentiation reduces the risk of excessive competitive supply, so continuity reduces the risk that activities complementary to the investment being considered, whether on the side of demand or of supply, will not be in place.3 The ability of firm and individual to predict and to plan is assisted by the stability of their environment, as afforded by the continuity to which we have referred. It is further assisted by the fact that aggregates commonly show less variation than their components. It is this circumstance that, in the market for consumer goods, makes contractual arrangements with individuals, even where practical, rarely resorted to. I have argued that differentiation and continuity can provide firm with sufficien assurance to plan their investments, while competition continues to operate on costs and prices and, through them, the allocation of resources. I have not maintained, however, that these circumstances will necessarily be able to do so in all markets and at all times. We have to ask ourselves whether differentiation and continuity might at some times be too weak to provide the stability needed for enterprise planning, or too strong for competition to exercise its traditional function. We have to ask, to put the matter differently, whether market economies may sometimes fail, either because uncertainty deters some worthwhile private long-term investment or because competition is too weak to prevent exploitation and inefficien y. These questions, even if they permit generalised answer, cannot properly be addressed in the compass of this paper, although I hope that the analysis it contains, together with further considerations to which I now wish to turn, may be of assistance in doing so.4 There are some general reasons for expecting that in most markets for most of the time, there will be sufficien differentiation to offer firm profi opportunities

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to which they can safely respond. In Adam Smith’s day, transport costs were frequently high enough for firm to have limited local markets, and as these costs declined with improved communications, the consequence he envisaged was not an increase in the number of businesses supplying the same market but a fine division of labour among them. The differentiation provided by geographical location, in other words, came to be replaced by that associated with specialisation in the different stages of a process of production. Firms could enjoy the relative stability afforded by local monopolies, or “particular markets,” in Marshall’s sense, while competition on their frontiers maintained a downward pressure on prices and costs. A fir may have a profi opportunity reserved for itself – at least for a time – by successfully developing a new product, process or market. Such innovation has been regarded as providing temporary abnormal profits but the rate of technological development is now so rapid in so many markets that continuous product and process development is a condition for earning a rate of return sufficien to stay in business. A firm s competitive success in these circumstances will depend on balancing the cost of product development against the prospect, which it provides, of temporarily “reserved” profi opportunities. In economic model building, market structure is normally featured as given, as influencin the behaviour of firm rather than being influence by it. In reality, however, these structures evolve in response to circumstances and, should they preclude informed decision-taking, or cause these decisions to be associated with an unacceptable degree of risk, they are unlikely to remain unchanged. One response to over-investment or to under-investment, occasioned by the presence of a large number of firm with insufficientl differentiated capabilities, may be a move towards consolidation. The United States oil industry in its early years, when there were many producers, suffered from endemic over-production until John D. Rockefeller forced through, by fair means and foul, a consolidation that, for a time, brought about a closer adjustment of supply to demand. There are indeed many instances of arrangements, with varying degrees of formality, which firm have entered into, with the professed aim of achieving this objective. This aim may not often have been achieved, the result – perhaps the intended result – being merely to dampen competition, shelter efficien y and obtain monopoly returns. But it is unreasonable to argue either that competition, if left untrammeled, would always secure an orderly adjustment of supply to demand or that firms faced with the reality of maladjustment, can never be right to seek remedies. Differentiation and continuity are necessary, I have argued, to enable firm to take the informed decisions without which there could not be a rational economic order. They are also necessary, as is more widely perceived, to enable competition to exercise its selective function, its function, that is, of permitting successful firm to grow at the expense of their less successful rivals. We should not interpret this

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function as promoting only efficien y in a narrow sense. I referred earlier to differences between firm in the structure of their awareness.5 I used this expression to convey the idea that firm are more or less specialised in the range of opportunities they perceive, but it may also help to remind us that firms like individuals, can only act on the basis of the pictures or models or representations of reality that they come to form and that prove, in the event, more or less successful in dealing with it. Firms whose representations prove successful will be rewarded in the competitive process, and economic progress will thus be promoted, not directly through rational calculation about how best to allocate known resources among known ends, but through a social process of experimentation by which knowledge is enlarged.6

NOTES 1. I must confess, however, that my knowledge of the relevant literature does not entitle me to the claim. But see Foss N. J.: The economic doctrines of an Austrian Marshallian; George Barclay Richardson, The Journal of Economic Studies, 22, 23–44. 2. The notion of capabilities is now well established in the literature. Mrs Penrose makes extensive use of it in her book: The Theory of the Growth of the Firm, Oxford University Press, 1959 and 1995. I put it to somewhat different uses in my; Information and Investment, Oxford University Press, 1960 and 1990, and in an article, now appended to that book, which is entitled The Organisation of Industry. 3. This argument is presented more fully in my Information and Investment. I have presented it here somewhat differently, having drawn on thinking carried out since I wrote that book. 4. I try to deal with the issue somewhat more fully in Information and Investment. 5. It is appropriate here to refer to the work of Israel Kirzner; e.g. his Competition and Entrepreneurship (1973), The University of Chicago Press. Professor Kirzner proceeds from the observation that investment opportunities may be neglected, and desirable economic adjustments consequently impeded, simply because of entrepreneurs’ lack of sufficien awareness of what is not deemed to be in their interest or, as Professor Loasby (and I) would rather put it, of what they are not interested in. There is no doubt that this “subjective” consideration can produce a differentiated response to “objective” opportunities. My concern in this paper, however, is with the circumstances which facilitate or impede prediction and thus deny opportunities to those subjectively qualifie to perceive them. 6. I touch in this last paragraph upon evolutionary economics and the process of social experimentation. I have chosen not to dwell on this theme as the importance of differentiation and continuity for efficien “selection” and evolutionary development is widely appreciated. the best known exposition probably being Nelson and Winter (1982), An evolutionary theory of economic change, Harvard University Press, Cambridge, Mass. Less widely appreciated is the importance of these circumstances in providing the stability necessary for enterprise prediction and planning.

ENTREPRENEURSHIP AND THE GENERATION OF KNOWLEDGE William N. Butos ABSTRACT The received Austrian theory of entrepreneurship is considered in light of the generation of knowledge. It is suggested that learning involving more than the discovery of profit opportunities provides a way to endogenize knowledge and to expand the scope of entrepreneurial activity. The theoretical and applied aspects for entrepreneurial studies of this approach are discussed.

INTRODUCTION This paper proposes a market process approach in which entrepreneurs not only discover existing knowledge but also generate new knowledge, in terms of both their own understanding of reality and of changes their actions induce in the market. This focuses attention in directions compatible with an Austrian perspective and also provides impetus for further theoretical and empirical work in entrepreneurial studies. Any Austrian perspective in entrepreneurial studies must proceed from the body of work that Professor Israel Kirzner has produced. His contributions provide economists with arguably the most carefully worked out theory of entrepreneurial activity available. The observation that “Paris gets fed” suggests that something similar to the coordinating process that Kirzner’s theory analyzes constitutes an indispensable element to the understanding of how markets work. At the same Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 97–112 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06007-1

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time, Kirzner’s theory of entrepreneurship, which centers on alertness, discovery, and the elimination of error, abstracts from certain kinds of real world activity arguably associated with entrepreneurial activity. The point of this paper is to suggest that recognizing entrepreneurship as knowledge-generating activity can usefully extend Kirzner’s insights. This approach may be seen as one way to endogenize the entrepreneurial process, a suggestion Rizzo (1996, p. xxiv) has recently made.

KIRZNER’S THEORY OF ENTREPRENEURSHIP Building on the work of Ludwig von Mises,1 Kirzner’s theory of entrepreneurship elucidates the principal mechanism of the market process. His theory involves three central components: the costless discovery of profi opportunities, the subsequent actions that discovery initiates, and the successful exploitation of opportunities via price arbitrage. For Kirzner “the market process . . . is set in motion by the results of the initial market-ignorance of the participants” and consists in “the systematic plan changes generated by the fl w of market information released by market participation” (1973, p. 10). Only when no market ignorance is present (given tastes, technological possibilities, and resource availabilities) will the market process have eliminated all opportunities for further gains and thereby have reached an equilibrium in which all decisions and plans dovetail perfectly. Like Mises who used a stationary model, the evenly rotating economy, only as a “mental tool for comprehension of entrepreneurial profi and loss” (1966, p. 329), Kirzner’s principal interest and theoretical analysis concern the process by which entrepreneurial activity exploits profitabl opportunities and not the conditions stipulated by or consistent with a state of equilibrium. In disequilibrium, the successful execution of utility-enhancing plans by potential transactors remains unrealized and thus constitutes a fiel of opportunity for entrepreneurial activity. For Kirzner, the initial ignorance of market participants and their consequent failure to exploit all exchange opportunities does not reflec transactions or search costs and hence is not categorized as “rational ignorance”; instead, theirs is “sheer ignorance” (1997a) which can only be rectifie by the interdiction of an entrepreneur alert enough to discover existing opportunities for profit 2 For Kirzner, it is this quality of alertness to previously unnoticed opportunities that is at the core of his theory of entrepreneurship. Alertness is an “attitude of receptiveness” (1997a, p. 72) and a disposition to “sniff out opportunities” (1979, p. 29) that itself involves no opportunity costs to the entrepreneur because it entails “the discovery of something obtainable for nothing at all” (1973, p. 48). If alertness refers to the entrepreneur’s mental state of awareness, then discovery

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refers to the identificatio of something in the external world sufficien to activate entrepreneurial action. While those actions occur in time, discovery is timeless in that it constitutes an instantaneous recognition or “moment of realization” of the existence of a profitabl opportunity. At one moment that awareness did not exist but at the next it does; the proverbial “flas of insight” has occurred. Although for Kirzner alertness and discovery induce an overhaul in the entrepreneur’s perception of the fiel of action, it does not refer to action as such; alertness and discovery precede action and are a precondition for action.3 The argument that Kirzner’s theory with its emphasis on discovery precludes a theory of choice, as Salerno (1993) suggests is, therefore, misplaced. When alert entrepreneurs discover opportunities for profi (and presumably choose to thereupon embark on certain courses of action and not others),4 their actions initiate a market process characterized, as Hayek (1937) emphasized, by the progressive transmission of relevant knowledge to market participants that they “are themselves unable to obtain” (Kirzner, 1973, p. 15). For Kirzner this is achieved by entrepreneurs competing with other entrepreneurs by exploiting price differentials between inputs and outputs and through those actions inducing movements in market prices that increasingly become consistent with the coordination of participants’ plans. As envisioned by Kirzner, this process, driven by “competition between the entrepreneurs as buyers, and again as sellers,” will “communicate to market participants” useful knowledge enabling each to formulate a “correct estimate of the other market participants’ eagerness to buy and sell” (p. 15). Prices move in the correct direction. The process ceases when no further discovery (i.e. profi opportunity) can be made – there is no relevant knowledge left to discover because all useful knowledge has, by virtue of the activity of entrepreneurs, already been utilized, exploited, and otherwise made available to all. The unintended byproduct of this process is the attainment of equilibrium market prices.5

LEARNING For Kirzner discovery and the action which follows hinge on an assumed capacity by entrepreneurs to interpret the current situation and to formulate a view of the future they imagine will entail profit for them. If the actions of entrepreneurs are to be characterized as equilibrating, it must be presumed that they have learned something about the environment that presents a genuine opportunity for arbitrage profits that is, entrepreneurs have become aware of some existing exploitable configuratio in prices. In Kirzner’s theory, it is in the course of their market experience that entrepreneurs will have acquired relevant knowledge that enables them to uncover or detect discrepancies in the prevailing market data and

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which thereupon provides them with the opportunity to earn profit (1973, p. 71). Economic analysis enters the picture at the moment of alertness, and it is the sequence of subsequent actions that such alertness sets into motion that instantiates the Kirznerian market process. Once that process is underway, Kirzner holds that decisions made by market participants will be based on knowledge they will learn in the course of their market activity. In Kirzner’s words: “decision-makers’ alertness to new possibly worthwhile ends and newly available means” suggests that decisions may be understood as the result of a sequential “learning process generated by the unfolding experience of the decisions themselves” (p. 36). As noted earlier, in the course of the market adjustment process all market participants in Kirzner’s theory gradually form more correct estimates of others’ plans through the adjustment of prices made possible by the activity of entrepreneurs. Entrepreneurial discovery and the subsequent activity it sustains set in motion a market process that is coordinating: individuals’ plans will more closely dovetail because entrepreneurial activity has induced, as a byproduct of its actions, the dissemination of knowledge and the elimination of error (see Kirzner, 1992, pp. 149–151). Kirzner argues that economics studies only the implications of alertness. At the same time, Kirzner holds that the process is driven by learning – discovery – and by the mechanisms through which those discoveries are dispersed within the market domain. Learning is central to this process because it opens up the possibility for the systematic removal of error and hence legitimating the possibility for the process to be coordinating. Kirzner’s theory, with the pivotal role that learning plays, provides a non-Walrasian model of market adjustment based on the capacity of purposeful agents to adapt their behaviors in response to perceived opportunities. If we are to maintain, along with Kirzner, that the process is in some sense non-random, we must suppose that learning is also systematic (or at least sufficientl so) if it is to generate a process that itself is systematic or, in Kirzner’s theory, equilibrating. But what does discovery and learning refer to in a market setting? Even if we are content to postulate the entirely sensible notion that learning occurs, that does not on its own tell us the learning capacities of agents in terms of what (if anything) is being learned and what learning depends upon. Such questions go to the core of subjectivism and its theory of agency and hence carry implications for theories that purport to describe the market process. Boland (1982, Chap. 4) points out that the way agents are modeled implicitly commits those agents to some position concerning how they epistemically cope in their environments. In this view, how a model works and the implications it sustains are not independent of the implicit theory of learning its agents are presumed to follow. We can imagine, for example, models generating results very different from each other depending on assumptions regarding the capacity of agents to learn or the role of knowledge and learning in

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the very specificatio of the model. Thus, Keynes’s bear speculators are assumed to have little capacity to learn in the sense of revising what they take individually to be the “safe” rate of interest. On the other hand, agents in perfect foresight models face no apparent constraints on what they can learn and consequently such models effectively devolve into models in which knowledge and learning have no role to play, as in standard Walrasian models of static competitive equilibrium. Complicating matters, Boland also argues that different theories of learning and knowledge are not on scientifi grounds equally plausible or correct. Some, he holds, are more correct than others. This suggests that the specifi epistemic practices of agents are relevant to how we depict the market process.6 Entrepreneurs who only look to tea-leaves for guidance would presumably generate market sequences different from entrepreneurs following more reliable and grounded approaches. The point here is not directed at subjecting Kirzner’s (or anyone else’s) implicit epistemics to the pointless exercise of prescriptivist methodology, but, instead, to suggest that what one means by learning matters because different conceptions of learning help to shape our theoretical models of the market process. This is not a question of getting the “right” theory of learning in hand as the more modest aim of simply developing and making more explicit what one means by an agent and its capacities. In Kirzner’s theory, entrepreneurial alertness and learning are confine to the costless discovery of existing price differentials between input and output prices. But if we wish to understand more fully how and why entrepreneurial activity is equilibrating (and the circumstances under which it is likely not to be), we cannot presume the result, viz., some sort of generic learning will inexorably occur, that we are seeking to demonstrate. It would be useful, in other words, to make more explicit what is meant by “alertness” and what it means to claim that entrepreneurs “learn.” This question and its ramification for Kirznerian entrepreneurship have recently been explored by several Austrian economists. Among the more noteworthy are those by David Harper (1996) and Young Bach Choi (1993). Harper’s approach, which presents a “cognitive-logical perspective on the rationality of the entrepreneur, on entrepreneurial learning and on the character of the market process” (p. 31), uses a Popperian-inspired application of conjectures and refutations to model entrepreneurial activity. Entrepreneurs formulate and put into motion plans based on theories – conjectures – they expect will result in profits Their actions can be understood as guided by various methodological principles that they choose to deploy depending on their problem situation and that allow them to learn from their market experiences in order to correct and modify plans and to generate new conjectures. In Harper’s treatment, entrepreneurial learning is thus endogenized. Within this “growth of knowledge” framework, entrepreneurial activity constitutes the principal mechanism for falsifying theories

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about entrepreneurs’ “structural knowledge” pertaining to ends and means and eliminating those that do not survive market tests. Harper’s treatment provides a rational reconstruction of the methodological procedures guiding the actions of entrepreneurs and the implications of those procedures concerning entrepreneurial learning. Appropriately, Harper refers to the market process as a “learning mechanism” (p. 290). Choi’s central concern is the relationship between perceptions (and their acquisition) and decision making and action under uncertainty. His principal claim is that individuals cope with uncertainty by searching for and adopting “paradigms” or models that provide an understanding (or perception) of their surroundings and the necessary confidenc to pursue various actions. Interactions among paradigm-seeking individuals at the social level tend to generate regimes of conventions that guide behavior. At the same time, however, the very stability of conventions promotes endogenous change in the form of opportunities for profi which go unnoticed and remain unexploited by convention-following individuals. This provides a window of discovery and for action by entrepreneurs with new or different paradigms which allow them to see the situation differently from others. Entrepreneurial learning, “the process by which we come to acquire paradigms,” provides the impetus for innovation and its acceptance as “commonplace knowledge in society” (Choi, 1999, p. 72). In this way, entrepreneurial discovery of profitabl opportunities promotes a process of social learning by which innovations become installed, at least temporarily, as new conventions. Other work by Butos and Koppl (1999) looks at Kirzner’s entrepreneurial theory from a perspective based on a Hayekian theory of expectations. They principally use Hayek’s The Sensory Order to examine the meaning of subjectivism from an epistemological and methodological standpoint and, in so doing, provide an account of how market participants learn in the course of their market activities.7 This forms the basis for a theory of “Hayekian expectations” that they deploy to give to an account of how market participants come to know relevant aspects (or what Harper calls “structural knowledge”) of the fiel of action. These approaches constitute, however, only a partial rendering of the implications that a theory of learning (Hayekian or otherwise) holds for Kirzner’s theory of entrepreneurship. The second part of the story involves the recognition that any genuine theory of learning must treat not only the discovery of existing knowledge, but also the generation of knowledge. The theories and conjectures agents formulate in pursuing their objectives may be described as deriving from internal models that process and transform signals into expectations (and behavioral response modes) via complex cognitive processes and multi-layered adaptive feedback mechanisms. These models serve as “production systems” by which agents generate interpretations – knowledge – of their environment. This

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was only hinted at in Butos and Koppl (1999, pp. 262–263, note 19). There, learning was identifie with the mechanisms that result in the individual’s forming an interpretation of external reality. On Hayekian “sensory order” grounds, if what we know about external reality is actually an interpretation, then our subjective knowledge of reality has somehow been constructed by the brain. Hayek’s cognitive theory provides an explanation of how this happens.8 In Hayek’s terminology, the brain produces a classification (interpretation) of external reality along any number of dimensions according to the perceived attributes the mind has constructed. In effect, Hayek’s cognitive theory directs our attention toward a conception of learning in which knowledge is generated. Aside from the question of how cognitive activity works, a matter better left to cognitive specialists, what matters is that such activity produces an output that we call knowledge. It is this point that forms the principal motif of the discussion here. That is, our interest is not in the psychology of cognitive activity, but in the implications of such activity. While we often and correctly associate learning with mechanisms by which existing knowledge is acquired or grasped, as is the case for Kirznerian entrepreneurs, a Hayekian perspective reminds us that learning also includes the transformation of existing knowledge and the generation of new knowledge. This suggests that Kirznerian alertness should encompass the capacity of entrepreneurs to discover knowledge and to generate new knowledge. In this “sensory order” sense of what learning means, we can move beyond a conception of entrepreneurial activity based on discovery of existing knowledge to a more inclusive one that also highlights the generation of knowledge. What is important here is not the particular explanation that Hayek offers to account for learning, but simply the recognition that in looking at learning in this way, our attention is directed toward additional considerations that may further our understanding of the market process.9

THE GENERATION OF MARKET KNOWLEDGE10 In market theory, the loci for the generation of knowledge are individuals and the social interactions they participate in. This knowledge is sometimes treated as “conjectures,” “theories,” “facts,” or “dispositions to act,” but the crucial point is that however that knowledge is characterized, it is knowledge that is not simply delivered as such to the individual or acquired in the sense of picking up pebbles from the beach. Claiming knowledge is something out there, waiting to be discovered, does not speak to the circumstances and conditions proximate to its generation (Butos, 1986, p. 851). Claiming that knowledge is analogous to picking up beach pebbles suggests that discovery simply involves the transference or communication of data from one realm to another, from the external world to

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the cognitive dimension. However, as Hayek (1978, p. 43) notes, knowledge is something that happens to the mind. If, following Hayek (1952), we view sensory impulses as the “inputs,” and the apparatus that sorts, organizes, and assembles them as sets of routines or rules governing their assignment, we have a model that helps us see the process by which an “output” – knowledge (however contingent and imperfect it may be) – is produced. Moreover, it is possible to stipulate that the routines governing the assignment of inputs are themselves mutable, responding via feedback loops in an obviously complex fashion in ways that may (or not) be useful for the agent’s successful adaptation to the actual environment. In Hayek’s theory, the rules governing cognitive mechanisms (including tacit or “supraconscious” ones) generate a classificatio over reality; it is a classificatio that the mind has produced. Within the constraints imposed by the physiology of the organism, the particulars of the knowledge individuals generate about reality – their interpretation and meaning they attach to aspects of the real world, both as is it and as it might be – is also unique to each individual, as determined by his past history and the cognitive routines that had been found useful. Yet, for the purpose at hand, it is not the particulars of Hayek’s cognitive psychology that make it relevant, but its suggestion that the principal characteristic of a particular order (here, the sensory order) is the generation of knowledge. This broadens what learning encompasses and thrusts into the mix considerations, such as creativity, that are at best implicit or treated as exogenous when learning is confine to the discovery of existing knowledge. The key claim here, then, is that such processes do not involve the deliverance of knowledge but a capacity to transform inputs by generating a classificatio over those inputs that we would identify as new knowledge. The leads Hayek provides in this context suggest that the categories of alertness and discovery may not adequately capture the full dispositional range of entrepreneurial activity. We also need to take account of the potential for the generation of knowledge when individuals interact within the framework of the market economy.11 In all forms of social contexts, individuals enter into interactions with a stock of “public knowledge,” presumably shared by all, concerning prevailing rules and conventions and other forms of useful knowledge. But individuals also have knowledge of a more personal sort peculiar and unique to each that could refer to Hayek’s knowledge of “time and place” as well as to knowledge about their preferences and plans and, lest we forget, to their capacity to generate knowledge about their own preferences and plans and form conjectures of the preferences and plans of others.12 Only in the context of the catallaxy do these interactions generate market prices as byproducts of the interactions entered into. The constellation of market prices reflect an outcome of a process that no simple extrapolation, addition, or summarization of each individual’s knowledge would have been sufficien to

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Table 1.

Inputs Mechanisms

Outputs

Sensory Order

Market Order

Sensory stimuli Rules and routines that connect impulses via a classificator apparatus for sorting, organizing, relating impulses within a particular physiological structure Individual knowledge (conscious, tacit, predispositions, preferences)

Individual knowledge Rules and routines of interacting individuals, ie. Institutions within a given property rights framework of exchange Market quasi-knowledge (prices, quantities, goods’ characteristics)

produce. Instead, the market process involves a transformation of knowledge at the individual level into a new form of quasi-knowledge that could not have been inferred beforehand and which is unique to the specifi framework in which those interactions exist, the sequence of those interactions, and to the specifi rules and routines individuals follow. In short, only catallactic interactions can generate market prices and this particular kind of knowledge cannot be disembodied from the particular circumstances and conditions associated with its generation. The same individuals interacting under a different set of (non-catallactic) rules will not generate market prices nor the same kinds and quantities of goods. And we only need observe actual market and non-market economies to highlight that, aside from any comparative welfare comparisons, such systems are unambiguously distinct in any number of vital ways. One way to understand how and why this should be is to recognize that the knowledge-generating capacities of individuals and social orders are not independent of the structure and functioning of the orders themselves.13 We should note that the knowledge produced at the market level most assuredly does not reflec any “group mind” at work. Unlike individuals, the market order is neither conscious nor teleological. The argument being drawn here attempts to highlight the kinds of knowledge that different structures and social arrangements generate. The knowledge an individual is capable of generating necessarily differs from that generated by interacting individuals. Nor would it be correct to suggest that the market is being conceived or treated as a “super consciousness.” The perspective being advanced here rejects that suggestion. The market economy only exists because individuals interact within its framework and it has no existence apart from those individuals. As such, we must recognize that these interactions involve a degree of complexity that is capable of generating outcomes unique to those interactions. The subject matter of economics is the analysis of those interactions; that is, economics has a rationale precisely because its subject matter is not the product of an omnipotent or super conscious being.

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ENTREPRENEURSHIP AND THE GENERATION OF KNOWLEDGE The discussion so far has suggested that the problem of the division of knowledge and the mechanisms for the transmission of knowledge, so famously associated with Hayek and Kirzner, constitutes one side (albeit a very important one) of the significanc of knowledge for economics. If it is indeed useful to explore the economics aspects of the generation of knowledge, part of that exploration would seem to suggest broadening the scope of the role of the entrepreneur in the market process beyond alertness to price differentials.14 One implication of a knowledge-generating perspective is that the discovery and elimination of error no longer constitutes the only relevant aspect of entrepreneurial activity. Instead, the theory of entrepreneurship also refers to the inherent capacity of individuals to create knowledge – Hayekian interpretations or Popperian conjectures – about their environment as it was, as it is, and also as it might be. When we view the market process as one which, through the actions of entrepreneurs, only removes error, the process itself becomes determinate in that its path is really an unfolding of the actions implied by the initial conditions.15 As Kirzner puts it, “a theory of process must establish the determinateness of the course of market events” (1979, p. 17, italics added). This seems a sensible way to theorize about certain essential aspects of the actual processes of the real world. At the same time, however, this approach does not consider the dependency of the generation of knowledge on the market process itself. This can be seen in Kirzner’s (2000) discussion of the horse-drawn carriage and automobile industries. Because it is only error that provides the context for entrepreneurial activity in Kirzner’s theory, any entrepreneurial action (in the illustration here it is manifested by the appearance of the automobile) only makes sense if it is stipulated that current economic activity is necessarily riddled with error. As Kirzner puts it: “we now see with 20–20 hindsight, that the horse-drawn carriage industry . . . was an industry in grave disequilibrium before the automobile actually appeared” (p. 250). From this ex post perspective, the introduction of the automobile simply “revealed the wastefulness and the misallocated character” of resources in the horse-drawn carriage industry (p. 251). The concentration on error, including its ex-post construction, suggests a description of the market process in which every actual decision real economic actors make is define as an error, where error is treated as a formal category against the backdrop of full certainty. In recognizing that the economic analyst and the actual agents would describe the process and their success (or failures) quite differently, an alternative explanation of the process emerges that does not require us to conclude the decisions and actions of the carriage builders to have been misallocations or wasteful. This interpretation can be sustained if the scope of entrepreneurial activity and the

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market process instantiating such activity is extended beyond the discovery and elimination of error. Thus, from the perspective of the carriage builders, their actions were believed to be maximizing ex-ante. That this did not turn out to be the case resulted from an innovation that they could not have known about prior to the fact. Indeed, there was no existing opportunity to be discovered; rather new knowledge (i.e. as represented by the invention of the automobile) was generated and once that innovation became available can we then speak of Kirznerian entrepreneurship springing into action, itself promoting subsequent. endogenous changes that such activity puts into motion. Thus, the prices that serve as the (temporary) “givens” for Kirznerian arbitrageurs are also byproducts of the overall market process and represent, consequently, knowledge which also has been generated. In the view suggested here, the market process involves agents who have the capacity to both discover and generate individual knowledge, their interactions, and the generation of market level byproducts stemming from those interactions. The process involves complex feedback loops operating at all levels and learning, both in the sense of correcting mistakes and of producing new knowledge. In a process of this kind, “market equilibrium” (in the sense of a description of a process that has eliminated all error) refers to the logical implications of a particular model without endogenous knowledge. The knowledge-generating perspective discussed here provides scope for introducing endogenous knowledge that may allow for a fuller treatment of the complexities associated with the market process and a basis to empirically support a more complete range of behaviors ordinarily associated with entrepreneurial activity. In considering entrepreneurial activity in terms of a broad array of characteristics, various Schumpeterian propensities might appear to provide a useful starting point. The dynamic qualities of Schumpeterian entrepreneurs fin empirical expression in the way real-world markets work, suggesting the desirability of incorporating such behaviors into market process theory.16 While no disagreement is harbored in recognizing the role of such Schumpeterian propensities, the discussion here seeks to highlight that the actions through which these propensities are instantiated reflec a knowledge-generating process of the entrepreneurs themselves and also of the changes in the market their actions induce17 be a recognizable for the latter issue.

CONCLUSIONS This paper has attempted to extend the received Austrian approach to entrepreneurship by broadening it to include the entrepreneur and the market as knowledge-generating entities. Emphasis on the discovery and transmission of

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dispersed knowledge, an insight central to the Austrian School since Hayek’s “knowledge papers,” does not provide a fully endogenous theory of the market process. Ironically, it is Hayek’s work in another domain that brings into relief the nature of the problem and a possible solution. I have suggested here that the theory of entrepreneurship may be productively extended to encompass the generation of knowledge. This claim and the possible kinds of research it suggests is, in fact, congenial with the received Austrian view and supportive of attempts to endogenize knowledge in a theory of the market process. The scope of the analysis suggested here is, in one sense, very broad. Questions about the generation of knowledge extend beyond the confine of the market economy to include the conditions and circumstances of its generation under alternative institutional frameworks in which markets and their attendant legal arrangements cannot or do not exist. But in terms of the focus of the present study, it may be possible to see the entrepreneurial function as including activities which have the effect, both intended and otherwise, of creating new means-ends frameworks and fomenting changes in consumer preferences, not simply discovering preferences or price discrepancies in the existing array of goods. Kirzner’s theory of entrepreneurship provides an account of a crucially important aspect of the market process; yet, it’s scope is such that while it can explain “how Paris gets fed each day,” it is less successful in endogenizing the process to explain that the way Paris gets fed and what it eats each day changes. In addition, what I have said here should not be construed as advocating a Schumpeterian approach to entrepreneurial activity. The Schumpetarian entrepreneur is an innovator who disturbs an existing equilibrium and puts into motion a process of “creative destruction.” This vision of the market economy carries great appeal because it corresponds in a casual empirical sense to what is commonly observed. From the perspective of the present study, however, a central feature of entrepreneurial activity involves knowledge-generating entrepreneurs, suggesting that as a theoretical and empirical matter entrepreneurial activity may express itself in manifold ways and forms, from arbitraging prices to creating new institutional structures. More specifi research entry points for developing the approach suggested here have already entered the literature, although not explicitly from the perspective of the knowledge-generating capacities of different social arrangements and the scope of entrepreneurial activity in those contexts. It seems, though, that such considerations could be usefully brought to bear when markets are affected by “Big Players,” such as central bankers, policymakers, and others more or less immune to the discipline of the market, as discussed by Koppl and Yeager (1996). The activities of such players alter the functioning of markets because they have the capacity to generate knowledge that dominates that of other participants.

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Their actions change the resulting configuratio of market prices and outputs. This analysis has a natural extension to situations where only one agent (or Big Player) operates in a regime of central planning, a scenario which has, of course, been widely discussed and analyzed in economics as the socialist calculation debate. In both cases, the issue is not simply the problems faced by Big Players in acquiring necessary knowledge, but – from the perspective of the argument here – how differing institutional forms – markets, Big Players in a market setting, and central planning – affect the generation of knowledge and thereby the stability and adaptability of the social order.

NOTES 1. Mises (1966) define the entrepreneurial function in the following way: “The term entrepreneur as used by catallactic theory means: acting man exclusively seen from the aspect of the uncertainty inherent in every action” (p. 252). Kirzner (1973) refers to this as a function which concerns “the very perception of the means-ends framework” (p. 33) and is distinct from action once that means-end framework has been identified Also see Salerno (1993), who argues that Kirzner’s theory is distinct from Mises’. 2. Mises speaks of the “concantenation of the market” as an “outcome of the activities of entrepreneurs, promoters, speculators, and dealers in futures and in arbitrage” (1966, p. 327) which conveys a scope of entrepreneurial activity wider than Kirzner’s. See Kirzner (1973, pp. 86–87) for a discussion of these differences. 3. See, for example, Kirzner (1973, p. 33–34). 4. This sort of “deliberation,” which Kirzner does not highlight, speaks to Mises’ notion of “appraisement” (1966, pp. 331–333). 5. Kirzner (1973) deployed a single-period model formulation. Later on, Kirzner (1982) developed a multi-period model to more effectively deal with uncertainty. See Kirzner (2000, Chap. 13) for his discussion of these developments. 6. For example, following Boland (1982, p. 67), if a particular agent is modeled as a pure inductivist, the researcher has effectively asserted an incorrect epistemology. 7. Kirzner (1973, p. 71) proposes a hard line separating psychology from economics, arguing that economics begins with the brute fact of alertness. At the same time, he notes “it is necessary to build formally into our theory the insight that such a learning process can be relied upon” (pp. 71–72). Kirzner (1985, p. 26) suggests that “applied entrepreneurial theorists should look to this research with considerable interest.” Harper’s “growth of knowledge” approach relies on a methodology that does not encompass the psychology of discovery, although he suggests that the two are potentially complementary (1996, pp 30–33). Lachmann (1977, p. 155) equates psychology with motives and argues that economics is concerned “with plans, not the psychic processes that give rise to them.” Lachmann’s reservations, like Kirzner’s, are echoed by many economists, including Mises and Hayek and rightly so. But it is also the case that cognitive theory has gone far beyond the behaviorist search for motives in attempting to understand and model “the internal structure and decision processes of agents” (Harper, 1996, p. 35). That economists should concentrate their energies on economics is not in dispute, but the ideas and concepts that

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feed into economists’ understanding of the market process, even when they originate outside of economics proper, have a long and valued history in the development of economics. If the boundary between economics and psychology has blurred, it is mainly due to the demise of the old psychology and the emergence and flourishin of a new cognitive science in the late 20th century. Though the domains are separate and distinct, productive links may exist between them. 8. In Hayek’s account, sensory impulses are sorted out within the hierarchical and relational structure of the brain. The welter of impulses have no meaning apart from the transformation they undergo at the cognitive level. It is out of this initial “chaos” that a particular order, the sensory order, is generated. See especially Weimer (1982). Also see Agonito (1975), Butos and Koppl (1993). Hayek’s cognitive theory seems compatible at a suitable level of generality with trends in modern cognitive science, as seen for example in the work of Edelman (1987), Searle (1984, 1995), and Dennett (1996). 9. On “knowledge-generating orders,” see Butos and McQuade (2002). 10. It is probably useful to maintain a distinction in what follows between knowledge as it pertains to the interactions in markets as opposed to those in science. Suffic it to say that the latter, while social and a byproduct of interacting scientists, cannot be assumed to be analyzable by the same kinds of mechanisms at work in the catallaxy nor to have the same epistemological status. See McQuade and Butos (2003). Alternatively, Harper’s (1996) approach, coming out of Popperian philosophy of science, is congenial to the proposition that both scientifi knowledge and entrepreneurial knowledge are similarly analyzable using an approach based on “conjecture and refutation.” Resolving such matters is not easy, in part because of the elusiveness of definin what knowledge finall is. 11. Table 1, which emerged out of discussions with Thomas McQuade, summarizes the analogies between Hayek’s cognitive theory and the generation of market knowledge. I thank Roger Koppl for suggesting that it is important to also point out the disanalogies between the sensory and market orders in that the market order is non-teleological and non-conscious. The reader may question whether it is appropriate to refer to market outcomes (prices, quantities, goods’ characteristics) as knowledge at all. While this raises concerns that cannot be fully addressed here, it may be useful to note that “knowledge” is used here as a generalization of a system’s capacity to produce a classificatio by some sort of transformational process performed on inputs. The system, in effect, generates an adaptive model of the environment dependent on those inputs and on the ways in which complex feedback loops affect the system’s functioning. In this conception, the generation of knowledge is not confine only to the human mind, but applies to other complex systems as well. Different kinds of systems, as define by their structure, the rules governing their operation, and functional attributes, will differ in their knowledge-generating capacities. Pending a fuller explication of these points and their usefulness in applying them to economics and social theory, the simple expedient of employing the term “quasi-knowledge” suggests itself. 12. Such knowledge will generally be expectational, contingent, and revisable, as no method in such contexts is likely to provide certain and time-invariant knowledge about one’s own preferences, let alone those of other individuals. The point here is that if an individual, as discussed earlier, has the capacity to generate new knowledge, then we need to recognize that so-called “givens” like tastes and preferences are also subject to endogenous generation. 13. The argument that socialist planners could replicate the results of the market economy fails utterly to comprehend that the kind of knowledge any social order is capable of

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generating cannot be separated from the nature of the order itself. See Butos and McQuade (2002). 14. Kirzner does not address the idea of entrepreneurial generation of knowledge, although his following remark may suggest a view different from the one proposed here: “When one becomes aware of what one has previously overlooked, one has not produced knowledge in any deliberate sense”(1997a, pp. 71–72). 15. See Rizzo (1996, pp. xvii–xix). 16. Kirzner (2000) suggests incorporating various psychological propensities – “boldness, self-confidence creativity, and innovative ability” (p. 248) – to account for how entrepreneurial activity expresses itself. In this construction, however, the generation of knowledge and the various modes of its expression, such as creativity and innovation, are treated as exogenous to the theory of the market process. 17. While Kirzner provides interesting leads about the sorts of changes generated by the market process, the argument developed here suggests possibly fruitful ways to develop some of their implications. Thus, in describing the process of market adjustment, Kirzner (1973) postulates that market participants, in learning of their past mistakes, “can be expected to develop systematic changes in expectations concerning ends and means that can generate corresponding alterations in plans” (p. 70). Such changes constitute changes in knowledge. Yet, they carry no implication in Kirzner’s discussion that the generation of this new knowledge will induce the market process to follow another path or reach a different equilibrium price; instead, the adjustment is confine to changes in prices that buyers and sellers will pay and receive as profitabl opportunities are grasped by entrepreneurs. Also see, for example, Kirzner (1997b, pp. 43–45) on “over-optimism” and “over-pessimism.” As McQuade (2000) notes, changes in expectations and plans imply changes in reservation prices by sellers and buyers and hence a change in market price and/or quantity. In the language of supply and demand analysis, both market schedules would shift.

ACKNOWLEDGMENTS This paper bears the imprint of discussions over several years with Thomas McQuade and Roger Koppl. I thank them for comments on an earlier draft of this paper and Sanford Ikeda for discussions on the theory of entrepreneurship. I also thank an anonymous referee for suggestions. All remaining errors are mine.

REFERENCES Agonito, R. (1975). Hayek revisited: Mind as a process of classification Behaviorism, 3(2), 162–171. Butos, W. N. (1986). The knowledge problem under alternative monetary regimes. Cato Journal, 5(3), 849–872. Butos, W. N., & Koppl, R. (1993). Hayekian expectations: Theory and empirical applications. Constitutional Political Economy, 4(3), 303–329. Butos, W. N., & Koppl, R. (1999). Hayek and Kirzner at the Keynesian beauty contest. Journal des Economistes et de Etudes Humaines, 9(2/3), 257–298.

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Butos, W. N., & McQuade, T. J. (2002). Mind, market, and institutions: The knowledge problem in Hayek’s thought. In: J. Birner, P. Garrouste & T. Aimar (Eds), F. A. Hayek: A Political Economist (pp. 113–133). London and New York: Routledge. Choi, Y. B. (1993). Paradigms and conventions: Uncertainty, decision making, and entrepreneurship. Ann Arbor: University of Michigan Press. Choi, Y. B. (1999). Conventions and learning: A perspective on the market process. In: S. Dow & P. Earl (Eds), Economic Organization and Knowledge: Essays in Honor of Brian J. Loasby (Vol. 1, pp. 57–75). Northampton, MA: Edward Elgar. Dennett, D. J. (1996). Kinds of minds. New York: Basic Books. Edelman, G. M. (1987). Neural Darwinism: The theory of neuronal group selection. New York: Basic Books. Harper, D. (1996). Entrepreneurship and the market process. London and New York: Routledge. Hayek, F. A. (1937) [1948]. Economics and knowledge. In: Individualism and Economic Order (pp. 33–56). Chicago: University of Chicago Press. Hayek, F. A. (1952). The sensory order. Chicago: University of Chicago Press. Hayek, F. A. (1978). New studies in philosophy, politics, economics and the history of ideas. Chicago: University of Chicago Press. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1979). Perception, opportunity, and profit. Chicago: University of Chicago Press. Kirzner, I. M. (1982). Uncertainty, discovery, and human action: A study of the entrepreneurial profil in the Misesian system. In: I. M. Kirzner (Ed.), Method, Process, and Austrian Economics: Essays in Honor of Ludwig von Mises (pp. 139–160). Lexington: Heath. Kirzner, I. M. (1992). The meaning of market process. London and New York: Routledge. Kirzner, I. M. (1997a). Entrepreneurial discovery and the competitive economic process: An Austrian approach. Journal of Economic Literature, 35(1), 60–85. Kirzner, I. M. (1997b). How markets work. London: Institute of Economic Affairs. Kirzner, I. M. (2000). The driving force of the market. London and New York: Routledge. Koppl, R., & Yeager, L. B. (1996). Big players and herding in asset markets: The case of the Russian ruble. Explorations in Economic History, 33, 367–383. McQuade, T. J. (2000). On the microfoundations of microeconomics, ms. McQuade, T. J., & Butos, W. N. (2003, forthcoming). Order-dependent knowledge and the economics of science. Review of Austrian Economics. Mises, L. von (1966). Human action. Chicago: Regnery. Rizzo, M. J. (1996). Introduction: Time and ignorance after ten years. In: G. O’Driscoll, Jr. & M. J. Rizzo (Eds), The Economics of Time and Ignorance (pp. xiii–xxxiii). London and New York: Routledge. Salerno, J. T. (1993). Mises and Hayek dehomogenized. Review of Austrian Economics, 6(2), 113–162. Searle, J. R. (1984). Minds, brains and science. Cambridge: Harvard University Press. Searle, J. R. (1995). The construction of social reality. New York: Free Press. Weimer, W. B. (1982). Hayek’s approach to the problems of complex phenomena: An introduction to the psychology of The Sensory Order. In: W. B. Weimer & D. Palermo (Eds), Cognition and the Symbolic Processes (Vol. II, pp. 241–285). Hillsdale: Lawrence Erblaum.

THE ENTREPRENEUR AS A CONSTRUCTOR OF CONNECTIONS Peter E. Earl ABSTRACT This paper attempts to recast the entrepreneur by synthesizing ideas from personal construct psychology and systems-based evolutionary economics. It retains an Austrian subjectivist emphasis but focuses on rapid product innovation rather than arbitrage. Profit opportunities are mental constructs that link products and revenue streams. Entrepreneurs develop new products by forming novel connections between existing product elements and diverse technologies, mindful of the connections between these products and the complex structures of consumer lifestyles. These linkages are often formed in the context of large multi-product firms, as well as being the basis of new enterprises, so entrepreneurship overlaps with strategic management.

INTRODUCTION This paper is an attempt to recast the Austrian view of the entrepreneur in the light of two recent works with which I have had some involvement. The “constructor” theme comes via a Ph.D. on the nature of entrepreneurship by Christine Woods (2002), for which I was an external examiner. Woods investigates the topic both theoretically and empirically via the Personal Construct Psychology of George Kelly (1955) that had earlier influence my own writing on business behaviour (see Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 113–130 Copyright © 2003by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06008-3

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Earl, 1984; Harper & Earl, 1996). The “connections” theme comes via a recent book by Jason Potts (2000), which shared the 2000 Schumpeter Prize and was based on a Ph.D. that I had the pleasure of supervising. Central to Potts’ analysis is the contention that mainstream neoclassical economics differs from heterodox varieties, Austrian economics included, by taking the mathematical notion of a “field as the basis for its perspective on the nature of an economic system. The key feature of a fiel is that each element in the system is connected to all the other elements in the system, and hence the system has no structural architecture of subsystems and hierarchy. When mainstream economics tries to emulate physics – rather than, say, chemistry – as a “hard science,” it sets out to emulate the field-base discipline par excellence. Potts contends that, one way or another, the critics of mainstream economics are operating from a perspective that sees the operations of economies as being affected by the failure of their component parts to be linked so comprehensively. Instead of viewing the economic system from a fiel perspective, Potts follows Koestler (1975a) in seeing the world as a system of systems that are themselves composed of systems, and so on: economic agents are complex biological systems operating in complex social and physical environments. From this standpoint, much of entrepreneurial behaviour entails the construction of new systems by forming connections that have not previously existed. Since this connection-constructing process is selective, it is appropriate to consider the workings of entrepreneurial minds before we consider physical and institutional areas in which entrepreneurs play a social role by putting new connections in place. It is here that Woods’ critique of Austrian thinking and her alternative focus on the mind as something that constructs hypotheses is significant I then explore the kinds of connections that entrepreneurs can construct, particularly given that consumer lifestyles are themselves systems of connections. This leads to a discussion of what the connectionist view of entrepreneurship implies about the dividing line between entrepreneurship and management, followed by a concluding section that reflect on the perspective offered with particular reference to the theoretical role of the entrepreneur in an age of globalization. Throughout the paper, I make copious use of examples, mostly from the music, publishing and automotive industries, to illustrate the kinds of connections that entrepreneurs form. We are not dealing here with a simple idealized world of trade-offs between alternative bundles of apples and oranges, but the real world of complex systems. Of necessity, therefore, the examples have to be much more detailed than economists are prone to employ and at times the style consequently looks more like that in marketing (where the introspective writing of Holbrook, 1995a has been a major inspiration) or management.

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THE CONSTRUCTION OF PROFIT OPPORTUNITIES Kirzner’s (1973) view of the entrepreneur as having a superior capacity for alertness to profi opportunities is problematic in that it fails to address the issue of how opportunities come to be perceived. Entrepreneurs may well differ from the general public in terms of the extent to which they go through life “on the lookout” for profi opportunities but profi opportunities are not things that lie around waiting to be found, to which are already attached labels marked “profi opportunity.” Rather, as Woods (2002) argues, entrepreneurs construct them as possibilities in their minds. This entails making connections. Consider the case of an academic publisher as an entrepreneur. In Kirznerian terms, we might expect enterprise to take the form of the publisher having an idea for a book and signing up an author or editor to prepare a manuscript. But the idea for the book does not in itself constitute a profi opportunity until the publisher has attached to it his/her vision of its potential costs and revenues. Only when that attachment has been made can the publisher see whether it is worth proceeding with it. The same applies when the publisher receives an unsolicited book proposal. In effect, the would-be author is saying, “I construe this a profi opportunity” but whether or not it becomes one in the eye of the entrepreneur depends on the prospective net revenue stream that the latter assigns to it. If the publisher sends it out to academic referees, their constructions of it as a profi opportunity may be rather different because they lack the publisher’s knowledge of how somewhat similar books have turned out in terms of costs and revenues. Likewise, different publishers, with different pools of experience and different ways of forming conjectures, may differ over whether or not it could be profitabl to take on a particular book. These conjectures sometimes change during the process of editing a manuscript. In the case of Holbrook (1995a), for example, the author’s laudable unwillingness to dumb down his manuscript beyond a particular point led to it eventually being published by a different fir (Sage) from the “Big Textbook Publisher” (HarperCollins) that had originally asked him to write it (see Holbrook 1995a, p. xii; 1995b, pp. 650–651). In short, although not everyone will have a particular idea for a product or an arbitrage opportunity, or be informed of it by someone else, it is not awareness of the possible business activity itself that makes it a profi opportunity but the awareness of the activity combined with the imagined net revenue stream they attach to it. To the extent that entrepreneurs do have original creative thoughts about what might form the basis of a business project, these too entail making connections. This is clear from the work of Koestler (1975b) and Shackle (1979), the former arguing that creativity entails a novel synthesis of existing notions rather than the construction of something out of nothing, and the latter seeing thoughts as

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based upon a limited set of elements that are capable of being combined in new ways, much as letters of the alphabet can be formed into new words. (This kind of perspective is also found in Adam Smith’s (1795/1980) writings on the history of astronomy, which Skinner (1979) drew to the attention of economists.) Clearly, people who can call upon different sets of ingredients will differ in the new ideas that they can construct, although different sets of ingredients may sometimes be combined to produce similar novel thoughts. Entrepreneurs may not only differ from the general public in terms of the mental ingredients they employ and their tendencies to experiment mentally with making new combinations. They may also be more willing to take risks because they do not construe hazards that the rest of the population sees – either due simply to not thinking in terms of particular dimensions, or because they have extra thought dimensions in certain areas that lead them to construe wider opportunities than the general public for gain and for managing problems. There is much work waiting to be done investigating these kinds of differences and their implications for policies aimed at promoting entrepreneurial activity.

LEARNING AS THE RECONFIGURING OF MENTAL CONNECTIONS Harper (1996) portrays entrepreneurial learning as Popperian process of hypothesis revision. From the present standpoint, it entails entrepreneurs making changes in their sets of mental connections. In seeking to come up with more effective ways of viewing the world, decision makers operate by imposing systems of thought on a problem that essentially has the format of a field Whether they are aware of it or not, they need to avoid being paralyzed by what philosophers of science know as the Duhem-Quine thesis. This holds that it is impossible to test any single hypothesis in isolation from a larger set. (It is discussed in relation to the fiel issue in Hoover, 1994, pp. 302–303; see also Loasby, 1989, Chap. 12.) In other words, when evidence at odds with a particular hypothesis is detected, the problem might lie not with the hypothesis itself but with other theories being taken for granted during the test. Unexpectedly low profit on a particular project might reflec mistakenly optimistic cost or revenue projections on the part of the entrepreneur, but need not do so. Possibly something unexpected is happening in the distribution chain, or something is amiss with the accounting information systems that are used, or someone “has their hands in the till.” Or possibly the answer lies in a combination of these factors and others not yet imagined.

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If absolutely everything is taken as open to question, entrepreneurial activity becomes impossible. If one cannot have some degree of trust in others with whom one forms business connections, or some confidenc that one has a better insight into what counts in a particular market or manufacturing process, there is no fir spot on which to build an enterprise of any particular form. To make decisions, the entrepreneur takes some things for granted and uses a particular set of core “do” and “don’t” rules (Earl, 1984; Harper & Earl, 1996) whose effica y is taken for granted. When anomalies are encountered, these core elements in the entrepreneur’s world-view determine how they will be construed, in other words, which of the more peripheral elements will be adjusted and the form the adjustment takes. Sometimes, the entrepreneur may sever a particular connection whilst maintaining core constructs – for example, “I no longer believe it is going to be possible to make money from selling executive cars that do not carry premium brand names, but pulling out of this market does not mean we are thinking of giving up making cars in general.” Sometimes, the entrepreneur will change the connections between an element and other elements, possibly including new lines of thinking – for example, “If we are to maintain our share of the liquor market, we will need to integrate forward into liquor stores and hotels.” Sometimes, the addition of a particular construct will be associated with a change in the strength of connection between other constructs – for example, “Given the effect of the September 11 events in New York on travel and the cost of insurance, our profi projections from running this event will have to be scaled back somewhat.” In deciding precisely how to change their minds, entrepreneurs will regard some kinds of business decisions or projections as unthinkable because they conflic with core notions. The latter will be preserved, if necessary, by all manner of twists at the periphery, just as astronomers prior to the Copernican revolution twisted their explanations to reconcile their earth-centered view with new data (cf. Smith, 1795/1980). By imposing different systems to deal with the Duhem-Quine problem, entrepreneurs, and people in general, end up with different views of what is feasible and differ in their openness to change. Entrepreneurs who think of themselves in terms of connections with particular activities – for example, as carmaker, movie producer, beer magnate, media mogul, property developer – will have particular trouble abandoning such lines of business because doing so requires them to come up with a new self-image. When their capabilities to construct viable hypotheses about market opportunities begin to wane in their core areas, their chances of surviving as entrepreneurs seem likely to be enhanced if they can concentrate thoughts about their core capabilities at a rather more abstract, non-product-specifi level. They can then try connecting them to new lines of activity rather than letting their attention become absorbed with anxiety regarding maintenance of existing activities.

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CONSUMPTION SYSTEMS If entrepreneurs are to survive in business, they will need to possess some understanding of the thought systems employed by end users of the products with which they are involved. Sales will not be achieved if the package on offer is deemed inadmissible by the rules of thought employed by many of those in the target market. Like entrepreneurs, consumers have their own fir spots on which to stand and their rules of thought normally operate in a way that is at odds with the fiel conception of economics. Consumers typically have lives that “revolve around” linked sets of activities and products that comprise their “lifestyle” (Earl, 1986; Thompson, 1996) and would not even dream of consuming many of the goods that lie outside of these sets but which fall within the lifestyles of others. Conversely, they would fin it unthinkable not to consume certain products. Knowing what will appeal to particular consumers thus requires an appreciation of the contexts in which choices are being made, which are themselves a reflectio of the thought systems that consumers use. To understand the fabric of particular people’s lives, the entrepreneur may need to trade with them repeatedly, itself a connection-forming activity. By cultivating the goodwill of a regular clientele, the entrepreneur can engage in relationship marketing, using knowledge acquired from previous transactions to make more accurate constructions of areas of possible demand (see further, Earl, 1999, pp. 253–257). For example, anyone who has dealt over a number of years with a good hi-f store will appreciate this point readily: staff seem to have an uncanny ability to recall what one’s system consists of, and hence how best to upgrade it on a piecemeal basis. The existence of consumer lifestyles means that patterns of substitution between rival brands of particular kinds of products depend on their complementarities with other kinds of products. Though already entailed in the comment about hi-f retailing, this point frequently applies in a much more subtle manner. For example, consider the adoption of automatic washing machines in Britain in the 1970s, in favor of twin-tub designs. British suppliers were bemused by the loss of market share to Italian products. The latter offered inferior drying abilities compared with more expensive local machines that had been designed to cope with the inclement British weather. The change in market share arose not because of the price difference per se but in association with the adoption of central heating systems that made it far easier to finis the drying process indoors if necessary (see Hesselman, 1981, p. 24). British manufacturers did not see this connection and had made their automatic machines so that they offered spin speeds equivalent to the outgoing twin-tubs, with all that this entailed in terms of extra production costs.

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Due to the complexities of household consumption systems, one change of lifestyle can have all manner of market implications but may be dependent on a crucial ingredient. Continuing the previous example, we might also note that the demand for automatic washing machines itself would have been associated with the growth in households where both spouses went out to work and hence required the convenience of machines that could perform the entire wash/spin cycle on their own, for example, during the night. Dual income households, in turn, were better able to afford central heating and double-glazing systems. However, they often could not function without a child-minding infrastructure (children’s television included!) and convenience foods. Their inability to be available at home to deal with trades-people during business hours meant that they would often need to engage in do-it-yourself work at weekends and would demand reliability as a key requirement of their appliances as well as providing a fertile market for home security systems – and so on. The successful entrepreneur may not only need to understand how potential customers make mental connections, and the connections that make up their lifestyles. There is money also to be made by construing synergistic marketing links (cf. Ansoff, 1965) between core products and possible tie-in products based on a shared brand. Shrewd thinking in terms of connections has led to the assembly of modern mass-media/entertainment businesses whose magazines promote television programs and vice versa and both promote particular kinds of merchandise (such as movies and recorded music) produced elsewhere in the corporate empire. Failing that, the media contents can be connected to products of particular advertising sponsors (as with travel and home-improvement programs) or devised to be ripe for commanding product placement fees. Similarly, a highly successful children’s novel is no longer merely a book competing in no particular manner with other books and other ways of spending money. Nowadays, it is a book to which may be connected a movie (with soundtrack CD and subsequent video and DVD release), PC and PlayStation games, displays or rides at theme-parks, a wide range of toys and artifacts, with licensed brand extensions even to clothing, bedding, food, toothpaste and so on. In fact, well before the age of Harry Potter and suchlike, children’s books were sold on the basis of connections: four decades ago Thomas the Tank Engine may not have had its marketing synergies exploited to the full, but its appeal was nonetheless increased by the fact that it was part of a series involving a shared set characters and hence offered scope for readers to spread the set-up costs of getting to know the characters more effectively and get more out of them. Likewise, publishers such as Hamish Hamilton used different imprints to signal comparable books in terms of style or level (even as 10-year-olds, my contemporaries and I knew what made a “Reindeer Book” different from an “Antelope Book,” much as

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many adults have particular expectations about books on a “Paladin” or “Picador” rack compared with those from a more mainstream brand of paperback). If the competitive arena really were a fiel in which products were all so transparent that there were no costs entailed in getting to know (about) them, then there would be no need for the entrepreneur to construct such connections and we would not see the remarkably skewed earnings that comes from an ability to capture rents by doing so.

CONNECTIONS, BROWSING AND SEARCH As the number of products on offer grows, despite the parallel growth in globally significan brands, the consumer’s problem remains one of bounded rationality (Simon, 1982). A corresponding marketing problem is to get one’s brand on the consumer’s agenda of things to explore and to keep it there. Earl and Potts (2000) examine this issue in relation to the role and design of shopping malls, but it clearly also has a counterpart in the world of “virtual” shopping. The rise of the internet may make it easy for consumers to search for things that they want, such as information about the latest activities of a particular recording artist and whether or not they have a new album available, or whether a particular highly specialized product exists. However, scope for findin information does not guarantee that consumers will think of trying to fin it. An increasingly significan entrepreneurial skill thus lies in the construction of connections that have corresponding hyperlinks that will capture the consumer’s attention and lead to particular browsing pathways being taken. Web-based retailers such as Amazon.com employ precisely such connection-based techniques to generate sales revenue for themselves and the firm whose books and music they supply: for example, investigation of a particular product at their website leads to information coming up about other products bought by previous purchasers of the product, thereby suggesting possible similarities or complementarities. Producers can similarly exploit connections with other producers by swapping links to each other’s websites, or by trading them if the fl w of benefit seems to be skewed in a particular direction. Thus, whereas I might have thought, without any provocation, to check via a direct search to see whether long-dormant progressive rock band Pallas had resumed their activities, my actual route to discovering their website and new album was from the King Crimson website to the Uriah Heep website (the link being John Wetton, who has played bass with both bands), and thence to browsing on the latter’s excellent list of other bands’ sites. There, I noticed a link to Pallas. In providing such a listing, Uriah Heep may not immediately generate sales of their own recordings but they increase their chances of staying on the

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agendas of potential customers: in future, when I want to look up particular bands or remind myself of bands that I ought to check out, I have a bookmark of their site ready and waiting. An increasingly important entrepreneurial capacity henceforth will be that of creating frequently visited website nodes to manage the networks of search and browsing that potential buyers undertake. Enterprising academics that seek to ensure a wide readership for their writings can pursue similar strategies in terms of the links they offer at their websites: Nicolai Foss, for example, provides useful links not only to fellow economists’ homepages but also to various organizations and to jazz guitar pages (see http://www.cbs.dk/staff/nicolai-foss/ njflinks.ht ).

PRODUCTS AS SYSTEMS From the Koestler/Shackle perspective, the creation of new products does not entail creating something from scratch but making new connections between existing ideas, capabilities and technologies. This happens at both the small business and corporate level. As an example of the former, consider the fusion between virtuoso violin techniques/compositions and the electric guitar, a genre known in rock circles as, of all things, “neoclassical shred.” The fusion is epitomized in unadulterated form by the work of Kevin Ferguson, an enterprising but little-known guitarist who recorded the extraordinary self-released album “From Strad to Strat.” In keeping with the earlier discussion of website links, I discovered this CD, after years of hoping someone would come up with just such a fusion, whilst trying to fin web materials regarding well-known electric guitar virtuoso Steve Morse. However, anyone with a similar vision – be they a would-be consumer or rival supplier – who thinks of keying “Paganini” and “electric guitar” into a search engine will discover that Ferguson is by no means the only artist to record violin showpieces on an electric guitar. Others have made further connections, most notably Julliard graduate Katherine Thomas, who performs as The Great Kat Guitar Goddess and seeks to appeal to the darker side of guitar fetishism by blending electric guitar renditions of classical violin and orchestral music with heavy metal rock and over-the-top, aggressively sexual Satanic/sadistic/masochistic video imagery. Whatever next? At the corporate level, as even an informal examination of the catalogues of modern consumer electronics firm such as Sony, or automotive firm such as Toyota, will attest, innovation tends to entail new combinations of a multiplicity of technologies. Each new product feature, such as a PlayStation II’s capacity to read DVDs, or electronic stability systems in cars, builds upon existing technologies,

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and the products of supposedly “different” industries may end up as elements of each other’s products – as with the incorporation of audiovisual entertainment systems and GPS/DVD-based navigation systems in cars, or the menus of digitized cars in PlayStation games such as Gran Turismo. Some technologies, such as LCD systems, soft touch keypads and memory chips, may be added to an astonishing variety of products and their growing ubiquity makes it easier to apply them in yet more applications, as users can employ the same skills in all manner of different contexts. All it requires is that an entrepreneur dreams up the possible connections or is prepared to back financiall an inventor who sees them sooner. As well as being the basis of new types of products, fresh connections provide the basis for new generations of existing products. In cases of the latter, however, innovation is often deliberately of a restrained nature in order to make the most of knowledge of how customers form mental connections regarding the particular firm s products. Successive generations of products as diverse as cars and the music of particular recording artists may incorporate some stylistic cues – what we might call “signature” or “trademark” design features – from previous generations, tending to evolve rather than making revolutionary breaks with the past. For example, over almost two decades, Volvo moved gradually away from safe but boxy designs to successively more curvaceous shapes and an emphasis on the combination of driver appeal and safety. Because of the gradual progression and ever-present distinctive grill design, current products remain recognizably Volvos: the Volvo/safety connection has been maintained even though customers may have taken a long time to adjust their constructs to the idea that structural integrity did not require cars to look like tanks. By contrast, Ford Europe in the early 1980s had trouble getting customers to switch straight from the conservative Cortina to the radical-looking Sierra, while the lackluster performance of Fiat in the lower-medium sector has been associated with an ongoing failure to connect one generation of its cars to another, even by model name (as if the fir was conceding that its products stood for nothing in particular).

“PARTS BIN” ENTERPRISE Firms with a capacity to devise new combinations that fi into buyers’ thought systems should have greater potential for survival than those that do not, for the latter will lose market share to them and suffer higher relative costs due to failures to achieve economies of scope. Just as we can test for the existence of a market for a particular product by using an internet search engine – as with the Paganini/electric guitar example – so one might even imagine strategists in

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these firm systematically looking at a matrix of all possible combinations of their products or major components to see what new connections might be made in theory and what might be the practical objections to them. By raiding the parts bins of existing models and adding relatively few new parts, the enterprising fir may be able to occupy lucrative new market niches and gain first-m ver advantages by definin a new genre of product. Toyota, for example, created the “soft roader” market when it created its RAV4 – essentially a re-bodied, jacked-up Corolla 4WD wagon with a 4WD Camry’s engine and transmission system. Subaru countered a few years later by re-bodying its Impreza (itself based on a shortened Subaru Legacy platform and shared transmission system) as its Forester model. When, later still, Ford got on to the act – by which time Toyota was already offering a second-generation RAV4 and maintaining its lead in styling appeal and premium pricing – it did so with an engine and 4WD transmission system in its Maverick/Escape model that was closely related to that of its Jaguar X-Type sedan. In turn, the latter owed quite a bit to the second-generation Ford Mondeo. Mere possession of a range of technological capabilities does not guarantee success in creating new products (see further Pavitt, 1999), for someone must firs notice the potential connections and overcome any barriers to making them happen. This entrepreneurial role is sometimes played by outsiders rather than by staff in the organization that seemingly should have been best placed to recognize the potential and act upon it. For example, the firs MGB V8 sports cars were put together by customizing specialists outside of British Leyland/Austin Rover, using the latter’s parts, as were the firs Range Rovers with larger capacity V8 engines. (In Australia, this was the resting place for many of the 4.4 liter engines from the spectacularly unsuccessful 1973–1974 Leyland P76 sedan, a decade before the manufacturer made the connection and despite the fact that the P76 engine had originally been developed in the U.K. in the late 1960s for a large Rover sedan that never made it into production.) Stranger still, the Fender Stratocaster electric guitar had been in production for over four decades before Fender offered its Big Apple model featuring twin-coil pickups of the kind that had been privately fitte by many players who wanted a Stratocaster that had the sound of a Gibson Les Paul, its main rival. In the meantime, firm such as Ibanez and Yamaha had begun to produce near-clones of the Stratocaster that offered the best of both worlds: a mixture of single-coil and twin coil pickups. (Fender’s recent Showmaster range is a belated attempt to produce something similar for the premium market.) Just as the creative insight may rest outside the fir that has the technological capacity to make new products by making new technological connections, so the technologies may be bought in from outside suppliers as ready-made components

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or as capabilities supplied through a corporate alliance. This being so, the entrepreneur may be someone with an eye for what will fi from other people’s parts bins – a key feature in the initial success of the Lotus sports car company was founder Colin Chapman’s legendry skills in this respect – or the capacity to persuade other suppliers to tailor something that will fit based on their particular skills (which may entail relational contracting or other forms of quasi-integration: see Richardson, 1972), or the capacity formally to stitch together workable business alliances. Entrepreneurs who have a vision for a product but whose comparative advantage does not lie in making deals with suppliers can subcontract this role to entrepreneurs who specialize in doing precisely that. An excellent example here is the “virtual firm system that is often employed in major building products: the property developer has the idea and raises the capital, but the transforming of it into reality is handled by a construction management company that hires and oversees an army of specialist subcontractors (see Earl, 1996). In some cases, the fact that certain components are outsourced may be something that can be exploited in marketing terms to appeal to those “in the know” amongst potential buyers. For example, Mitsubishi reminds potential buyers that its Lancer EVO VII is equipped with Brembo brakes, OZ wheels, Momo steering wheel and Recaro seats, just as the pickups on a Big Apple Stratocaster guitar remained branded as Seymour Duncan products. In other contexts, entrepreneurs do not shout about their skills in outsourcing; a very notable example being Rolls-Royce, whose cars prior to the German takeover employed inputs from less elite brands such as Citroen (adaptive suspension systems) and General Motors (transmission). To do otherwise might result in customers making all the wrong connections regarding the quality of the product. Skills in keeping the customer uninformed of the connections upon which products are founded look set to become a major entrepreneurial capacity the more that skills in making additional product lines relatively cheaply from existing elements are used as part of a strategy of price discrimination. The car market again illustrates this difficult . For Jaguar and Volvo to remain premium brands under Ford’s ownership, their use of Ford components needs to be discrete. Similarly, if it becomes widely known that one can obtain premium Volkswagen or Audi buildquality, engines and structural engineering at a budget price by buying a Skoda or SEAT, then the brand equity of the firs two marques will collapse. Whilst the manufacturers seek to conceal their capacities to make connections, enterprising consumer magazines can set about trying to make potential buyers aware of them and in doing so provide the latter with all the ammunition they might need to justify to their peers their deviant decisions to buy products whose brands have hitherto lacked cachet.

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ENTREPRENEURSHIP AND DESIGN STANDARDS If entrepreneurship is about making connections, then competitive success may depend upon setting up systems within which it is more difficul for other entrepreneurs to make connections that one is capable of making. This process is obviously at work in some markets, where even though products take the form of modules that can be combined in different combinations, the interfaces between them are specifi to the brand in question. The specific of Canon and Minolta camera and lens relationships provide an example here, as do Apple Macintosh computers versus PCs. However, there are also many cases – the IBM PC being one of them – in which entrepreneurial insight takes the form of setting out to create a set of open standards to enable other entrepreneurs to make money by selling products that hook up with one’s own and in the process generate demand for one’s own product. Sometimes the creation of common interfaces between modular products will be necessary in order to remove technological uncertainty for customers and thereby promote the growth of the market as a whole, as with the development of the digital synthesizer market following the adoption of the Musical Instrument Digital Interface (MIDI) standard that enabled different brands of synthesizers and peripherals to be wired together. In markets where systems can be assembled in this way, the role of the entrepreneur may evolve along a variety of connectionist tracks as the market develops, including the following (see also Langlois & Robertson, 1995): (1) As a standards promoter, such as by selling licenses to one’s technology or by promoting cooperative activities at the trade association level or through strategic alliances; (2) Trying to become a leading specialist supplier of a particular product that connects with the output of other suppliers rather than continuing to be a supplier of an entire system; (3) Specialization in designing systems tailored to those with particular requirements; (4) Using purchasing skills to package other producers’ elements into low-cost systems for a mass market; or (5) Developing new kinds of modules that hook into the technology. The choice of track to take will depend not merely on being able to envisage oneself in that role in the firs place, but also on assessments of comparative advantage in terms existing capabilities and capacity to develop what seem to be pertinent new ones.

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WHERE ENTREPRENEURSHIP STOPS AND MANAGEMENT BEGINS The view of the entrepreneur proposed in this paper needs to be considered in relation to the roles of strategists and other managers in firms for clearly it is not a viewpoint that applies merely to the start-up phase of business. It can be used to frame decision making in firm of diverse sizes and stages of evolution. It can be applied to the founding of a business, where the entrepreneur construes that there is money to be made by making a particular connection, such as between product elements to form a new product or system, or between potential customers with a particular unmet need and various presently under-utilized resources that can be combined to meet that need. It can be applied further, to making sense of the growth of a business via relationships with customers and/or linkages between past products and ones subsequently added to the firm s portfolio. These linkages may be within the supply chain of what the entrepreneur’s business already produces, where vertical integration of some kind is seen as necessary to ensure quality, cost or supply goals are met. Or they may be made horizontally between any particular activity and others that employ similar production processes and/or marketing. By successively constructing new connections, the entrepreneur builds a complex business architecture that often entails both some degree of vertical integration and horizontal diversification with new products based on lateral linkages later being produced with the aid of further forays into vertical integration. Such a view of entrepreneurship overlaps to some extent with linkage-based views of the economics of corporate strategy offered by Moss (1981) and Kay (1997), but both present business strategists as rather defensive characters who manage connections between products or activities in order to keep the fir going in the long run. Moss draws his inspiration from the forward/backward linkages literature in development planning. Whereas Austrians such as Kirzner tend to provoke thoughts about the start-up of a business, Moss concentrates on how additional business opportunities come to be taken on by firm that already exist. Instead of seeing this as a reflectio of an inherent drive of entrepreneurs to strike forth boldly with the aim of bringing some grand vision to fruition or, more modestly, “to make things happen” (as many of the subjects in Woods’ (2002) study saw their own motivation), Moss argues that the direction taken by a business as it grows is a reflectio of attempts to solve resource imbalance/capacity under-utilization problems perceived in what it is doing right now, or which are judged likely to arise in future due to competitive activities of others. Kay’s analysis of strategy begins with the connectionist thinking of Ansoff’s writing on synergy but then sees the development of larger firm as increasingly being concerned to contain

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the strategic vulnerability that comes from building too much on too few common threads. Each time the structure comprising the fir adds a new connection between production activities in a vertical or horizontal direction it will be doing something new, to a greater or lesser extent. Adding twin-coil pickups to an electric guitar may have had very few manufacturing implications for Fender, beyond cutting out guitar bodies and scratch-plates differently, and somewhat different wiring. Dropping a more powerful engine into an existing car may require more challenges to be addressed, such as re-engineering front chassis members to accommodate the width of a V8 engine, or learning how to create reliable turbocharger or supercharger installations and fi them within the confine of an existing body. Other kinds of diversification particularly those involving vertical integration, may entail coping with a whole host of problems that entail totally unfamiliar technologies (as would attempts by Fender to diversify into digital keyboard instruments, or a mainstream automotive manufacturer setting out to make an electric car with a body formed from plastic composites). In order to judge whether a new line of business represents a profi opportunity, the entrepreneur needs to have a capacity to judge the implications of such a move in terms of the competences required, as well as physical resources. From a connectionist perspective, we might see competence in terms of the ability to make a particular connection with a particular degree of reliability and for a particular cost. A useful analogy here is with the playing of a musical instrument, a matter of matching finge movements to instructions on the sheet music: an accomplished player may need very little time to be able to perform a particular piece seamlessly and without error, whereas a novice might require much practice and still be able barely to offer a tolerable performance. Without an ability to judge the degree of difficult the business will experience in implementing a new connection, the entrepreneur will be unable to size up the costs the new venture entails and may over-estimate revenue streams in the event that quality and reliability levels turn out to be harder to achieve than anticipated. This capability requirement casts the entrepreneur in a role very much like that of the strategic manager in the recent literature on resource-based approach to the firm with its focus on understanding the core competences of the fir and how its particular set of resources gives it a competitive advantage. (For a compilation of the key sources, see Foss (Ed.), 1997.) In the context of the large firm a team often undertakes this role, though ultimate responsibility for it may rest with a particular individual, such as a chief executive office who “signs off” any significan new venture. The strategic decision makers may not have the task of making the hypothesized connections come true, but they have to be able to judge that the new connections are capable of being put into place and, if not assembling

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the teams who will actually have to implement their decisions, they will need to be able to make good decisions when assigning to someone else the responsibility and resources for assembling and running a team to do so. Operations managers in such teams in turn plan, coordinate activities and deal with surprises as the need arises, in order to try to make a reality of the connections envisaged by the entrepreneur.

CONCLUSION: ENTREPRENEURSHIP IN A GLOBALIZING WORLD The connectionist perspective on entrepreneurship is sharply at odds with how mainstream economists are driven to view the theoretical place of entrepreneurs in the modern world of globalization, a viewpoint that leads them to favor particular policies aimed at fostering it by making entrepreneurial activity more attractive to undertake. From the fiel perspective, the world is increasingly a place in which competition may come from any quarter, limiting scope for the earning of supernormal returns. The removal of barriers to parallel importing enables entrepreneurs who spot opportunities for arbitrage anywhere in the world to constrain the ability of manufacturers to practice price discrimination between markets. Aided by internet search engines, consumers can choose in an informed manner with unprecedented ease and source their purchases from anywhere on the planet that offers the best deal. The same applies to the allocation of investment funds in a world of electronic share trading. Workers, too, are able to shift to any location where their services are in demand, aided by increasing standardization of language and business practices, whilst physical relocation may not even be necessary insofar as tasks can be performed remotely via modern telecommunications systems. The rise of the internet and cheap access to high-powered computers means that many e-commerce businesses can be started up at very low cost (see further, Friedman, 1999). In short, an increasing perfection of markets is eliminating breaks in chains of substitution. If globalization really did entail the economic system coming closely to approximate a field then little role would remain for the typical Austrian conception of the entrepreneur as someone whose special capacity of alertness to arbitrage-based profi opportunities helps to bring the economic system closer to equilibrium. In the world of globalization, everyone is under pressure to be alert to potential for doing a better deal in order to prevent others from encroaching on their standards of living, and the information necessary for doing so is available to anyone with an internet connection. One conundrum would remain, however, for mainstream and Austrian views of market coordination alike, namely, the

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difficult that decision makers have in deciding where to invest when they do not know the plans of others in terms of investment schemes that are competitive with and complementary to possibilities that they are considering (what is sometimes known as the Richardson Problem, following Richardson, 1960/1990). The message of this paper is that if we cast the entrepreneur in the role of someone with a comparative advantage in making connections between product elements, products, capabilities and cost/revenue streams, the entrepreneur emerges as a much more dynamic character than the typical Austrian figure Instead of acting to take the economy nearer to some kind of Pareto optimum, the connection-making entrepreneur is a disequilibrating agent who opens up opportunity sets in the manner envisaged in Schumpeter’s (1943) work. By making novel, previously unimagined connections (cf. Shackle, 1979), the entrepreneur creates new elements from which yet further sets of combinations can be made, leading to economic growth and the seemingly infinit variety of products between which modern consumers can choose. Rather than necessarily fillin in gaps in chains of substitution and making the economy better approximated by the neoclassical “field perspective, new combinations may provide bases for rents to be earned – at least for a time – by offering, for example, “unique selling propositions” and/or providing a niche-market product that appeals to customers who otherwise would have found themselves choosing between rather different possibilities none of which really did what they wanted. Whilst its non-equilibrium aspect may go against the Austrian tradition, the connectionist approach provides opportunities for building bridges between economics, marketing, strategic management, and the literature on innovation. If Austrian writers fin it appealing, it may also take them into an interest in the cognitive process, such as lateral thinking, by which entrepreneurs come to construct novel connections.

REFERENCES Ansoff, H. I. (1965). Corporate strategy. Harmondsworth: Penguin. Earl, P. E. (1984). The corporate imagination. Armonk, NY: M. E. Sharpe, Inc. Earl, P. E. (1986). Lifestyle economics. New York: St. Martin’s Press. Earl, P. E. (1996). Contracts, coordination and the construction industry. In: P. E. Earl (Ed.), Management, Marketing and the Competitive Process (pp. 149–171). Edward Elgar: Cheltenham. Earl, P. E. (1999). Marketing as information economics. In: S. Macdonald & J. Nightingale (Eds), Information and Organization: A Tribute to the Work of Don Lamberton (pp. 243–261). Amsterdam: North-Holland. Earl, P. E., & Potts, J. (2000). Latent demand and the browsing shopper. Managerial and Decision Economics, 21, 111–122.

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Foss, N. J. (Ed.) (1997). Resources, firms and strategies: A reader in the resource-based perspective. Oxford: Oxford University Press. Friedman, T. (1999). The Lexus and the olive tree. New York: Giroux, Farrar & Strauss. Harper, D. A. (1996). Entrepreneurship and the market process. London: Routledge. Harper, D. A., & Earl, P. E. (1996). ‘Growth of knowledge’ perspectives on business behaviour. In: P. E. Earl (Ed.), Management, Marketing and the Competitive Process (pp. 306–328). Cheltenham: Edward Elgar. Hesselman, L. (1981). Non-price factors in the U.K. washing machine market: A hedonic approach. Economic Working Paper No. 1, NEDO, London. Holbrook, M. B. (1995a). Consumer research: Introspective essays on the study of consumption. Thousand Oaks, CA: Sage. Holbrook, M. B. (1995b). The four faces of commodificatio in the development of marketing knowledge. Journal of Marketing Management, 11, 641–654. Hoover, K. (1994). Pragmatism, pragmaticism and economic method. In: R. E. Backhouse (Ed.), New Directions in Economic Methodology (pp. 286–315). London: Routledge. Kay, N. M. (1997). Pattern in corporate evolution. Oxford: Oxford University Press. Kelly, G. A. (1955). The psychology of personal constructs. New York: W. W. Norton. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago, IL: University of Chicago Press. Koestler, A. (1975a). The ghost in the machine. London: Pan Books. Koestler, A. (1975b). The act of creation. London: Pan Books. Langlois, R. N., & Robertson, P. L. (1995). Firms, markets and economic change. London: Routledge. Loasby, B. J. (1989). The mind and the method of the economist. Aldershot: Edward Elgar. Moss, S. J. (1981). An economic theory of business strategy. Oxford: Martin Robertson. Pavitt, K. (1999). Divisions of labor in the innovating firm In: S. C. Dow & P. E. Earl (Eds), Complexity, Contingency and the Theory of the Firm (pp. 138–155). Cheltenham: Edward Elgar. Potts, J. (2000). The new evolutionary microeconomics: Complexity, competence and adaptive behaviour. Cheltenham: Edward Elgar. Richardson, G. B. (1960). Information and investment. Oxford: Oxford University Press (republished, 1990). Richardson, G. B. (1972). The organization of industry. Economic Journal, 82, 883–896. Schumpeter, J. A. (1943). Capitalism, socialism and democracy. London: Allen & Unwin (reprinted 1992, London: Routledge). Shackle, G. L. S. (1979). Imagination and the nature of choice. Edinburgh: Edinburgh University Press. Skinner, A. S. (1979). Adam Smith: An aspect of modern economics? Scottish Journal of Political Economy, 26, 109–125. Simon, H. A. (1982). Models of bounded rationality (Vols I & II). Cambridge: MIT Press. Smith, A. (1795/1980). The principles which lead and direct philosophical enquiries: Illustrated by the history of astronomy. In: W. P. D. Wightman (Ed.), Essays on Philosophical Subjects (pp. 33–105). Oxford: Oxford University Press. Thompson, C. J. (1996). Caring consumers, gendered consumption meanings and the juggling lifestyle. Journal of Consumer Research, 23, 388–407. Woods, C. (2002). Entrepreneurial action: Casting the entrepreneur in the market process. Unpublished Ph.D. Thesis, University of Auckland.

MARKET OPPORTUNITY AND ORGANIZATIONAL GRIND: THE TWO SIDES OF ENTREPRENEURSHIP Ulrich Witt ABSTRACT In pursuing profit opportunities, entrepreneurs often use multi-person firms. Since employment contracts leave some discretion to the employees, organizational coherence requires that they are coordinated on the entrepreneurial business conception as their own frame of action. Accordingly, the entrepreneurial reorganization of production and trade implies two different coordinating tasks: the exploitation of market opportunities and the seeing through of the business conception in the firms’ daily organizational grind. The former has been center stage in the Austrian school of economics. For the neglected latter task a cognitive theory is suggested which highlights an Austrian, or entrepreneurial, approach to the firm.

1. INTRODUCTION Entrepreneurship is the core of the dynamics of modern capitalism. There is no enhancement in the division of labor and no rise in the degree of specialization without a reorganization of production and trade conceived of, and carried out by, entrepreneurs. This fact not withstanding, entrepreneurship only plays a peripheral role in economic theorizing (cf. Casson, 1982). In modern microeconomic Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 131–151 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06009-5

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textbooks it is barely mentioned. Their static equilibrium-cum-optimization perspective means that of course the dynamics of modern capitalism disappear too. It is not accidental, therefore, that two of the most eminent acknowledgments of the entrepreneurial role in economics are closely interwoven with an equally pronounced emphasis on the dynamics of capitalist markets. These acknowledgments come from Schumpeter (1934) on the one hand, and Mises (1949) and Kirzner (1973) on the other. Different as their interpretations are, entrepreneurship is the hallmark of both acknowledgements. However, in the way in which they portray entrepreneurship, they both abstract equally from how entrepreneurs actually organize production and trade. Given the empirical, organizational context in which entrepreneurship occurs in most cases, this appears to be inadequate. The way entrepreneurs pursue business ventures hinges on how they conceive of them. They acquire resources to produce and offer products and services to the markets. But this usually calls for the creation of a multi-person organization with an internal division of labor. It is based on employment contracts which leave a certain amount of discretion to the agents who have been hired. This means that the entrepreneurial goals are attained better, the better the employees are coordinated on the entrepreneurial business conception, and are motivated to adopt it for their own productive activities in their respective areas of discretion. Thus, entrepreneurial reorganization of production and trade usually implies two quite different coordinating tasks. The firs is to help achieve coordination within the markets by specifi and often new productive services (cf. Foss, 1994). The second is to achieve coordination within the organization created for productive purposes. Following up some earlier work (Witt, 1999, 2000) it will therefore be argued here that a full understanding of the entrepreneurial role can only be gained if two challenges to entrepreneurship are recognized. One is to establish or seize market opportunities; the other is to master the organizational grind. The paper proceeds as follows. In Section 2, the theories of entrepreneurship suggested by Schumpeter and Mises/Kirzner are reviewed. They are shown to be two different versions of the market opportunity centered view. Schumpeter’s version emphasizes how entrepreneurs establish opportunities, while Mises’ and Kirzner’s version focuses on how they seize them. Later on Schumpeter (1942) changed his view and put managers and bureaucracies in the place of entrepreneurs. But he continued to ignore all organizational issues. They were introduced into his framework of capitalist development only later by Nelson and Winter (1982). Section 3 briefl reviews their contribution which – as the late Schumpeter does – neglects the role of entrepreneurship. In contrast, Mises and Kirzner have stuck to their interpretation, but they also continued to disregard the organizational aspect of entrepreneurship and the theory of the fir in general. Section 4 therefore turns to some recent efforts

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to address the organizational issues from the point of view of Austrian economics. The discussion shows that the intra-organizational, entrepreneurial, coordinating task can best be characterized as one of achieving cognitive coordination. Section 5 therefore analyzes the challenges accruing to entrepreneurship at the cognitive level in the daily organizational grind in some detail. Section 6 offers conclusions.

2. VIENNA STYLE ENTREPRENEURSHIP: ENTREPRENEURS WITHOUT FIRMS In 1908 Schumpeter published his habilitation thesis, accepted the previous year by the University of Vienna, which qualifie him for a professorship in the Austrian Empire. It was a scholarly, but somewhat uninspired, survey of the work of contemporary non-German neoclassical writers (Schumpeter, 1908). A question that Schumpeter seems to have found lacking in those works induced him to start writing a new book. If, as the neoclassical gospel has it, the economy is supposed to gravitate back to a state of equilibrium after each disruption, why and how is the equilibrium state disturbed in the firs place? Shouldn’t it be possible to explain the tremendous industrial transformation of the European economies which Schumpeter witnessed by focusing on systematic features in those disruptions? The book with his theory of economic development appeared in 1912 (revised English edition: Schumpeter, 1934). In the seventh chapter of that book Schumpeter explicitly recognized the heuristic analogy with gravitating systems in Newtonian physics as the source of the neoclassical preoccupation with the equilibrating forces in the economy.1 He argued that using such an analogy rules out any possibility of development occurring “from within” the economy. A “developmental method” would be needed to make theoretic progress. As the core element of that “developmental method,” Schumpeter chose a theory of entrepreneurship which built on ideas derived from his teacher Wieser (cf. Streissler, 1983). The unique entrepreneurial achievement, he claimed, is the “carrying out of new combinations,” more precisely of product innovations, process innovations, the making of new output markets, the tapping of new input sources, and the reorganization of markets like, e.g. cartelization (Schumpeter, 1934, p. 66). The uniqueness of the entrepreneurial achievement is, according to Schumpeter (ibid., pp. 74–94), explained by the entrepreneur’s distinctive personality characteristics. Being an “entrepreneur” is not an occupation or a profession, but rather a capacity. It presupposes initiative, authority, imaginative foresight, leadership (and is entirely independent of capital ownership). The incarnation of the entrepreneur is the “promotor,” the “captain of industry” – as long as (s)he is innovative – as opposed to the “plain businessman” who only

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follows conventional paths. Schumpeter (ibid., p. 88) holds that inventiveness and creativity are not the key features of entrepreneurship. It is not the entrepreneur who figure out new possibilities. These are already present in abundance, are often even common knowledge, and thought up by all sorts of people. Entrepreneurship according to Schumpeter is the “doing the thing”; the will to demonstrate that vaguely perceived possibilities can be turned into reality. Considerable emphasis is given to the problem of explaining the entrepreneur’s motivation. Typically, it is claimed, an entrepreneur shows little interest in the “hedonistic satisfaction” that might result from his efforts (ibid., p. 92). He works relentlessly because of what, in more modern terminology, would be called achievement motivation (McClelland & Winter, 1969, on this cf. also Khalil, 1997) and a craving for recognition. Dreams and wishes about founding a private kingdom are mentioned; the sensation of power, leadership and authority, whose fascination is particularly strong for people who have no other chance of achieving social distinction; the will to conquer, the impulse to fight and the satisfaction from getting great things going.2 Given the exceptional qualities attributed to the entrepreneur, it stands to reason that, in Schumpeter’s mind, entrepreneurs are rare – in any case much less numerous than those who, as factory owners, managers, or administrators, to him personify the “plain businessman.” Indeed, the distinction drawn between the entrepreneur with rare innovative talents on the one hand, and the plain businessman on the other, is a reflectio of elitist views quite characteristic of the zeitgeist.3 Schumpeter’s hypotheses about how entrepreneurial innovativeness disrupts and revolutionizes the production processes, the supply of goods, and the organization of the economy are significan and help in understanding the role of entrepreneurship (cf. Kirzner, 1999). But they do not give a full account of that role. In order to realize their ambitious “carrying out of new combinations,” entrepreneurs usually create fir organizations. Indeed, how else could Schumpeter’s terminology of “captains of industry” who “found a private kingdom” enjoying “power, leadership, and authority” be understood? However, the question of how the entrepreneur acts within the firm s organizations is not addressed by Schumpeter’s theory. Authority and leadership – attested in Schumpeter’s psychological portrait of the entrepreneur – are capabilities which do matter for the pursuit of particular entrepreneurial tasks, namely those of coordinating the intra-organizational activities. However, these activities are not dealt with by Schumpeter. Even though the intra-organizational processes and conditions may by crucial for the success of the entrepreneurs’ ventures, they are ignored. Schumpeter (1934) confine himself to the market level and the question of how entrepreneurs eventually succeed in seeing through profitabl new combinations and push forward the reorganization of the markets.

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Schumpeter’s views on entrepreneurship changed significantl after his emigration to the U.S. in 1932. At Harvard University he got interested in the role of the large trusts. In the grand view of modern capitalism which he offered in Schumpeter (1942), trusts are already seen as dominating the industrial dynamics. He argues that entrepreneurs, as pioneering promoters, are losing out against the professional teams and trained specialists of the large corporations. Innovative reorganizations are no longer the exclusive achievement of heroic leaders, but a result of just another form of bureaucratic offic work (ibid., pp. 132–133). However, even the replacement of the figur of an elitist entrepreneur by a fir organization with internal specialization in diverse entrepreneurial tasks did not induce Schumpeter (1942) to address the problem of intra-organizational coordination. In his references to the operation of corporate divisions, he did not offer any detailed ideas about how they work. It is perhaps because of this lack of interest in organizational coordination that he did not recognize that even anonymous routine-like, industrial innovativeness is still very much contingent on a coordinating entrepreneurial influence What did interest him were the implications for market coordination, more precisely, for the proper appraisal of market competition (ibid., Chap. 8). Schumpeter was convinced that the innovative operations of the large trusts were beneficia for economic growth and for the wealth of the nations. But he also claimed that they embraced monopolistic practices as a necessary concomitant. This assessment challenged the static model of perfect competition. It provoked a debate on the relationships between market structure and innovativeness that occupied economists for decades (see Baldwin & Scott, 1987, for a survey). The other distinguished, but significantl different, view on entrepreneurship to be discussed here is that of Ludwig von Mises, Schumpeter’s contemporary. Mises received a doctorate from the University of Vienna in 1906. Unlike Schumpeter, hostile conditions denied him a full-time academic career in Vienna (cf. Craver, 1986). It was therefore not until he went into exile in Geneva in the late 1930s that Mises could elaborate in detail his views on homo agens, which implied his interpretation of entrepreneurship. The work was published in 1940 (revised English edition: Mises, 1949). The background of Mises’ interpretation of entrepreneurship is his praxeological approach. Mises (1949, Chaps 1 and 2) portrays economic behavior – or, as he calls it, “human action” – as exclusively comprised of deliberately considered, purposeful acts.4 As a matter of pure ratiocination, he argues, human action is an object not of empirical conjectures, but of a logical reconstruction of means-ends-relationships. Related to his concept of homo agens (but difficul to reconcile with a purely logical analysis) is a hypothesis on the motivation to act. Mises submits that human action is inspired by a man’s endeavor to overcome dissatisfaction with the conditions given at any particular moment of time:

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His mind imagines conditions which suit him better, and his action aims at bringing about this desired state. The incentive that impels a man to act is always some uneasiness. A man perfectly content with the state of his affairs would have no incentive to change things (ibid., pp. 13–14).

This means that human action is not only considered a matter of always choosing the most suitable among available means for some given ends, but also of looking out alertly for new possibilities and advantages. Mises (ibid., pp. 252–256) identifie this alertness, a general feature of homo agens, with entrepreneurship. This is to say that an entrepreneurial element is supposed to be a part of human action. It was Mises’ student Israel Kirzner who later developed some concrete hypotheses on what that entrepreneurial element means in daily market operations. Like Mises, Kirzner (1973, 1982) considers a situation of widespread ignorance of the actual market conditions as the initial (given) condition for entrepreneurship. Disorientation, erroneous decisions, and missed chances offer profitabl market opportunities for agents who are alert enough to discover the not yet perceived mismatches. Given Mises’ hypothesis about homo agens’ uneasiness and eagerness to improve her/his situation, Kirzner (1979) claims that there will always be such alert agents who discover profi opportunities. They can seize them by making offers that have not yet been made, including relocation (arbitrage), lower prices and/or higher quality of goods and services. Consequently, Kirzner holds that if arbitrage opportunities become feasible in the markets, they will always be exploited until every profitabl opportunity has been exhausted in market equilibrium. The Mises–Kirzner approach to entrepreneurship obviously differs in several respects from that taken by Schumpeter (1934). Two points of particular interest here are the following.5 First, by shifting emphasis to a universal entrepreneurial element in human action Mises avoids Schumpeter’s elitist view of entrepreneurial personalities. All agents possess, as it were, more or less of an entrepreneurial trait. Second, and as a consequence of the firs point, the entrepreneurial theory is no longer confine to epochal innovations. On the contrary, particularly in the interpretation of Kirzner (1979), the focus is now on the low profil profitabl opportunities lurking “just around the corner” in everyday life. They range from dime-a-dozen innovations to simple price arbitrage which, to Schumpeter, were the activities of “plain businessmen.” With these modifications the Mises–Kirzner approach surely comes closer to what is associated in everyday language with the notion of “entrepreneurship.” Indeed, allowing the full range of entrepreneurial possibilities reaching from small scale businesses to large scale promoters’ ventures, and from short term arbitrage to long term investment for realizing profitabl opportunities, would seem a desideratum of a theory of entrepreneurship.

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However, as far as the intra-organizational aspects of the coordinating entrepreneurial actions are concerned, the Mises/Kirzner approach is just as ignorant as Schumpeter’s interpretation. Whether talking about small-scale entrepreneur (in Mises/Kirzner) or about a “captain of industry” (in Schumpeter), the fact that the organizational basis of the entrepreneur’s operations is a multi-person fir is disregarded in both cases. Kirzner considers entrepreneurship to be entirely unrelated to organizational form (for him this is only a matter of productive services being sold to an entrepreneur). He abstracts from the fact that entrepreneurial action in many cases achieves coordination not only via markets, but also in a most essential way through organizing a firm To neglect the intra-organizational, coordinating role that entrepreneurs choose to take when creating a multi-person fir therefore seems to draw an incomplete picture of entrepreneurship. In a sense, this neglect corresponds with the praxeological framework of the Mises–Kirzner approach. Coordinating the members of a fir organization to achieve the collective production goals is not a matter of minimal behavioral hypotheses like “seizing opportunities which pop up” or “seeking action because of some uneasiness.” (In line with Mises’ aprioristic program of economics, such hypotheses place the burden of explanation on the outcome of the market process.) Coordinating fir members is, as will be explained below, instead a process of continued wrestling with rivaling conceptions and agendas within an organization. To explain the complex coordinating task, detailed notions of the motivational and cognitive background of the various agents’ behavior are required. It is not simply “alertness,” but a whole set of personal and social skills and characteristics like persuasiveness, persistence, authority, trustworthiness, and so on which affect the entrepreneur’s capacity to master the intra-organizational coordination task. These necessary theoretical underpinnings can hardly be provided within the framework of an aprioristic, i.e. non-empirical, conception like Mises’ praxeology. As argued already in Witt (1989), what is needed is a richer psychological foundation for human action and its implicit entrepreneurial element.

3. NEO-SCHUMPETERIAN EXTENSIONS: FIRMS AND ROUTINES WITHOUT ENTREPRENEURS As explained in the previous section, Schumpeter changed his views on the entrepreneurial role. In Schumpeter (1942) he concluded that, in the era of large trusts, it is no longer through the outstanding figur of the promoter-entrepreneur that new market opportunities are established. This task is done instead by the bureaucratic work of the specialized divisions of those trusts. However, he did not explain either how the corporate teams and departments actually operate or

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how the division of labor internal to the organization is coordinated. Some forty years later the issue was taken up again in the neo-Schumpeterian revival initiated by Nelson and Winter (1982). They worked out a synthesis of Schumpeter’s views with more recent theoretical developments. Their synthesis also fill the explanatory gap which Schumpeter had left. One set of ideas entering that synthesis comes from the behavioral theory of the fir developed by the Carnegie school (Cyert & March, 1963; March & Simon, 1958; Simon, 1949). Following the notion of bounded rationality and its implications for fir behavior, Nelson and Winter suggest that the internal interactions of organizations are based on behavioral routines and rules of thumb. Production planning, calculation, price setting, and even the allocation of R&D funds, all follow rule-bound behavior. The second theory element added to the Schumpeterian framework in Nelson and Winter’s synthesis is a loose analogy with the concept of natural selection.6 Nelson and Winter (1982) identify the routines used by organizations for internal coordination with “genotypes” in the neo-Darwinian model of natural selection. Correspondingly, they consider specifi decisions that result from the firms routines as the analogue of “phenotypes.” The latter may be more or less favorable for the firm s overall performance and thus result in potential differences in profitabilit . Assuming that profitabilit differentials translate into growth differentials, and that routines which successfully enhance growth will not be changed, Nelson and Winter see fir expansion as an increase in the relative frequency of the corresponding “genes.” Routines that cause a firm s performance to deteriorate are, by contrast, unlikely to disseminate.7 Because of the complexity of the interactive selection dynamics operating on the routines at the different layers of the fir organization, Nelson and Winter (1982) derive the implications of their neo-Schumpeterian synthesis by extensive simulations. The perhaps most significan findin is that their approach supports what has been called the inverse (rather than the original) Schumpeter hypothesis concerning the relationship between market structure and innovativeness. According to the inverse hypothesis, the degree of concentration within an industry, which indicates a potential for monopolistic practices, is a consequence of, rather than a prerequisite for, a high rate of innovativeness in the industry. Nelson and Winter thus provide a different rationale for Schumpeter’s notion of a “perennial gale of creative destruction” and the relationships between market structure and innovativeness. However, to obtain their results Nelson and Winter specify the intra-organizational working of the large trusts in a way that does not even mention entrepreneurship. The question that can be raised here is whether a full understanding of how coordination is achieved on the organizational level can indeed be achieved if the role of the entrepreneur is completely ignored. Can a theory of routines and

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selective routine replication succeed which denies entrepreneurship any signifi cance? To investigate this question let us subsume “what is regular and predictable about business behavior . . . under the heading ‘routine’ ” (Nelson & Winter, 1982, p. 15). This means aiming at a comprehensive interpretation of what is going on inside firm exclusively in terms of the routines which the firm employ. However, organizational routines refer to the form of interactions inside the organization, including the form of communicating information. As such they may constrain the amount, and perhaps even the quality, of information thus processed, but they do not determine the meaning or cognitive content of the information. If, as will be claimed here, the cognitive level is important for understanding what happens inside fir organizations, then an analysis based exclusively on organizational routines is not sufficient In their actions the members of a fir organization follow their subjective intentions, conceptions, and conjectures. No less than organizational routines to which the fir members adhere, their cognitive notions may be a source of regular and predictable features in business behavior and, as such, a significan and specifi feature of the organization. It is at this cognitive level that entrepreneurship becomes a crucial input to coordination in the organization. As will be explained in more detail below, the entrepreneurial input is to conceive, implement, and enforce a business conception which provides the cognitive orientation through which the fir members can coordinate. Business conceptions are needed to create and shape a firm As such, they may inspire the design of organizational routines, but they are not themselves organizational routines. In fact, it is only on the cognitive level that conflict can be diagnosed between a business conception and the behavioral inertia resulting from the pursuit of some organizational routines, or among behavioral inertia. An entrepreneurial task that may be crucial for the success and survival of the fir – and that is often surprisingly difficul to achieve (Loasby, 1991, Chap. 3) – may then be to do battle with this inertia and overcome it. In addition to the problems on the cognitive level, there are also motivational or incentive problems. These also relate to entrepreneurship, and they also tend to be neglected with an exclusive focus on organizational routines. What an entrepreneur conceives of as desirable, and what is actually realized in the operation of the fir organization, may be very different. Routines in Nelson and Winter’s sense imply recurring, multilaterally expected patterns of interactions between the fir members. Such routines may involve or induce incentive conflicts They may, for example, be vulnerable to free riding or to hold up. The more frequently hold up and free riding crops up, the more likely entrepreneurial action will be taken to control and figh them. Some of the measures chosen may consist of new organizational routines intended to keep hold up and free riding

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in check. The crucial point is, however, that the corresponding organizational change is an intentionally produced response to the incentive problems diagnosed. As explained elsewhere (Witt, 2000), such problems depend on the size and age of an organization. Their systematically changing impact may give rise to an endogenously caused development of fir organizations which cannot be explained by relying exclusively on a selection mechanism. In fact, if the entrepreneurial role is fully acknowledged, the heuristic value of the selection metaphor itself becomes questionable. A major difficult is the fact that, for selection among organizational routines to produce systematic change – as Nelson and Winter, of course, imply – there must be sufficien inertia both in the organizations’ environment (the markets) and in their routines which selection forces are supposed to operate on. In a turbulent, changing market environment and/or with rapidly mutating routines, selection would have no time to become a shaping agent. While the pace of change in the market environment is not necessarily subject to entrepreneurial discretion, the inertia in the organizational routines clearly is. When they rely on organizational routines, entrepreneurs have strong incentives to identify low performance routines and to replace or improve them before being forced out of the market (i.e. falling victim to selection). Entrepreneurial problem solving of this type amounts to a kind of intentionally produced mutation and an “internal” rather than an “external” selection process. Since “internal” selection is likely to depend on hypothesis formation and learning from insight (relating, to be sure, to the cognitive level), the very notion of selection is of little help in understanding entrepreneurship. Cognitive processes are likely to produce adaptations which follow their own regularities. As they emerge from a limited human information processing capacity – which means that people are forced to be selective in what they sense, learn, and perceive – the regularities reflec mental “selection” processes which both in their dynamics and in their outcomes are not necessarily the same as population-bound, genetic selection processes. Nelson and Winter thus do extend Schumpeter’s views on the role of trusts in economic development. They fil the theoretical gap left by Schumpeter (1942) with regard to the question of how those large corporate organizations operate internally. However, perhaps inspired by the late Schumpeter’s verdict on the declining role of entrepreneurship, they do so in a way that completely ignores the role of entrepreneurs. Moreover, their heuristic frame, which is based on organizational routines and the selection metaphor, makes it difficul to get to the level where subjective cognition and its motivational implications matter. Yet it is precisely this level which is central to the Austrian approach to economics and which should therefore be given careful attention in the analysis.

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4. NEW ADAPTATIONS IN AUSTRIAN ECONOMICS: ENTREPRENEURS AND FIRMS? Unlike Schumpeter and the neo-Schumpeterian writers, the Austrian school of economics considers the uncertainty and subjectivity of individual knowledge as key features of economic action (cf., e.g. O’Driscoll & Rizzo, 1985). Different agents hold different expectations. The coordination of these expectations is particularly important if the subjective knowledge underlying the expectations, and thus the expectations themselves, change (cf. Lachmann, 1977). Coordination is achieved in different ways in markets and organizations. However, although in the Mises–Kirzner approach to entrepreneurship coordination within markets is considered a result of entrepreneurial action, coordination within fir organizations is not considered at all. Indeed, even the idea of a subjectivist, entrepreneur-centered approach to organizational economics in general, and the theory of the fir in particular, has until recently been ignored in the Austrian camp. Given that the very creation of a fir organization is an entrepreneurial action, the neglect of the organizational variant of entrepreneurial coordination does not seem justifie – even less so in view of the total neglect of entrepreneurship in the various existing theories of the firm Most recently, however, some reflection about how to approach the fir organization from the point of view of Austrian economics (in a wider sense than the Misesian one) have started. These attempts to adapt the explanatory program of Austrian economics differ significantl in the extent to which they address the entrepreneurial role for intra-organizational coordination. With reference to Kirzner’s theory of entrepreneurial alertness, Ioannides (1999) tries to make a connection between entrepreneurship and the fir organization. The question he poses is why an entrepreneur should create a fir organization. More precisely, why should the discovery of a profi opportunity – Kirzner’s entrepreneurial action – result in the emergence of a multi-person organization? The reason, Ioannides argues, is simply that, in order to realize a profi opportunity, it is often necessary to employ human assets. They are hired according to the standard profi maximizing logic, i.e. as long as the profi increase entailed by employing them for the entrepreneurial idea exceeds the competitive wage rate. (Since, in the Misesian interpretation, entrepreneurship is a universal element in human action, the fact that human assets can be hired means that employers and employees sort themselves according to their differing faculty of discovering and exploiting profi opportunities.) In the market process perspective, profitabl opportunities that have been discovered of course tend to be competed away. If the fir organizations which have been created to exploit the specifi profi opportunities do not disappear at the same pace as the profi opportunities do, then the simple

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explanation offered so far is incomplete. Indeed, the persistence of fir organizations is the key issue in Ioannides’ adaptation of the Mises–Kirzner approach. Their persistence points to features of fir organizations that go beyond a mere ad hoc-instrument for pursuing the short-lived entrepreneurial profi opportunity as they underlie Kirzner’s arbitrage oriented notion of entrepreneurship. The additional argument which Ionannides proposes is that fir organizations may persist because, once in existence, they allow further profitabl opportunities to be discovered both by the entrepreneur and by other fir members. Only the faculties to act in an entrepreneurial way (which are supposed to differ between employer and employee) need to be suitably coordinated. Ioannides submits that this is done by implementing proper rules. “It is such rules – organizational forms, command structures, promotion ladders, recruitment tactics, etc. – that shape the environment within which the members of the fir act, thus directing their entrepreneurial behavior towards the attainment of the firm s goals” (ibid., p. 93). The question raised by this additional argument is, of course, why the members of the fir do not pursue their entrepreneurial activities by setting up their own fir rather than submitting to the given firm s master entrepreneur. Unless a satisfactory answer to this question is developed, it seems unclear whether the two ingredients to Ioannides approach to the fir – the arbitrage-based notion of (short-lived) entrepreneurship a` la Kirzner and the obvious persistence of real world firm – indeed go together. An approach which blends Schumpeter’s early notion of innovative entrepreneurship and Kirzner’s theory of entrepreneurial arbitrating alertness (along with many other sources of ideas) in a “praxeological” theory of the fir has been suggested by Yu (1999). Yu argues that the fir organization is a social world constructed by the entrepreneur for the purpose of facilitating communication and coordination. The fir is also endowed with capital that enables it to produce. The capital structure is shaped in the way the entrepreneur sees it as being most profitable As the entrepreneur exploits profi opportunities, the firm s capital stock is supposed to grow and to induce more and more complex combinations of capital. Specialization of, and complementarity in, the firm s capital structure eventually lead to vertical disintegration. However, while all these conjectures in themselves appear plausible, it is not clear why, and in which way, entrepreneurship in either Schumpeter’s or Mises/Kirzner’s senses is indeed necessary for all this to happen. The production structure and its relationship to the knowledge problem also figur prominently in Dulbecco and Garrouste (1999). They focus on the coordination over time of the firms production plans, trying to trace the implications of the Austrian theory of roundabout production to the level of the firm On that level, the specificit or “complementarity over time” (Lachmann, 1977, p. 205) of capital

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investments make revisions of the plans a difficul and costly process. A strong incentive therefore exists to try an ex-ante coordination which acknowledges those complementarities. The authors argue that the incentive is internalized by the entrepreneur. The role of the entrepreneur is thus to coordinate production and to plan the corresponding capital structure according to her/his available subjective knowledge or guesses of the future. The size of the fir which the entrepreneur implicitly decides on by carrying out those plans, depends on the extent to which the complementarity of capital investments needs to be fi ed ex-ante. With their argumentation, Dulbecco and Garrouste add an important element both to Schumpeter’s early notion of entrepreneurship and to the Mises/Kirzner approach to entrepreneurship. It is certainly true that production aspects have been neglected both in the theory of entrepreneurship and the theory of the fir (cf. Langlois & Foss, 1999). Dulbecco and Garrouste offer a convincing interpretation of the allocative decision problem involved here. Moreover, their interpretation accords with the emphasis on uncertainty and the subjective nature of knowledge in Austrian economics. Yet their focus on the coordination of future production by means of investment activities addresses only one aspect of the intra-organizational coordination problem. The question of how the actions of the agents in a fir organization are coordinated where they are not uniquely determined by the capital structure is not explored. This is, however, the crucial question unless the entrepreneurial plans do not need the organizational form of the firm because future production structure is contracted via the market. If investment and future production are realized within a firm this is a matter of tasks divided among the employees whose productive actions therefore have to be coordinated. The very notion of planning, e.g. of the future production structure, surely relates to both the fir and the entrepreneur’s role in it (cf. Foss, 1997). It is not entirely clear, though, what this relationship looks like. Moreover, in the light of the socialist calculation debate (on the feasibility of central planning in an economy) and the strong position taken by the Austrian school in this debate, the relationship does not seem unproblematic. In fact, the success of the large, multi-division, and often even multi-national, corporations which seem to rely on planning procedures may appear to challenge the earlier arguments against central planning. It is not surprising, therefore, that the role of planning in large fir organizations has attracted some attention in contributions dealing with the theory of the fir from the point of view of Austrian economics. Sautet (1998) and Sautet and Foss (1998), for example, argue that large fir organizations face a knowledge problem that in fact prevents them from engaging in central planning. The managers in these organizations usually have only incomplete knowledge about their employees’ knowledge and, on top of that, may be ignorant of their own ignorance. The fact that the large corporations

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are often very successful is, it is claimed, due to their use of procedures other than detailed central planning. Among these procedures is the scheduling of rules that compel the fir members to rule-follow behavior. Sautet and Foss (1998) suggest that many aspects of the internal organization of firm as, e.g. corporate culture and some corporate strategy can be understood as rule-following behavior. Rules are created to induce the fir members to make use of their own subjective, dispersed, and partly tacit knowledge. The question is, of course, whether such arguments blur rather than sharpen the contrast to central planning – according to Hayek (1967), rules and specifi commands are mutually exclusive in instructing and guiding individual behavior. In a similar vein, Langlois (1995) maintains that firm plan in the sense that the authority to give directives to (re-)configur the internal system of rules of conduct is centralized. He explicitly refers to visionary entrepreneurship as a basis for giving these orders. If this is true, an interesting question arises: how are the relevant directives communicated by the entrepreneur and how can the employees be induced to adopt them as rules for their own conduct, particularly if this incurs opportunity costs for them? The execution of definit orders and commands, or of the assignments of a quantitative plan in the literal sense, can easily be controlled. In contrast, the internalization of a specifi rule of conduct, namely the one the entrepreneur prefers, can neither be done by order, nor can it be fully controlled. Hence, to understand the challenges which entrepreneurship faces within the fir organization, a closer look at how an entrepreneur is, or is not, able to coordinate the individual actions of her/his employees seems worthwhile.

5. INTRA-ORGANIZATIONAL COORDINATION AND ITS COGNITIVE BACKGROUND A multi-person fir is a way of organizing the division of labor. Much as in the case of the division of labor via markets, such a fir has to rely on knowledge dispersed among several agents (cf. Minkler, 1993). These agents must be motivated to undertake the physical and mental efforts through which they acquire, improve, and apply their individual knowledge to contribute to the objectives of the fir – in short, they must be motivated to contribute to the firm s goals. Moreover, the individual efforts must all be coordinated. Thus, when approached from the cognitive level, motivational problems and coordination problems are closely intertwined. A firs precondition for coping with these problems is to make sure that all organization members are informed about, and have a sufficientl coherent understanding of, the purpose of their particular activities within the broader frame of the firm s goals. The degree of cognitive coherence among the fir members is a non-trivial

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problem largely neglected in economics, particularly in agency theory which is supposed to deal with motivational conflicts In order to obtain cognitive coherence among the members of the fir organization, these members must be coordinated on some basic understanding of what the entire business is all about and what the role of each member is (for a different, though related, interpretation cf. Koppl & Langlois, 2001). Any division of labor, be it market-based or firm-based has its origin in entrepreneurial ventures. These ventures rest on an ideas about how to (re-)organize work, ideas which initially may not be more than just more or less speculative imaginings. Such ideas about organizing the division of labor have been called “business conceptions” (cf. Witt, 1998, 1999). They represent the entrepreneur’s image of the goals of a fir organization, i.e. of what business to do, and how to do it with the staff hired. If conveying a business conception were simply a matter of telling each organization member about the general business and the particular individual action to be taken, then the intra-organizational coordination problem would seem easy to solve. Moreover, if assigning tasks to organization members were to leave no room for the level of effort taken by the members in pursuing the assigned tasks, then no motivation problem (and no motivational hazard) would ever put a strain on a business. However, neither of these conditions is reality – it is simply not feasible to fi everything just by issuing nominal instructions. In addition, it would not even be possible for the entrepreneur to issue all necessary instructions, because her/his bounded imaginings prevent her/him from anticipating all the activities that can become relevant as the business venture unfolds into the future. All sorts of unforeseen changes and complications can show up in each and every single task assigned in organizing the division of labor within a firm If every such unanticipated deviation from nominal instructions had to be communicated in every detail to the entrepreneur in order to determine the proper response, the fir organization would virtually stifle For this reason, organizing the division of labor within a fir organization always has the connotation of organizing a division of problem solving (Loasby, 1991). Under these circumstances, the entrepreneur is well advised to try to convey, in a more general form, how unanticipated problems should be framed in order to solve them. This frame is precisely the business conception in its relevant parts. If adopted as a cognitive frame by the employees, it will become the basis for their own problem solving activity. Cognitive frames channel selective information processing and control the access to memory on an associative basis. Since the limited mental operating capacity allows only one cognitive frame to be used at any point in time, this also means that, while in use, such a frame cannot itself be at the same time made the object of cognitive reflection The

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capacity of imagining and reflectin on alternatives for action is constrained and, hence, selective as well. Some particular courses of action, rather than others that could in principle be imagined, are conceived and thought through more or less carefully.8 Since each fir member operates on the basis of an individual cognitive frame, dispersed knowledge and individual endeavor would be concerted most effectively if all fir members were to adopt the entrepreneurial business conception as their own cognitive frame. The rather unspecifi nature of the shared business conception would leave room in the employee’s situational problem solving for making use of her/his individual knowledge and for accounting for the special conditions of the individual case. Moreover, it makes a great difference from the motivational point of view whether or not people see themselves as contributing to a common goal. If they do, their task perception tends to be framed in a way which means that their attention is devoted more to solving problems in the interest of the firm s goals than to pursuing private short run inclinations and separate interests. Conversely, it may be concluded that the level of individual effort – which is particularly difficul to observe in problem solving behavior – may suffer if rivaling business conceptions are pursued within the firm It would be even worse if the fir members perceived no one as contributing to a common goal and instead saw everyone trying to get an easy benefi from participating in the organization. Therefore, an entrepreneurial business conception can no longer accomplish an efficien division of labor within the firm i.e. organizational coherence, if it is losing ground within the fir organization beyond a certain threshold. To communicate the entrepreneur’s business conception and to induce the fir members to adopt it is not a trivial task. As already explained, no one can be induced to adopt a cognitive frame simply by being ordered to do so. Consequently, for the entrepreneur’s business conceptions and suitable social models of behavior to be adopted by the members of a fir organization, it is not sufficien to give instructions or to devise organizational and administrative routines. Rather, the social formation of individual cognitive frames follows its own regularities. Communication with, and observation of, other agents are a prominent source of information, a major factor in attracting attention, and an important instance of learning.9 The more intense and lasting communication and observational learning are, the more likely the agents involved will tend to develop collectively shared interpretation patterns as well as common tacit knowledge of facts, hypotheses, practices, and skills. Observational learning is also behind the formation of the social models of how to behave that are characteristic for a group. Certain patterns of behavior tend to prevail within any group of regularly interacting individuals. Both conformity to, and deviation from, these patterns can be observed by the group members. Since

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the members focus on much the same limited set of behavioral patterns, these tend to become socially shared models of behavior. If a fir organization forms an intensely interacting group, there thus may be commonalities in the conceptions adopted by the fir members and in the alternatives of action that they selectively recognize as being feasible – and, of course, those that they disregard. Moreover, as a consequence of intense and lasting communication, the fir members may share some common standards of conduct exemplifie by socially shared models of behavior. The work motivation of the agents in the fir depends strongly on the nature of those models.10 Thus, from the motivational point of view, the question of what kind of social model of behavior or rule of conduct prevails in the fir organization is consequential. For the entrepreneur it would be desirable to be able to control the kind of behavior that emerges as a social model. However, this is difficul to achieve with observational learning being present. Since, in small groups, the consequences of the other members’ behavior can easily grasped by everyone without requiring the effort and costs of own experimentation, any attempt to challenge an established social model for whatever reasons acquires the status of a vicarious experiment (Bandura, 1986, Chap. 7). If it is observed to be successful, deviant behavior may pose a serious challenge to a prevailing social model of behavior. The members of a fir organization may be induced to recognize previously unconsidered extensions of their choice set. It should not be taken for granted, therefore, that an entrepreneur can succeed in making the employees adopt her/his business conception and the social models of behavior that would be conducive to it. Because of her/his formal power over the fir organization, the entrepreneur may be able to determine the structure and the agenda of formal communications, but not the agenda of informal communication that takes place spontaneously every day. On the informal level, entrepreneurial conceptions and social models may well be contested by rival cognitive frames and social models. Failure to prevent these from tacitly taking the lead in the firm s informal communication can have far-reaching consequences for organizational coherence and, hence, for the firm s performance. In the struggle to maintain “cognitive leadership” (Witt, 1998), particular social skills like communicativeness, persuasiveness, and persistence, as well as fairness, credibility, appreciativeness are relevant. But the intrinsic features of business conceptions are also important. If a conception is too complex and sophisticated, it lacks soundness and appeal, not least in terms of expected career options, remuneration, qualificatio enhancement, and working conditions for the employees. If it is obviously unsuited for the imagined business, it is difficul to make employees adopt it. In general, cognitive frames that do not work well in making sense of information coming from the environment tend to be modifie or replaced if they are adopted at all.

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6. CONCLUSIONS In this paper an attempt has been made to show that entrepreneurship manifests itself in coordinating action on two levels, that of the market and that of the fir organization. In pursuing profi opportunities which they try to realize in the markets, entrepreneurs in many cases acquire human resources on the basis of employment contracts, i.e. within the organizational form of a multi-person firm Since such contracts leave a certain amount of discretion to the agents who have been hired, the coordinative task, and hence the pursuit of a profitabl opportunity, in this case takes a form different from that of ordinary market contracts. To realize a profi opportunity as perceived in an entrepreneurial business conception, the employees need to be coordinated on, and motivated to pursue, the entrepreneurial business conception as their own frame of action. Accordingly, the entrepreneurial reorganization of production and trade implies two different coordinating tasks. The one focuses on exploiting the market opportunities. It has been extensively discussed by writers like Schumpeter, Mises and Kirzner. The other coordinating task is to see through the entrepreneurial business conception in the intra-organizational interactions of the multi-person fir in the daily organizational grind. This side of entrepreneurship has been largely ignored in almost all strands of economics. The cognitive approach to the problem suggested in the present paper provides a fruitful basis for discussing the theory of the fir from the point of view of the Austrian school of economics and its core assumptions of uncertainty and subjectivity of individual knowledge.

NOTES 1. A problem which has been explained in great detail by Mirowski (1989). For unknown reasons, the seventh chapter was omitted from later editions of Schumpeter’s Theory of Economics Development and, thus, from the English translation that appeared in 1934. It has only recently been translated into, and published in, English as Schumpeter (2002). 2. Only later, in the context of a discussion of the surplus, does Schumpeter (1934, pp. 128–156) mention the profi motive. Successfully realizing new combinations promises “promotors’ profits ” 3. Cf., e.g. Nietzsche (1899) and his influentia elitist philosophy. 4. More precisely, Mises suggests to defin economics in such a way that any other kind of behavior is not a subject of economics but rather of psychology. 5. For a discussion about the more frequently made distinction between disruptive (Schumpeter) and equilibrating (Mises–Kirzner) effects of entrepreneurship cf. Kirzner (1999). 6. “Economic natural selection,” as Winter (1964) called it, refers to biological analogies in the theory of the fir discussed in the 1950s. With these analogies, it was claimed that

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profi maximization has a selection advantage over other forms of fir behavior – and that the neoclassical optimization approach can thus be vindicated. 7. Drawing on the satisficin hypothesis (March & Simon, 1958, pp. 47–52), it can be argued that a deteriorating performance triggers a search for improved routines, i.e. a kind of induced mutation. 8. For a comprehensive summary see Anderson (1990, Chap. 3). Different cognitive tasks can, of course, be pursued on the basis of different frames at different times. 9. This aspect has been widely neglected in the literature on bounded rationality. A notable exception is March (1991). The present approach relies in this point on Albert Bandura’s social cognitive learning theory (Bandura, 1986). 10. As is well known in social psychology, social models which emphasize task commitment, cooperative problem solving, fairness, and frankness help keep intra group frictions and individual frustrations down (see, e.g. Paulus, 1989).

ACKNOWLEDGMENTS I am grateful to Peter Murmann and Klaus Rathe for helpful discussions and to an anonymous referee for useful comments. The usual disclaimer applies.

REFERENCES Anderson, J. R. (1990). Cognitive psychology and its implications (3rd ed.). New York: Freeman. Baldwin, W. L., & Scott, J. T. (1987). Market structure and technological change. Chur: Harwood Academic Publishers. Bandura, A. (1986). Social foundations of thought and action – A social cognitive theory. Englewood Cliffs: Prentice-Hall. Casson, M. (1982). The entrepreneur – An economic theory. Oxford: Martin Robertson. Craver, E. (1986). The emigration of the Austrian economists. History of Political Economy, 18, 1–32. Cyert, R. M., & March, J. G. (1963). The behavioral theory of the firm. Englewood Cliffs, NJ: PrenticeHall. Dulbecco, P., & Garrouste, P. (1999). Towards an Austrian theory of the firm Review of Austrian Economics, 12, 43–64. Foss, N. J. (1994). The theory of the firm The Austrians as precursors and critics of contemporary theory. Review of Austrian Economics, 7, 31–64. Foss, N. J. (1997). Austrian insights and the theory of the firm Advances in Austrian Economics, 4, 175–198. Hayek, F. A. (1967). Rules, perception and intelligibility. In: F. A. Hayek (Ed.), Studies in Philosophy, Politics, and Economics (pp. 43–65). London: Routledge & Keagan Paul. Ioannides, S. (1999). Towards an Austrian perspective on the firm Review of Austrian Economics, 11, 77–97. Khalil, E. L. (1997). Buridan’s ass, risk, uncertainty, and self-competition: A theory of entrepreneurship. Kyklos, 50, 47–63. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press.

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Kirzner, I. M. (1979). Equilibrium versus market process. In: I. M. Kirzner (Ed.), Perception, Opportunity and Profit – Studies in the Theory of Entrepreneurship (pp. 3–12). Chicago: University of Chicago Press. Kirzner, I. M. (1982). Uncertainty, discovery, and human action: A study of the entrepreneurial profil in the Misesian system. In: I. M. Kirzner (Ed.), Method, Process, and Austrian Economics (pp. 139–159). Lexington: D. C. Heath. Kirzner, I. M. (1999). Creativity and/or alertness: A reconsideration of the Schumpeterian entrepreneur. Review of Austrian Economics, 11, 5–17. Koppl, R., & Langlois, R. N. (2001). Organizations and language games. Journal of Management and Governance, 5, 287–305. Lachmann, L. M. (1977). Capital, expectations, and the market process. Kansas City: Sheed Andrews. Langlois, R. N. (1995). Do firm plan? Constitutional Political Economy, 6, 247–261. Langlois, R. N., & Foss, N. J. (1999). Capabilities and governance: The rebirth of production in the theory of economic organization. Kyklos, 52, 201–218. Loasby, B. (1991). Equilibrium and evolution. Manchester: Manchester University Press. March, J. G. (1991). Exploration and exploitation in organizational learning. Organization Science, 2, 71–87. March, J. G., & Simon, H. A. (1958). Organizations. New York: Wiley. McClelland, D. C., & Winter, D. G. (1969). Motivating economic achievement. New York: Free Press. Minkler, A. P. (1993). The problem with dispersed knowledge: Firms in theory and practice. Kyklos, 46, 569–587. Mirowski, P. (1989). More heat than light. Cambridge: Cambridge University Press. Mises, L. von (1949). Human action – A treatise on economics. London: W. Hodge. Nelson, R. R., & Winter, S. G. (1982). An evolutionary theory of economic change. Cambridge, MA: Harvard University Press. Nietzsche, F. (1899). Thus Spake Zarathustra. SI: Unwin. O’Driscoll, G., & Rizzo, M. (1985). The economics of time and ignorance. New York: Basil Blackwell. Paulus, P. (Ed.) (1989). Psychology of group influence (2nd ed.). Hillsdale: Erlbaum. Sautet, F. (1998). An entrepreneurial theory of the firm Dissertation, University of Paris IX. Sautet, F., & Foss, N. J. (1998). The organization of large, complex firms An Austrian view. RESPECT working papers, Copenhagen: Copenhagen Business School. Schumpeter, J. A. (1908). Das Wesen und der Hauptinhalt der theoretischen National¨okonomie (The Essence and Main Content of Theoretical Economics). Leipzig: Duncker & Humblot. Schumpeter, J. A. (1934). The theory of economic development. Cambridge, MA: Harvard University Press. Schumpeter, J. A. (1942). Capitalism, socialism, and democracy. New York: Harper. Schumpeter, J. A. (2002). The economy as a whole – 7th chapter of the theory of economic development. U. Backhaus (Trans.). Industry and Innovation, 9, 93–145. Simon, H. A. (1949). Administrative behavior. New York: MacMillan. Streissler, E. (1983). Schumpeter and Hayek: On some similarities in their thought. In: F. Machlup, G. Fels & H. M¨uller-Groeling (Eds), Reflections on a Troubled World Economy (pp. 356–364). London: MacMillan. Winter, S. G. (1964). Economic “natural selection” and the theory of the firm Yale Economic Essays, 4, 225–272. ¨ Witt, U. (1989). Subjectivism in economics – A suggested reorientation. In: K. G. Grunert & F. Olander (Eds), Understanding Economic Behavior (pp. 409–431). Boston: Kluwer.

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Witt, U. (1998). Imagination and leadership – The neglected dimension of an evolutionary theory of the firm Journal of Economic Behavior and Organization, 35, 161–177. Witt, U. (1999). Do entrepreneurs need firms A contribution to a missing chapter in Austrian economics. Review of Austrian Economics, 11, 99–109. Witt, U. (2000). Changing cognitive frames – changing organizational forms: An entrepreneurial theory of organizational development. Industrial and Corporate Change, 9, 733–755. Yu, T. F. (1999). Toward a praxeological theory of the firm Review of Austrian Economics, 12, 25–41.

THE BUSINESS FIRM AS A HYBRID HAYEKIAN ORDER: WHAT IS THE ROLE OF THE ENTREPRENEUR? Stavros Ioannides ABSTRACT Starting from Hayek’s distinction between spontaneous and man-made orders, we attempt to analyze the role of the entrepreneur in business organizations. The business firm shares important elements of both categories, thus we describe it as a hybrid order. We proceed to construct an account of the entrepreneur that is consistent both with the attributes of the firm that reflect its affinity with man-made organizations, as well as those that reflect its affinity with spontaneous orders. We highlight the concept of entrepreneurial leadership as the major factor for the existence of business organizations and we discuss why the actual mode in which entrepreneurial leadership is exercised has important implications for the development of the firm.

1. INTRODUCTION The rediscovery of Hayek’s thought in the 1970s and 1980s focused largely on the role of his ideas in the rejuvenation of liberal political philosophy. Hayek was thus praised by some and condemned by others, as a free market ideologue.1 It is striking that in this intellectual climate what most students of his thought have not seemed to ask themselves is, how come this dedicated advocate of free markets, never Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 153–171 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06010-1

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focused on the concept of the entrepreneur. Indeed, in his most important works after 1960, the word appears only once in the Index of Hayek (1979). The same work contains a mere passing reference to Israel Kirzner, the leading proponent of the theory of entrepreneurship in the modern Austrian school of economics, in a footnote. Despite this neglect of the entrepreneur, Hayek’s ideas on knowledge, discovery processes and learning have provided an invaluable source of inspiration for students of entrepreneurship, and especially those of the Austrian tradition.2 This was already evident in Kirzner’s (1973) seminal contribution, where the entrepreneur was described as an agent seeking to discover new knowledge in the form of profi opportunities. More recently, but in the same vein, Harper (1994, 1996, 1998) has proposed a view of the entrepreneurial role that focuses on the entrepreneur’s processes of learning, which he likens to the process through which scientifi knowledge develops. Butos and Koppl (1999) also focus on learning processes and draw insights from Hayek’s (1952) theory of mind. Hayekian ideas have also figure prominently in a recent stream of work that attempts to introduce Austrian ideas into the theory of the fir (Dulbecco & Garrouste, 1999; Foss, Foss, Klein & Klein, 2002; Ioannides, 1999a, 2003; Langlois, 1992, 1995, 2001; Lewin & Phelan, 2000; Sautet, 2000).3 In this paper, we employ Hayekian ideas in order to analyze the role of the entrepreneur in business organizations, thus linking the theory of entrepreneurship with the theory of the firm Our starting point is Hayek’s distinction between spontaneous and man-made orders. We will argue that the business fir shares important elements of both categories, and that we can thus describe it as a hybrid order. Many authors, regardless of the term they have chosen to refer to it, have pointed out the hybrid character of the firm What distinguishes our argument is that we describe the relation between the two sets of elements as one of inherent tension. This poses a problem for an understanding of the entrepreneurial role in the context of the business firm For, on the one hand, the elements of the fir that reflec its affinit with man-made organization imply a view of the entrepreneur as the agent who can impose his/her purpose on the workings of the firm On the other hand, the elements that reflec the firm s affinit with spontaneous order imply that it must be understood as an entity with endogenous forces of development, which is not possible to be controlled by a central center of command. But if that is the case, what is the role of the entrepreneur? Hayek’s ideas allow us to construct an account of the entrepreneur in the context of the fir that is consistent both with the attributes of the fir that reflec its affinit with man-made organizations, as well as those that reflec its affinit with spontaneous orders. Moreover, we argue that these ideas prompt us to understand the entrepreneur as the agency that constantly resolves the tension we referred

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to above in a way that allows the fir to grow. Thus, we highlight the concept of entrepreneurial leadership as the major factor for the existence of business organizations. We will go on to show that the actual mode in which entrepreneurial leadership is exercised has important implications for the development of the firm In the context of entrepreneurship studies, our analysis thus relates to the 3rd research question according to the taxonomy of Shane and Venkataraman (2000, p. 218), the “why, when, and how different modes of action are used to exploit entrepreneurial opportunities.”4 We begin (Part 2) with a discussion of Hayek’s distinction between spontaneous orders and organizations. The central concept here is that of the “rules of conduct,” which are pertinent for social structures of both categories. We then show (Part 3) that the business fir must be thought of as a hybrid order, as it shares important features of both spontaneous orders and man-made organizations. Importantly, both sets of features are related to the character of the rules that govern the operation of the order. We go on to argue (Part 4) that, as the business fir grows both in size and in complexity, the nature of the rules that its members have to follow tends to change from specifi to abstract, thus tending to transform the organization of the fir itself into a spontaneous order. Part 5 argues that for the fir to be maintained as an organization, entrepreneurial leadership has to be exercised. In Part 6, we argue that this concept can be divided into two aspects: leadership-as-authority and cognitive leadership. We go on to discuss how this idea can be translated in the framework of Hayek’s theory on the relation between various “layers” of rules. Finally, we conclude (Part 7) by briefl showing how the two aspects of entrepreneurial leadership relate to different phases of the firm s development.

2. THE DISTINCTION BETWEEN SPONTANEOUS ORDERS AND ORGANIZATIONS5 The distinction between the categories of spontaneous orders and organizations, which constitutes one of the major building blocks of Hayek’s social theory, hinges on the role of purposeful agency in the creation of these structures. A spontaneous order is created unintentionally through the actions of individual agents. By contrast, organizations are products of a directing intelligence, i.e. deliberately designed constructs.6 It is important to note that, however, crucial the distinction between the two categories may be, they are both simply divisions of the same general concept, that of order.7 It follows that several notions that relate to it are relevant for both categories. Two such notions, which are crucial for our discussion, are those of

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“abstract” and “concrete” orders. According to Hayek (1973, p. 38), the character of the former cannot be grasped intuitively, thus its explanation requires the social scientist “mentally to reconstruct it by tracing the relations that exist between the elements.” By contrast, the orders, which he describes as “concrete,” can be perceived intuitively by inspection. Hayek (1973, p. 38) maintains “such orders are relatively simple or at least necessarily confine to such moderate degrees of complexity as the maker can still survey.” Thus, the concepts of abstractness and concreteness are directly linked to the complexity that the order – whether spontaneous or man-made – can achieve. In other words, as the complexity of an order increases, so does its abstractness. As Hayek (1973, p. 43) argues, “the formation of spontaneous orders is the result of their elements following certain rules in their responses to their immediate environment.” Obviously, the nature of these rules of conduct is of paramount importance for the character of the order that will result. For a spontaneous order to emerge, Hayek stresses that the rules must be characterized by three attributes. First of all they must be largely tacit. Although rules of conduct have to be known by agents, for only if they are known they can be followed, this knowledge need not be articulable. Of course, as we will see below, Hayek admits that some part of the rules governing the behavior of the elements of a spontaneous order may be formally constituted and thus explicit. However, he insists that there must always be a sub-stratum of tacit rules for a spontaneous order to emerge. The second attribute of rules, according to Hayek (1967, p. 56), is that they must be largely negative rather than positive, as they must mostly determine a permissible range of behavior rather than specifi actions. Precisely because of their negative character, Hayek describes rules of conduct as abstract, and links the abstract character of the rules to the abstract nature of the resulting order. A third attribute of the rules of conduct fl ws directly from the firs two. If rules are indeed largely tacit and abstract, they must also be general, in the sense that they must be valid for all individuals and applicable to an infinit number of future instances. But how does the following of rules lead to the creation of an order? The key notion here is that of ignorance. The obedience to rules of conduct helps agents cope with ignorance, in a double sense: first by allowing them to draw from the experience with dealing with specifi situations, which is embodied in these rules; and second, by making the actions – or expected actions – of other agents intelligible, for the simple reason that themselves they are based on obedience to the same rules of conduct. Thus, the major advantage of rule-following behavior stems from the quantity of knowledge that agents can make use of. Therefore, the character of the rules must have important implications for the quantity of knowledge that the elements of a spontaneous order can use and produce. The

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more abstract and negative the rules are, i.e. the more they do not restrict freedom of action, the more complex the resulting order. By contrast to spontaneous orders, Hayek (1973, p. 49) maintains that manmade orders – i.e. organizations – are created through the specifi commands of a directing authority. Thus, he seems to introduce a very clear criterion for distinguishing between the two types of order. However, the simple relations: (spontaneous orders-spontaneous evolved rules), and: (organizations-specifi commands), do not hold unambiguously. In fact, as we will see presently, he introduces two independent criteria for distinguishing between spontaneous orders and organizations. Hayek (1973, p. 43) maintains that it is conceivable that a spontaneous order may rest entirely on rules that have been deliberately designed: Although undoubtedly an order originally formed itself spontaneously because the individuals followed rules which had not been deliberately made but had arisen spontaneously, people gradually learned to improve those rules; and it is at least conceivable that the formation of a spontaneous order relies entirely on rules that were deliberately made8 [emphasis added].

Note, firs of all, that Hayek distinguishes between the spontaneous origins of the rules on which an order rests and the spontaneous character of the order itself. The significan point here is that, even if all rules are deliberately designed, a spontaneous order may still result provided that these rules have all the attributes that we have discussed above, i.e. abstractness, generality and independence of purpose. Furthermore, Hayek maintains that a spontaneous order “undoubtedly” formed itself originally through the obedience of individuals to rules of conduct, which were themselves spontaneous. Therefore, the firs criterion he introduces for distinguishing between spontaneous orders and organizations relates to the origins of each type of order: whether the rules that constituted it originally were spontaneous or deliberately designed. However, Hayek introduces also a second criterion for distinguishing between orders and organizations. He observes (1973, p. 49) than an organization run entirely by commands could only reach a limited degree of complexity, as it would be unable to make use of the tacit knowledge possessed by its members. Therefore, he admits that even in organizations, and depending on the degree of complexity the commanding authority wishes to attain, the latter may also employ rules rather than merely commands. However, Hayek (1973, p. 49) adds, “Rules of organization are thus subsidiary to commands, fillin in the gaps left by commands.” Therefore, the rules of organization are the creation of purposeful authority, and can only develop on a substratum of authority relations. Thus their nature is essentially different from that of the rules that lead to the formation of spontaneous orders. On these

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grounds, Hayek (1973, p. 48) argues that the rules in the context of organizations are characterized by three attributes that are exactly the converse of the attributes of the rules that lead to spontaneous orders. (1) They are not abstract but concrete, since they must guide the actions of agents in specifi directions. (2) They are not tacit but explicit, since the commanding authority needs to ensure that all agents will know and obey them. (3) They are not general but specifi to the particular position of the organization that an agent occupies.

3. BUSINESS FIRMS AS HYBRID ORDERS To which of the two categories of order – spontaneous orders or organizations – do business firm belong? Given Hayek’s discussion on the distinction between the two, which we only briefl sketched in the previous part, the answer may not be as straightforward as it may appear at first To begin with, a business fir is characterized by some of the most important attributes that Hayek thought as describing man-made orders. It is obviously the product of a directing intelligence, rather than the unintended outcome of individual action. The single act of creating a fir signifie the purpose of an agent to take advantage of a profi opportunity that may be realized through the joint and coordinated use of a bundle of resources, which he/she subordinates to his/her authority through the legal person of the firm As in all man-made orders, commands constitute the major tool through which the commanding authority directs the joint operation of its resources. In fact, economic theory has traditionally upheld one notion of the fir that seems to be entirely compatible with Hayek’s notion of organization: the fir as a production function. The latter assumes that the commanding authority9 is in the position to direct its subordinates unproblematically to act for the success of the authority’s purpose, i.e. profi maximization. In the most extreme neoclassical formulations of the logic of the fir as production function, it is assumed that the commanding authority is omniscient, in the sense that it knows with complete certainty the technological possibilities, the input and output prices, as well as whether its inputs – especially the firm s employees – perform according to contract. More modern formulations have attempted to relax especially the latter assumption and have introduced opportunism in various guises as the behavioral description of the relation between the commanding authority and its subordinates. Thus, in the modern “contractual” approaches to the firm we fin analyses of principal-agent relations (Fama, 1980; Fama & Jensen,

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1983; Jensen & Meckling, 1976), the monitoring function (Alchian & Demsetz, 1972), and establishment of joint ownership (Grossman & Hart, 1986; Hart, 1995; Williamson, 1975, 1985), as solutions to the problem of opportunism in the context of economic organization. Although each one of these approaches signifie a rejection of a major aspect of the commanding authority’s omniscience, they simultaneously reconfir the nature of the fir as a man-made organization, as they reassert the capacity of the commanding authority to design efficien contractual arrangements that allow it to fully direct the operation of the whole on the basis of direct commands. Obviously, this account of the nature of business organization displays some important attributes of man-made organizations in Hayek’s schema. To begin with, the fact that the commanding authority fully controls both the emergence of the organization as well as its operation surely means that a business fir has to be conceived as a concrete order. Both the emergence and the operation of such an order can be fully explained, for the simple reason that both are determined by the will of one single mind. In such a context, there is little difference between an army and the typical business firm 10 However, this unambiguous identificatio of the business fir with man-made organization can be contested. The members of the fir constitute an intensely interacting social group. Their interactions, although unfolding in the context of the commands and the rules of organization that are set by the commanding authority, inevitably lead individuals to learn new things. Richard Langlois (1992, p. 176) refers to these learning processes and links them directly to Hayek’s theory: “The . . . personnel of a fir follow, invent, learn and imitate routines that persist over time. As in Hayek’s theory of culture, the routines are often tacit and skill-like, followed unconsciously because they produced success in the past.” These remarks are representative of a recent stream of literature that, explicitly or implicitly, views the fir as an entity that tends to evolve spontaneously in directions neither foreseen, nor entirely controllable by the directing authority (see Ioannides, 1999a, 2003; Langlois, 1992, 1995; Langlois & Robertson, 1995; Sautet, 2000; Witt, 1998, 2000). This literature links naturally to the competencies or capabilities perspective (Foss, 1994, 1996), which describes the fir as spontaneously creating new features that the commanding authority has, firs of all, to discover and, secondly, to coordinate with its strategic vision (Nelson & Winter, 1982; Penrose, 1959/1995). Few parts of this literature refer explicitly to Hayek’s schema and more specificall to his distinction between spontaneous orders and man-made organizations.11 However, many of the aspects of spontaneous orders that, according to Hayek, explain their superiority in handling knowledge are also relevant in the case of the business firm If that is valid, we should approach the latter

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rather as a hybrid order, i.e. an order that displays important elements of both spontaneous orders and organizations. We will later argue why this is a major issue in describing the role of entrepreneurship in economic organization. We have seen that Hayek considers spontaneous order as the social arrangement that has arisen because of its capacity to handle knowledge. However, the coordination of individual actions and the creation of new knowledge are important not just for spontaneous orders but also for the business firm In the case of spontaneous orders, rule-following behavior makes social interaction intelligible, for the simple reason that every agent may plan his/her action on the presumption that he/she understands what the others are doing or how they will react to his/her action. Thus a “cognitive commonality” is created (Witt, 1998, 2000) among the members of the spontaneous order, in the sense of a volume of socially shared and largely tacit knowledge, which, although not possessed by any one in its entirety, still allows the elements of the spontaneous order to act in a coordinated fashion. Interestingly, Ulrich Witt has introduced the notion of cognitive commonality in his discussion of the development of business firm rather than spontaneous orders. But why is cognitive commonality important for the operation of the firm Isn’t the purpose of the commanding authority, expressed through direct commands, enough to ensure the coordinated actions of fir members? Following Hayek, we have to look for the answers at the level of rules of conduct. But how can this be possible, given his insistence on the different nature of rules of organization and rules that lead to the formation of spontaneous order?

4. RULES OF ORGANIZATION AND SPONTANEOUSLY EVOLVING RULES We have argued so far that the business fir comprises elements of both man-made organization and spontaneous order and, thus, that we should better think of it as a hybrid order. However, the important point is that the coexistence of the two classes of elements and, therefore, the hybrid character of the resulting order must be perceived as reflectin a constant process of tension between the two souls of the business firm But why talk of tension? Let us begin by asking what these elements are. Obviously, the elements that reflec the character of the fir as a man-made order are commands and rules of organization, while those that reflec its character as spontaneous order are spontaneously evolving rules. It is perfectly thinkable that a business fir may be run entirely on the basis of direct commands.12 However, we have seen that

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Hayek believes that such an organization could only attain a limited degree of complexity, which explains why the introduction of rules of organization becomes more important than commands as the fir grows. As in the case of spontaneous orders,13 rule-following behavior allows agents to make use of knowledge that they do not possess individually.14 Therefore, in the case of business firms the reliance on rules – and not merely on commands – increases the quantity of knowledge available to the firm 15 However, it is precisely the introduction of rules of organization that leads to the tension we referred to above. There are three considerations that may explain this. First, the more complex the organization becomes, the more the rules of organization that have been set by the directing authority will tend to acquire a character of generality, thus being gradually transformed into the type of rules that lead to the formation of spontaneous orders.16 Second, this gradually tends to transform the character of the organization from a concrete to an abstract order. Third, according to Hayek, abstract orders tend to rest on abstract rules. Thus, the fact that business firm tend to acquire the characteristics of abstract orders must transform also the nature of the rules on which they rest from concrete and specifi to negative and general. Of course, Hayek maintains that rules of organization are deliberately designed rather than spontaneous outcomes of human interaction. However, recall that, according to Hayek (1973, p. 43), spontaneous orders can emerge out of systems of deliberately designed rules. In fact, we will now argue that, in the context of the operation of the business firm there are identifiabl tendencies leading to the transformation of rules towards generality and abstractness and, thus, of the organization towards spontaneous order. Note that both commands and rules of organization emanate from one single center of command, which explains their intimate relation to the notion of manmade order. However, there is an important difference between the two. In contrast to commands, rules of organization set the general framework within which the employees of the business fir can act, thus allowing some freedom of action. This freedom inevitably entails the possibility to establish ever-new rules for the coordination of their activities. These rules will now be established spontaneously, since none of the agents of the organization will have designed them intentionally. Consequently, their persistence or disappearance must be thought of as taking place in the same way that Hayek describes for the rules of conduct in the case of spontaneous orders.17 These spontaneously evolving rules are the routines of the firm as define by Nelson and Winter (1982). They embody a knowledge that is both tacit and shared by the members of the organization and, therefore, they allow agents to cope with ignorance and to act in ways that make their actions mutually consistent.18

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Our analysis suggests that the setting of rules of organization by the commanding authority cannot block the spontaneous and constant creation of routines – or spontaneously evolving rules, as we described them – through the interaction of the members of the organization. But this leads towards a transformation in the nature of the firm from a typical Hayekian man-made order, to one that tends to acquire the character of a spontaneous order. We can now see clearly the tension that we referred to above: the introduction of rules of organization allows the fir to grow both in size and in complexity; at the same time, however, the spontaneous growth of routines tends to dissolve the organization, by tending to transform it into a spontaneous order. We believe that it is precisely this tension that justifie the application of Hayekian ideas to the theory of economic organization. We have seen that the view of the fir as a hybrid order is hardly novel, as we have traced it both in Austrian contributions to the theory of the fir as well as to the capabilities approach. However, Hayek’s distinction between spontaneous orders and organizations prompts us to realize that the coexistence of the two sets of elements is inherently contradictory rather than merely reflectin a collection of heterogeneous attributes. We will see below that the manner in which the tension is resolved has important consequences for the development of the business firm In fact, the analysis of this tension is possible through a conceptual schema that Hayek (1979, p. 159) proposes, when he talks about “layers” of rules that govern the functioning of spontaneous orders. He describes man-made rules as “the thin layer of rules, deliberately adopted or modifie to serve known purposes.” Beneath that layer there is the layer of spontaneously evolving rules, which in turn sits on top of a third layer that comprises the rules that have evolved genetically. Although Hayek’s discussion refers to spontaneous orders, there is no reason why this “layered” account of the relations between various types of rules cannot be extended to business organizations. In the latter, the top layer would include both commands and rules that are set by the commanding authority. There would still be, however, a layer of routines or spontaneously evolved rules beneath that layer. Our line of argument suggests that, inevitably, this middle layer will tend to grow at the expense of the top layer as the fir grows. So what is it that maintains the fir as an organization, thus blocking its transformation into a spontaneous order? It is here, we will argue, that we must seek the role of the entrepreneur.

5. ENTREPRENEURIAL LEADERSHIP Let us return to the view of the business fir as a hybrid order. A corollary of the fact that the fir comprises important elements of man-made organization

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is that it must also be thought of as being run by a purposeful agency. We saw in Part 2 that Hayek proposes the concept of purpose as the major distinguishing characteristic of man-made organizations. Therefore, for the fir to retain the character of man-made organization rather than slip towards the status of a spontaneous order, the existence of a purpose must be conceived as an ongoing process that reproduces these structures as organizations. We defin this process as entrepreneurial leadership. If this process of constantly reaffirmin a purpose for the organization ceases to be effective, the emergence and the evolution of spontaneously evolving rules that we have already discussed will tend to transform the fir into a spontaneous order. Therefore, a business fir will retain its character as an organization for as long as entrepreneurial leadership is effectively exercised. But why describe this process as “entrepreneurial leadership” rather than simply as “entrepreneurship”? We will argue below that the term we propose can better capture the role of the entrepreneur in maintaining the business fir as a hybrid order. Note, firs of all, that the entrepreneur may be viewed as the agent who “puts the elements of a set in their places” – to use Hayek’s words again. In other words, the implementation of a “purpose” through the exercise of entrepreneurship may be thought of as being conducted solely through the issuing of commands, thus reducing the business fir to a typical Hayekian man-made order. However, such an understanding of entrepreneurial action would ignore the implications of the spontaneous growth of rules and routines within the business fir that we have already discussed. Indeed, a view of the fir as an organization run entirely on the basis of commands and rules of organization would imply a view of the entrepreneurial role as consisting in the single-minded execution of a preconceived plan, with the employees of the fir merely and loyally executing the plan. However, Ulrich Witt (2000, p. 743) provides a different view of the role of the entrepreneur and maintains that: The limitations of the human mind prevent the entrepreneur, as much as everyone else, from imagining all possible moves that unfold into the future. There is always new information that needs to be classifie and assessed with respect to its implications within the existing interpretative framework. A business conception can furnish such a framework . . . .

In this view, the promotion of the entrepreneur’s business conception requires the information absorption capacity, the creativity and the problem-solving capability of fir members. All these capabilities presuppose that the individual member acts within a framework of sufficientl abstract rules. As we saw in the previous part, this rule-following behavior will tend to produce spontaneously ever-new rules and routines. In other words, the fir cannot but, at the same

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time, must not operate on the basis of commands and rules of organization proper. Therefore, we must think of the exercise of entrepreneurship as consisting primarily in the execution of a plan that unfolds in an uncertain future, thus making necessary the constant absorption of new knowledge by all team members, its interpretation, and the implementation of the necessary adjustments to the firm s operation. It is for this reason that Witt (2000, p. 740) maintains that a business conception has to be “general and unspecific ” so that it can provide orientation to fir members and, at the same time, encourage them to utilize their problem-solving capabilities. However, it is precisely the need for the employee’s of the fir to exercise initiative in the context of the overarching interpretative framework that is provided by the entrepreneur’s business conception that precludes a view of the fir as a typical Hayekian organization, i.e. an entity whose operation rests on the commands issued by the entrepreneurial authority.

6. TWO ASPECTS OF LEADERSHIP The above reasoning addresses the entrepreneurial component of the concept of entrepreneurial leadership. Let us now turn to the leadership component. We can defin leadership as the activity of the summit of a hierarchy that aims at keeping the lower levels operating in a coordinated fashion for the achievement of the leader’s purpose.19 However, Hayek’s ideas prompt us to recognize the importance of the mode in which leadership is actually exercised. A firs mode is leadership as authority, i.e. as the power of the leader to tightly monitor the operation of team members and to coordinate their actions through the issuing of direct commands. In Hayek’s schema of layers of rules, the exercise of leadership-as-authority operates at the top layer. It implies that the locus of entrepreneurship may change the relation between commands and rules of organization on the one hand, and spontaneously evolving routines, on the other. For example, it may widen the scope of the former, thus restricting the scope of the latter. In Hayek’s schema, the top level of deliberately designed rules would become thicker, at the expense of the middle layer of spontaneously evolving rules. Alternatively, if the entrepreneur believes that the spontaneously evolving routines enhance his/her capacity to implement successfully her/his business conception, she/he may decide to restrict reliance on commands and centrally imposed rules and thereby encourage the growth and reproduction of routines. Obviously, the notion of leadership-as-authority is entirely consistent with a view of the fir as being run entirely by commands, i.e. as a typical Hayekian

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organization. Of course, the exercise of leadership in that mode would entail some major drawbacks. First, running the fir by commands thwarts the creativity and the problem-solving capacity of its members, while, at the same time, it is very costly in terms of the attention the entrepreneur has to devote to even the simplest operations.20 Second, and related to this, the complexity that the organization could attain would be limited, because of the inevitable limitations of the entrepreneur’s ability to effectively monitor all aspects of the firm s operations. Thirdly, the exercise of leadership in that mode confronts internal constraints arising from the past evolution of routines within the firm Therefore, both the decision of the commanding authority to act in order to alter the mix of commands and spontaneously evolved routines, as well as the options for action that are open to it, will be heavily constrained by the path dependence of the organization’s development. However, there is another mode in which leadership can be exercised. Rather than directing the actions of fir members by fia – as in the case of leadershipas-authority – the entrepreneur may attempt to influenc informally the cognitive frameworks of fir members, thus inducing them to behave in accordance with his/her business conception. Ulrich Witt (2000, p. 746) define this as cognitive leadership and maintains that: . . . conceptions and social models preached and practiced by the entrepreneur . . . may well be contested by rival cognitive frames and social models both on the level of the individual employee and on that of subgroups or coalitions. Failure to prevent rivaling frames and models from tacitly taking the lead in the firm s informal communication can have far-reaching consequences for organizational coherence . . . Therefore, for the entrepreneur to succeed in shaping informal communications in a way that is advantageous to the propagation of her/his business conception . . . a particular capacity is required. That capacity may be called ‘cognitive leadership.’

Ensuring that the employees of the fir perceive, interpret and act upon knowledge on the basis of a cognitive framework that is consistent with the business conception of the entrepreneur increases the coordination and the effectiveness of their actions. On the other hand, the effective exercise of cognitive leadership becomes increasingly difficul as the group of employees whose actions the entrepreneur strives to coordinate becomes bigger.21 Again, however, the idea of cognitive leadership can be easily transposed to Hayek’s schema of layers of rules. The exercise of this form of leadership now aims at shaping developments at the middle layer of Hayek’s schema, the layer of spontaneously evolving routines. Through the exercise of cognitive leadership the entrepreneur attempts to influenc the “tacit cognitive commonalities” of fir members, thus shaping their interactions so that they tend to produce routines that are consistent with the entrepreneurial conception. In other words, the spontaneous behavior of the members of the

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fir will tend to be: (a) coordinated; and (b) consistent with the strategic vision that the entrepreneur pursues.

7. ENTREPRENEURIAL LEADERSHIP AND THE DEVELOPMENT OF THE FIRM Casting the concept of leadership in this Hayekian schema is important because it allows us to clarify the mode in which the two aspects of the concept – leadershipas-authority and cognitive leadership – interrelate. Notice, firs of all, that they constitute a genuine trade-off, thus the strengthening of the one inevitably leads to the weakening of the other. The balance between the two aspects seems to be theoretically indeterminate; thus every specifi business organization will establish its own mix of the two. But for all organizations, the two aspects will inevitably operate in opposite directions, thus affecting the complexity that they may achieve. However, this indeterminateness only relates to a static view of business organizations, i.e. on the relation between the two aspects of leadership at a point in time and at a particular stage of their development. When the development of the fir is the object of inquiry, our analysis suggests that the two aspects may be shown to be systematically related to different, but very specific instances of this development. The reason is that each one of them is better suited for different instances of the pursuit of an entrepreneurial conception. Leadership-as-authority is essential for the initial stages of implementation of an entrepreneurial project or the instances in a firm s development that the entrepreneur attempts to effect a major refocusing of his/her conception. These are instances in which the entrepreneur’s purpose – in the Hayekian sense – has to be more forcefully asserted, in order to ensure the coordinated operation of the firm s members. The importance of leadership-as-authority in the initial founding of the fir is, of course, self-evident. However, interesting examples can also be found in instances where the firm s locus of entrepreneurship opts to pursue a project outside the existing organization, e.g. through the creation of a spin-off22 or the participation in a joint venture.23 In all these cases what the entrepreneur attempts to do is to obtain new, potentially profitable knowledge in ways that are not constrained by the cognitive commonalities that are already established in the current organization, i.e. independently of what we have referred to as Hayek’s “middle layer” of rules. We have seen, however, that leadership-as-authority inevitably puts upper bounds to the growth of the firm as it restricts the capacity of its employee’s to look for new knowledge, to process it in the context of the entrepreneur’s business conception and take decentralized action accordingly. Therefore, it is cognitive

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leadership that is much more important for the growth of the fir and especially for its development to ever-higher degrees of complexity. The reason is that through cognitive leadership the entrepreneur can ensure the coordinated action of the firm s members and, especially, their coordinated and, at the same time, creative response to the new contingencies that the organization’s development confronts. Unlike leadership-as-authority, the exercise of cognitive leadership is much more difficul to discern empirically, since, as we have seen, it refers to the ability of the entrepreneur to influenc informally the cognitive commonalities of team members. However, interesting examples may be sought in instances where cognitive leadership is evidently ineffective or even totally lacking, e.g. clashes – or, more generally, incompatibilities – of “corporate cultures”24 in recently merged organizations. In Hayek’s schema of layers of rules, our analysis suggests that, although the top layer, which consists of commands and rules of organization, is indeed essential for the emergence of the firm it is the middle layer of routines and spontaneously evolved rules that determines the growth and development of the firm It is the maintenance of cognitive leadership by the entrepreneur at that layer, i.e. his/her ability to ensure that the cognitive commonality shared by all employees is consistent with the entrepreneurial business conception, that allows the fir to develop, thus blocking its dissolution and, consequently, its transformation from an organization into a spontaneous order. The interesting line of empirical research that this analysis leads to is the investigation of the relation between the use of direct commands and rules of organization for the running of specifi business firm – i.e. the exercise of leadership-as-authority – to the unplanned evolution of routines within the same organization. Most research on this issue is conducted in the context of investigations into the role of “corporate culture” and focuses on static comparisons between monitoring costs and the “thickness” of the corporate culture of a specifi organization. Camerer and Vepsalainen (1988, p. 122), for example, maintain that “since cultural rules are substitutes for communication and explicit monitoring, if the costs of communication and monitoring fall then cultures will get thinner. That is, the number of written rules will grow and the number of agreed-upon unwritten rules will shrink.” Obviously, we see here the trade off to which we referred above, as well as the idea that when the top layer of rules in Hayek’s schema grows, the middle layer inevitably shrinks. However, what this static account of the problem misses is the relevance of corporate culture, i.e. Hayek’s middle layer of rules, for the growth of the firm In contrast to such a static approach, therefore, the interesting line of research that our Hayekian schema opens up is the study of the manner in which the exercise of cognitive leadership by the entrepreneur relates to the development of the firm

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NOTES 1. The 1990s have been more sober in that respect, as academic interest has increasingly focused on the analytical value of his social theory, quite independently of the political vision, which he had constructed it to serve. Fleetwood (1995) is an excellent example of this shift. 2. See Koppl and Minniti (2003) for a survey. 3. A major source of inspiration for this stream of literature is Loasby (1991), who described the fir as an institution specializing in problem-solving. 4. The firs two questions that they propose are “(1) why, when, and how opportunities for the creation of goods and services come into existence, and (2) why, when and how some people and not others discover and exploit these opportunities.” 5. This part draws from Ioannides (1999b). 6. Hayek (1973, p. 37) maintains that: “The distinction of this kind of order (i.e. spontaneous) from one which has been made by somebody putting the elements of a set in their places or directing their movements is indispensable for any understanding of the processes of society as well as for social policy.” 7. Which Hayek (1973, p. 36) defines “. . . as a state of affairs in which a multiplicity of elements of various kinds are so related to each other that we may learn from the acquaintance with some spatial or temporal part of the whole to form correct expectations concerning the rest.” 8. And he adds: “The spontaneous character of the resulting order must therefore be distinguished from the spontaneous origin of the rules on which it rests, and it is possible that an order which would still have to be described as spontaneous rests on rules which are entirely the result of deliberate design.” 9. Loosely referred to as the “entrepreneur.” See, for example, Henderson and Quandt (1958/1971, p. 52). 10. Arguably, the most important differences would be, first the severity of the sanctions that the commanding authority can impose on the lower levels of the hierarchy in order to curb opportunism and, second, the unavailability of the exit option to dissenters. 11. There are two notable exceptions in that respect. First, Langlois (1992, p. 169) discusses the need to study what he describes as “organic organizations,” i.e. organizations that display important elements of both spontaneous orders and organizations. Second, Sautet (2000, p. 99) introduces the concept of the “complex” firm which he define as an organization in which the commanding authority faces a “Hayekian knowledge problem”: i.e. “the entrepreneur-promoter can be ignorant of his/her ignorance with respect to the knowledge possessed by some of his/her employees.” Thus, both authors seem to approach the fir as a “hybrid order,” according the terminology we are adopting here. 12. Sautet’s (2000, p. 85) concept of the “simple” fir is relevant here. 13. See Langlois (1992, 1995) and Vanberg (1994, p. 114). 14. A kind of knowledge, in other words, which is uncentralisable because of its very character. See Hayek (1967, p. 61). 15. See Minkler (1993) for a similar argument on the role of knowledge in business firms 16. See Vanberg (1994, p. 114) for a similar point. 17. The interaction among fir members tends to create ever-novel mutations of the rules. The ones that will be selected will be those that prove to have greater capacity to coordinate the actions of agents.

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18. Routines effect coordination not only contemporaneously but also in the intertemporal sense of allowing action to take into account past experience. This aspect of routines implies that any attempt to redesign them may involve a great cost, which may not be immediately obvious to the reforming agency. For even if successful in bringing about a more effective coordination of contemporaneous acting, it may destroy the ability of agents to tap the accumulated knowledge that is embodied in them. 19. This general definitio has been put forth in Ioannides (1999b, p. 880). 20. See Witt (2000, p. 748): “However, a high price has to be paid for running an organization on the basis of a monitoring regime . . . Monitoring curbs individual creativity and the intrinsic motivation in problem-solving . . . . Furthermore, coordination through detailed directions, regulations, authorization, and tight control causes frictions and is slow and costly in terms of time resources. The larger the firm the more these negative effects tend to lower its efficien y.” See also Witt (1998, p. 167). 21. This relates in an interesting way to Penrose’s (1959/1995, p. xii) theory of the growth of the firm In her view, one of the major obstacles to this growth is the acquisition of managerial services that can be easily “absorbed” by the existing managerial team: “. . . managerial resources with experience within the fir are necessary for the efficien absorption of managers from outside the firm Thus, the availability of ‘inherited managers’ with such experience limits the amount of expansion that can be planned and undertaken in any period of time.” Obviously, the “absorptive capacity” of the existing management team is intimately related to the effectiveness with which it can establish what we have described as “cognitive commonality,” especially with respect to the managerial resources obtained from outside the firm 22. See the account in Langlois (1992) of the organizational mode – i.e. through the creation of a spin-off-that the management of IBM chose in order to develop and market the firs PC. 23. For a view of joint ventures as “hybrid” forms of organization, see Williamson (1996). See also Caloghirou et al. (2003) for a survey of the theoretical and empirical literature of a very interesting type of joint venture (Research Joint Venture) that involves cooperative R&D. 24. For the concept of corporate or business culture see Casson (1991) and Camerer and Vepsalainen (1988).

ACKNOWLEDGMENTS A firs version of this paper was presented in Jena, at the seminar of the Max Planck Institute for Research into Economic Systems, Evolutionary Economics Unit, in December 2001. The author wishes to thank the participants and especially Ulrich Witt for helpful comments. The usual disclaimer applies.

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Koppl, R., & Minniti, M. (2003). Market processes and entrepreneurial studies. In: Z. Acs & D. Audretsch (Eds), Handbook of Entrepreneurship Research. Boston: Kluwer Press. Langlois, R. N. (1992). Orders and organizations: Toward an Austrian theory of social institutions. In: B. J. Caldwell & S. B¨ohm (Eds), Austrian Economics: Tensions and New Directions. Boston: Kluwer Press. Langlois, R. N. (1995). Do firm plan? Constitutional Political Economy, 6, 247–261. Langlois, R. N. (2001). Strategy and the market process: Introduction to the special issue. Managerial and Decision Economics, 22, 163–168. Langlois, R. N., & Robertson, P. L. (1995). Firms, markets and economic change. London: Routledge. Lewin, P., & Phelan, S. E. (2000). An Austrian theory of the firm Review of Austrian Economics, 13(1), 59–79. Loasby, B. J. (1991). Equilibrium and evolution: An exploration of connecting principles in economics. Manchester: Manchester University Press. Minkler, A. (1993). The problem with dispersed knowledge: Firms in theory and practice. KYKLOS, 46, 569–587. Nelson, R. R., & Winter, S. G. (1982). An evolutionary theory of economics change. Cambridge, MA: Harvard University Press. Penrose, E. T. (1959/1995). The theory of the growth of the firm. Oxford: Oxford University Press. Sautet, F. E. (2000). An entrepreneurial theory of the firm. London: Routledge. Shane, S., & Venkataraman, S. (2000). The promise of entrepreneurship as a fiel of research. Academy of Management Review, 25(1), 217–226. Vanberg, V. J. (1994). Rules and choice in economics. London: Routledge. Williamson, O. E. (1975). Markets and hierarchies: Analysis and anti-trust implications. New York: Free Press. Williamson, O. E. (1985). The economic institutions of capitalism. New York: Free Press. Williamson, O. E. (1996). The mechanisms of governance. Oxford: Oxford University Press. Witt, U. (1998). Imagination and leadership: The neglected dimension of an evolutionary theory of the firm Journal of Economic Behavior and Organization, 35, 161–177. Witt, U. (2000). Changing cognitive frames – changing organizational forms: An entrepreneurial theory of organizational development. Industrial and Corporate Change, 9(4), 733–755.

INFORMATION, ENTREPRENEURSHIP, AND ECONOMIC PROGRESS Randall G. Holcombe ABSTRACT Recognition of a profit opportunity requires a framework of knowledge to place information about a profit opportunity in a context where it can be recognized. The same information about a profit opportunity could be revealed to many people, yet only a few with the appropriate knowledge will be able to place this information into a context that suggests to them a profit opportunity. This paper discusses how entrepreneurs gain knowledge to enable them to be more entrepreneurial, and shows how an economy generates information about entrepreneurial opportunities. Entrepreneurship adds to an economy’s knowledge base, making it easier to recognize profit opportunities when they arise.

INTRODUCTION Entrepreneurship is the act of discovering and acting upon a previously unnoticed profi opportunity. Kirzner (1973, 1979, 1985) has analyzed at length the role of entrepreneurs in the economy and their impact on the market, but has paid less attention to the origins of the previously unnoticed profi opportunities that give rise to entrepreneurship. They must come from somewhere, and Holcombe (1998) argues that the most common source of profi opportunities is from the entrepreneurial actions of other entrepreneurs. New entrepreneurial ideas arise Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 173–195 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06011-3

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when an entrepreneur sees the results of the actions of earlier entrepreneurs who have created previously unavailable profi opportunities. Entrepreneurial opportunities tend to appear within the context of a specifi time and place, following Hayek (1945), so entrepreneurial opportunities are more likely to reveal themselves to people who are at the right “time and place” to make the discovery. Everyone is not equally likely to notice an entrepreneurial opportunity: many people may be at the same location at the same time, but one person may notice it while it remains unseen by others. This paper considers some factors that determine how individuals come to recognize these previously unnoticed profi opportunities, and what factors give individuals that specifi knowledge of time and place that allows them to make entrepreneurial discoveries. As Kirzner (1973) describes it, entrepreneurs happen to notice what nobody has noticed before. Whether an entrepreneurial opportunity actually is noticed depends on many factors, but those factors can be divided into two general categories: factors specifi to the individual, and factors related to the individual’s economic environment. Many individuals might observe the same information revealing an entrepreneurial opportunity, yet only a few may have the wisdom to actually act on it. One focus of this paper is on how individuals transform the economic data they observe into a systematic body of knowledge that allows them to spot entrepreneurial opportunities. A second focus of this paper is on the role the economic environment plays in signaling that certain data actually represent a profi opportunity. A growing economy is more conducive to revealing profi opportunities to potential entrepreneurs, for reasons that will be discussed in detail below, and within an economy, those areas that are growing more rapidly will offer more profi opportunities. Entrepreneurial activity in an economy creates data about profi opportunities that potential entrepreneurs add to their knowledge base, which then makes it easier for them to recognize other unexploited profi opportunities. This paper discusses how entrepreneurs acquire information about entrepreneurial opportunities, and how entrepreneurial activity itself generates information that fosters additional entrepreneurial activity.

INFORMATION, KNOWLEDGE, AND WISDOM Boettke (2002) notes that economists are inconsistent in their use of the terms information and knowledge. For present purposes, and consistent with Boettke’s use of the terminology, information refers to data that an individual can collect. Individuals can search for information, and may be aware of information they are lacking that, if attained, could help them achieve their goals. For example, people might read newspaper ads looking for information about prices for goods they intend to

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buy. They may be unaware of other information that would help them if they had it. Knowledge refers to the incorporation of information into a framework where it can be used for decision making. Information about the price someone charges will be of little use unless the person with the information can place it in context. For example, what do other sellers charge for the same or similar goods? Is this price likely to fluctuate so that next week’s price might be considerably higher or lower? Do some sellers offer non-price advantages that might make it desirable to look at other information besides prices before deciding whether to buy? These are the types of factors that enable an individual to place information in a context that makes that information a component of the individual’s knowledge. Wisdom refers to the use of knowledge to make good decisions. Because many factors must be weighed to arrive at a decision, and because some of those factors may be difficul to articulate or weight in a mathematical sense, many people may have the same knowledge, but even with identical knowledge, some will make better decisions than others. Boettke (2002, p. 268) notes that “information is a f ow concept, while knowledge is a stock notion.” By extension, Boettke (2002, p. 269) observes, “Knowledge is ever changing and is multifaceted, while information is something fi ed.” The fl w of information adds to the stock of an individual’s knowledge, but new information may also change the context within which old information is interpreted. Knowledge is more than just the sum of all information possessed by an individual. If one pictures a pitcher of water, and an individual adding a f ow of water to the stock of water already in the pitcher, this analogy inadequately describes the relationship of fl w information to the stock of knowledge. Instead, picture someone adding flou , water, yeast, and the right amount of heat, to produce bread. In the kitchen, the fl w of ingredients yields a stock of food that is qualitatively different from the fl w of ingredients that produced it. Just as bread is not some flou , some water, and so forth, a person’s knowledge is not just all the information the person possesses. And just as some chefs are more successful than others at producing meals even with the same stock of ingredients, many individuals might have similar stocks of knowledge, yet some have the wisdom to make better economic decisions with their knowledge. Kirzner (1973, p. 67) makes a similar distinction between knowledge and entrepreneurship. “But as closely as the element of knowledge is tied to the possibility of winning pure profits the elusive notion of entrepreneurship is, as we have seen, not encapsulated in the mere possession of greater knowledge of market opportunities. The aspect of knowledge which is crucially relevant to entrepreneurship is not so much the substantive knowledge of market data as alertness, the ‘knowledge’ of where to find market data” (emphasis in original). Kirzner means by data what this section refers to as information. But knowledge as

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Kirzner describes it in this passage is knowledge about where to fin information. One must put that information in context to have knowledge, and must be able to use that knowledge productively to have wisdom. In most instances, acting on an entrepreneurial insight is a risky undertaking. The well-known fact is that most new businesses fail within their firs fi e years, illustrating that in many cases, what appears to some as an unexploited profi opportunity turns out not to be profitabl after all. When Kirzner talks about someone noticing a previously unexploited profi opportunity, what the potential entrepreneur notices is information. The entrepreneur must be in a position to turn that information into knowledge, and to turn that knowledge into wisdom. The setting within which the information reveals itself plays an important role in whether the information about a profi opportunity ultimately is transformed into knowledge, and then wisdom, leading to action to exploit the opportunity on the part of the entrepreneur. Consider a simple example of an individual who notices that apples can be bought for $0.25 in city A and sold for $0.50 in city B. These prices are information. The individual can place this information into a framework that can lead to an entrepreneurial insight: a profi opportunity may exist by buying apples in A and selling them in B. More must be known than just the prices, however. The potential entrepreneur would have to factor in transportation costs, and for a true profi opportunity to exist, not only would the entrepreneur need this information on prices, but also a reasonable expectation that the price differential would continue to exist long enough for the entrepreneur to complete a transaction. If an apple can be shipped from city A to city B for $0.10, there is still the possibility for a profit if after buying apples for $0.25 in city A and shipping them to B, the price in B has not fallen below $0.36. The entrepreneur may have information about the propensity for apple prices to fluctuat in the short run, or may be able to avoid the risk of fluctuation in the spot market by contracting ahead of time with a buyer in city B. Prices by themselves provide information, but as this simple example shows, information by itself does a potential entrepreneur little good. The entrepreneur must be in a position to place that information in a framework that yields knowledge before a profi opportunity can be spotted. In this sense, Hayek (1945) was discussing the use of knowledge in society, as his title says, not the use of information. Wisdom goes a step further, and is the ability to use knowledge to make good decisions. The fact that most new businesses fail within the firs fi e years suggests that many people incorrectly believe they have discovered profi opportunities. For example, the apparent profi opportunity above might be undone if too many apples are spoiled or damaged in transit, or if the entrepreneur failed to account for the possibility that transportation costs might fluctuat even while taking account of price fluctuation

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for the apples themselves, or any number of other complications. Wisdom lowers the probability that one is wrong when making a decision based on knowledge. With hindsight, one can separate good decisions from bad decisions on the basis that good decisions yield profit while bad decisions produce losses. One can never know whether a decision was “optimal,” in the sense that it was better than other available alternatives, because as Buchanan (1969) notes, one can never know what would have been the outcome of a foregone alternative. Information is relatively easy to evaluate, in the sense that one can check on its validity, despite the fact that people can obtain information that is wrong, incomplete, or faulty in some other way. Knowledge is more difficul to evaluate, because one must be aware of the context within which information is used, and it is easy to envision how someone’s knowledge could be faulty because the person is lacking some information the person does not even realize would be useful. Wisdom is more difficul to evaluate than knowledge, because even in hindsight one cannot compare the outcomes of decisions people make with what would have been the outcomes if they had chosen differently. If one views entrepreneurship as seeing and acting upon a previously unnoticed profi opportunity, it is apparent that two people could observe the same information, and one would see it as an unexploited profi opportunity while the other might not, either because the second person did not have the knowledge to place that information in context, or did not have the wisdom to see that the information does, in fact, reveal the opportunity to make a profit Ray Kroc, who built the McDonalds restaurant chain, sold restaurant equipment before he took over McDonalds. He had an order for a large number of milkshake makers, and went to the restaurant started by the McDonald brothers to see personally how a restaurant could be selling so many milkshakes. What he saw was an innovation in restaurant operation. Before McDonalds, restaurants got customers’ food orders and then prepared the food, but McDonalds had the entrepreneurial insight that they could prepare the food before it was ordered so customers could get their food right away. This system required that management be good at predicting the number of customers and food orders so the right amount of food would be on-hand, and hindsight shows that they had a good system. Ray Kroc did not develop this system himself, but he recognized it as a profi opportunity. He had the information from seeing the operation of McDonalds, he had the knowledge from years of experience in the restaurant industry, observing many different types of operations, and he had the wisdom (moreso than the original innovators) to see this as a profi opportunity. So he bought the restaurant from the innovators and established it as a world-wide chain. Perhaps Kroc was just lucky. It is difficul for an outside observer to separate out luck from wisdom, because there is no formula for identifying how individuals can use knowledge to make good decisions. It is easier to see how knowledge

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can prevent people from making bad decisions, by identifying potential problems before they arise, but how did Ray Kroc have the insight to see what a profi opportunity McDonalds presented when the innovators who started the restaurant were (using their sale as evidence) less optimistic. Part of the answer likely lies in the different knowledge bases of Kroc and the McDonald brothers. The McDonalds may have had the knowledge to start and operate a restaurant, and the brilliant insight to prepare the food before the customers ordered it, but Kroc, as a vendor selling to many restaurants, had a broader knowledge of the industry. Regardless of whether this speculation on the differences in knowledge between the McDonalds and Kroc is true, this is an example of how two people could have the same information about a profi opportunity, and yet because the two individuals had different knowledge bases, one saw it as a more profitabl opportunity than another. Perhaps Kroc was lucky, but there’s an old slogan, “Luck is when preparation meets opportunity,” and it seems to apply here.1 Kroc was prepared because of his background in the restaurant industry, and had the opportunity when the McDonald brothers were willing to sell him their restaurant. But many people believe they have spotted profi opportunities that result instead in losses. Perhaps their knowledge was faulty, but consider companies like IBM on the brink of bankruptcy in 1991, or Xerox and Polaroid on the brink of bankruptcy in 2001. Surely the management in those companies had ample knowledge of the computer, photocopying, and photography industries, respectively, but that knowledge did not translate into the wisdom that led to profitabl decisions. In the real world (unlike the neoclassical model of the firm) profitabilit is a moving target, and activities that were profitabl a decade ago – or even a year ago in rapidly-evolving industries – may not be profitabl today. As Christensen (1997) notes, decision makers can be misled by their past successes into thinking that strategies that brought them profit in the past can continue to do so in the future. As the IBM, Xerox, and Polaroid cases show, more than knowledge is required to spot profi opportunities. Entrepreneurship is built on a foundation of knowledge, but also requires the wisdom (or luck) to be able to sort the good strategies from the bad.

CAN ENTREPRENEURSHIP BE PRODUCED? As Kirzner define entrepreneurship, the entrepreneurial act itself is costless, and uses no resources. It is simply the act of noticing what nobody has noticed before. But people can invest resources into activities to make it more likely that they will make an entrepreneurial discovery. Research and development activities are not entrepreneurship, but R&D creates an environment within which

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entrepreneurial opportunities are more likely to present themselves. Research and development generates information, which can add to knowledge. Within a neoclassical framework, where things are produced by combining inputs in a production function, research and development is undertaken by combining land, labor, and capital, to produce technological change. The successes attributable to investment in research and development are indisputable, but R&D expenditures cannot be the whole story, because once the research is done, the results need to be applied to make production less costly, or even more mysteriously, to produce goods and services that have never been produced before. Schumpeter (1934) distinguishes invention from innovation. Invention is a possible product of R&D, but inventions do not necessarily lead to economic improvements. The innovation is taking the invention and applying it to produce new products, or to produce existing ones more efficientl . The taking of inventions and making them into innovations is the role of entrepreneurship. Fifteen hundred years ago China was the most technologically advanced nation in the world, but did not turn its inventions into innovations, whereas during the industrial revolution, Europe did. Similarly, Xerox invented the computer interface used on the Apple Macintosh and in Microsoft Windows, including the use of windows to show different tasks, and the use of the mouse to navigate the operating system and its applications, but Xerox did not turn its invention into an innovation. Steve Jobs of Apple, and Bill Gates of Microsoft, saw what Xerox had done, incorporated that information into their stock of knowledge, and with that knowledge had the wisdom to see that the commercialization of that interface was an unexploited profi opportunity. The information was revealed to those at Xerox first but those who saw the information firs failed to see that it revealed an entrepreneurial opportunity. The story of the development of the graphical user interface for the computer parallels the story of the development of fast food restaurants told in the preceding section. While entrepreneurship may involve that flas of recognition that a profi opportunity exists, entrepreneurship can be produced, in the sense that individuals and firm can create an environment that is conducive to entrepreneurial discovery. People can search for information about market conditions, about production processes, and about possible innovations and new goods. Research and development can be viewed as the creation of an environment that produces information that could reveal entrepreneurial opportunities. Some information about an entrepreneurial opportunity is available to everybody. Price discrepancies and arbitrage opportunities fall in this category, and those most alert will notice them. Some information is available only to a few, and the object of commercial research and development is to generate information that nobody else has. This gives the researcher a substantial advantage in transforming the proprietary information into a profit but as the Xerox example above shows, it is not an

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insurmountable advantage. Despite the fact that Xerox developed the information to produce the graphical user interface for the computer, the company did not have the wisdom to recognize it as a profi opportunity, so those profit from the information Xerox generated ended up going to Apple Computer and Microsoft. Information about entrepreneurial opportunities can be produced, and firm actively undertake activities to produce that information. The knowledge to place the information in context can also be produced. Businesses go to great lengths to try to understand not only the engineering aspects of the products they produce, but also the nature of the market within which their products are sold. As Christensen (1997) notes, firm always run the risk of misunderstanding their markets, even when they are market leaders, and sometimes past successes lead firm to overlook the future direction of the market. But firm do try to understand their markets so that they can remain successful. Understanding the market means taking available information and placing it in context so that the fir can make successful decisions. To that end, firm undertake marketing research, engineering research, and other information-gathering activities, and consolidate that information to try to acquire the knowledge to make managerial decisions. This knowledge is necessary for entrepreneurship. Information about entrepreneurial opportunities can be produced, and that information can be aggregated into knowledge about entrepreneurial opportunities. In that sense, entrepreneurship can be produced. But the wisdom to use one’s knowledge effectively is more problematic. It can be produced by experience, but some people seem more adept at making wise decisions than others. As Boudreaux and Holcombe (1989) note, it is more than just good management – findin ways of minimizing costs and combining inputs efficientl . Entrepreneurship means findin a better way of doing something, and there is no benchmark for comparison. Can entrepreneurship be produced? Information that can help people act entrepreneurially can be produced, and the knowledge to place that information in context can be produced, but there is no clear-cut way to produce the wisdom that leads to entrepreneurial discoveries. Entrepreneurship is more than just noticing something, as the record of business failures suggests. It involves having the wisdom to separate actual profi opportunities from tempting options that will not generate profits

THE ORIGINS OF ENTREPRENEURIAL OPPORTUNITIES How readily an unexploited profi opportunity is recognized is related to the ways in which entrepreneurial opportunities arise. Some profi opportunities

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are easier to spot than others. Holcombe (2003) argues that entrepreneurial opportunities arise from three different sources: factors that disequilibrate the market, factors that enhance production possibilities, and as the by-product of previous entrepreneurial actions. Within a neoclassical framework, and within Kirzner’s (1973) framework, factors that disequilibrate the market provide the most obvious source of entrepreneurial opportunities. If some trades are being made at disequilibrium prices, then an entrepreneurial opportunity exists, and the act of entrepreneurship pushes the market toward equilibrium. Factors that Disequilibrate the Market Kirzner (1973, pp. 72–75) contrasts his equilibrating view of entrepreneurship with Schumpeter’s (1934), which Kirzner characterizes as disequilibrating. “Schumpeter’s entrepreneur acts to disturb an existing equilibrium situation . . . . The entrepreneur is pictured as initiating change and generating new opportunities” (pp. 72–73, emphasis in original). Kirzner then quotes Schumpeter as concluding that entrepreneurship is at odds with equilibrating activity. Kirzner, in contrast, argues that the entrepreneur “. . . brings into mutual adjustment those discordant elements which resulted from prior market ignorance” (p. 73, emphasis in original). Kirzner raises the issue because he believes Schumpeter’s discussion of entrepreneurship is “. . . likely to generate the utterly mistaken view that the state of equilibrium can establish itself without any social device to deploy and marshal the scattered pieces of information which are the only source of such a state” (pp. 73–74).2 A key point here is seen in Kirzner’s reference to the scattered pieces of information required to equilibrate the market. The necessary information is readily available in the form of market prices, but for entrepreneurship to equilibrate the market, there must be somebody with the knowledge required to take advantage of the information. If the market is disequilibrated through a shift in supply or demand, the change in the status quo should provide a relatively obvious signal of an entrepreneurial opportunity, and provides the most likely case that an entrepreneurial opportunity would be recognized. People who already trade in a market are likely to spot opportunities that are created by factors that disequilibrate the market as a byproduct of their routine economic activity, so many people will have the required knowledge, and relatively little wisdom is required to spot such a profi opportunity. Factors that Enhance Production Possibilities The second source of entrepreneurial opportunities, factors that enhance production possibilities, create entrepreneurial opportunities in several different ways.

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Most obviously, more production means people have higher incomes, so there is a profi opportunity to produce more output for them to purchase. More significantl , higher incomes will lead to changes in the mix of goods demanded. As income rises, people tend to demand more automobiles relative to bicycles, and may shift from auto or train travel to travelling by air. People may demand more steak relative to hamburger, and may demand more restaurant meals relative to home-cooked meals. Changes in the composition of demands for various types of output creates profi opportunities. Perhaps more significan as a source of profi opportunities, a more productive economy has a greater role for the division of labor, as Smith (1776) noted, so even if the output of all goods did increase proportionally, there would still be the opportunity to change production methods to produce more efficientl with a fine division of labor. As Richardson (1975, p. 351) notes, in Smith’s view “the division of labor is at once both a cause and an effect of economic progress.” Young (1928) and Kaldor (1972) also emphasize Smith’s principle of the division of labor as an important and underappreciated engine of economic progress. In this case, the exact nature of an entrepreneurial opportunity will not be as obvious as in the previous case (for factors that disequilibrate the market). If there is an opportunity to produce new goods to sell to a broader market, it is not always obvious what new goods it would be profitabl to produce. Likewise, if there is an opportunity to profi from increased specialization in production, or by any other change in the production process, it is not always obvious how this could be done. Consider Henry Ford’s insight that because of a growing market, automobiles could be mass-produced on assembly lines to lower the cost and bring the opportunity of automobile ownership to the masses. Many people had the same market information as Ford, but he had the wisdom to seize that profi opportunity. While it looks obvious in hindsight, many automobile companies led by people with less wisdom than Ford failed in the early 20th century. For a similar example, consider the success of Palm Pilots – small hand-held computers. Do readers recall the Apple Newton, which was Apple Computer’s entry into that market only a few years before the Palm Pilot? Apple spotted the information signaling a profi opportunity in that market before Palm,3 Apple had the knowledge to see that there was a profi opportunity (the evidence is Palm’s profi in that market), but Apple was unable to profi from it. Profi opportunities created by enhanced production possibilities probably take more wisdom to turn into actual profit than those created by the other two categories. The process by which profi opportunities are generated is more evolutionary and continuous than in the other cases, the knowledge required to make a profi is typically substantial, and the wisdom necessary to make good decisions is substantial, as the Newton-Palm example illustrates. One interpretation of this example is that the failure of the Newton in this market provided information

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to Palm which helped them to succeed. These opportunities are considerably more complex than spotting a $20 bill lying on the sidewalk, or seeing that something can be bought for less in one location than it can be sold for in another, and the failure of the Newton to capitalize on the same profi opportunity later exploited by Palm illustrates the difficult of seeing the exact nature of a profi opportunity.

Entrepreneurial Opportunities Produced by Entrepreneurship The third and most significan source of entrepreneurial opportunities arises from entrepreneurial actions that have taken place in the recent past. As Kirzner (1973) depicts it, entrepreneurial opportunities lie unnoticed until entrepreneurs see and act on them. If this was all there was to it, entrepreneurial opportunities would be used up as entrepreneurs exploited them. Once the market reached equilibrium, no more opportunities would appear – unless, as noted above, factors disequilibrated the market, or production possibilities were enhanced. However, entrepreneurial actions themselves produce new entrepreneurial opportunities, as Holcombe (1998), Minniti (1999), and Minniti and Bygrave (2000) note. Consider, for example, the cordless computer mouse. Some entrepreneur had the idea that computer users would prefer a mouse that was not tethered to the computer by a cord, so created a battery-operated mouse that would communicate with the computer through radio waves or infrared light (there are at least these two types of cordless mice). That entrepreneurial insight would not have been possible had Steve Jobs and Bill Gates not had the entrepreneurial insight to adapt Xerox’s graphical user interface to the PC. And in turn, the graphical user interface would not have been an entrepreneurial opportunity had not the PC been commercialized. And the opportunity to create the PC would not have been available had the microprocessor not been developed, and there would have been no opportunity to develop the microprocessor without the invention of the transistor. The point is that entrepreneurial actions do not use up entrepreneurial opportunities: on net they create more entrepreneurial opportunities. The main source of entrepreneurial opportunities is from the act of entrepreneurship itself. To see entrepreneurship in this way adds to Kirzner’s (1973) model of entrepreneurship in an important way. As Kirzner describes it, entrepreneurial opportunities lie unnoticed until entrepreneurs seize them, but Kirzner does not describe where they come from, and leaves the impression that entrepreneurs use up entrepreneurial opportunities as they act on them. Seen in the broader way described here, entrepreneurs create new entrepreneurial opportunities as they act on existing ones, so entrepreneurial actions create more opportunities and more

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entrepreneurship. One might picture, following Kirzner, profi opportunities lying unnoticed until the spark of recognition hits an entrepreneur, but in fact, most entrepreneurial opportunities do not lie unnoticed for long. The opposite is true: most profi opportunities get noticed by entrepreneurs because they are new. This is true whether the entrepreneurial successes are spectacular or more mundane. This effect of entrepreneurship suggests Schumpeter’s vision of economic progress as a spontaneous, revolutionary, and discontinuous process.4 Surely the seizing of an entrepreneurial opportunity can upset people’s expectations, because almost by definitio (Kirzner’s definition at least), entrepreneurial actions must come as a surprise to everyone but the entrepreneur, because nobody noticed the opportunity before. But once the entrepreneur acts, information on the entrepreneurial activity becomes widely available as market data, alerting others to the potential of profi opportunities. Consider some great American fortunes. Andrew Carnegie was able to build the foundations of U.S. Steel by capitalizing on the newly developed Bessemer process. John D. Rockefeller’s Standard Oil Company developed because he was able to control the distribution network, which at the time relied on the recentlyconstructed railroad infrastructure. Henry Ford’s assembly lines were feasible only when there was enough of a mass market for automobiles, and the fortunes of Bill Gates rose along with the fledglin personal computer industry. None of these individuals invented the technology that made them wealthy, but they had the insight to take advantage of an entrepreneurial opportunity. Note, however, that in each case the opportunity was newly developed, and the entrepreneurial opportunity did not go unnoticed for long. Entrepreneurial opportunities are not just lying around waiting for someone to notice them. Rather, they appear and then entrepreneurs rapidly move to take advantage of them. Consider again the innovation of the cordless computer mouse. It is a small development, to be sure, but is a good example of an entrepreneurial insight and the capitalization of a previously unnoticed profi opportunity. The profi opportunity arose solely because of a previously non-existent market niche, and once that market niche appeared, it did not take very long for an entrepreneur to seize on the idea. Notice that this entrepreneurial insight did not arise for either of the firs two reasons discussed earlier. It did not arise because of a profi opportunity created by a temporary disequilibrium in the market. Before personal computers used mice (which also is an example of an entrepreneurial insight), there would have been no possibility for the insight, regardless of how far the market was out of equilibrium. It did not arise because of the second reason either, which is a bigger market. The division of labor has nothing to do with the insight that a mouse could communicate with a computer through infrared or radio technology (although it might have something to do with what type of fir produces the technology). An

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increase in wealth could not create the demand for infrared mice without the innovation of mice as a computer input device. This entrepreneurial insight capitalized on a new opportunity, which was created by other entrepreneurial insights. In each of the above examples, the entrepreneur had some specifi knowledge of time and place as a context for new information revealed through the market about profi opportunities produced by recent entrepreneurial acts. The entrepreneurial act of seizing those opportunities that produces the engine for economic progress, and lays the foundation for more entrepreneurial discoveries. Where do entrepreneurial opportunities come from? Many of them come from the actions of other entrepreneurs. Henry Ford could not have succeeded in mass-producing automobiles until there was a substantial market, including infrastructure such as roads, gasoline stations, and repair facilities. Bill Gates could not have made his fortune had not Steve Jobs seen the opportunity to build and sell personal computers, and Steve Jobs could not have built a personal computer had Robert Noice not invented the microprocessor. When entrepreneurs take advantage of profi opportunities, they create new entrepreneurial opportunities that others can act upon. Entrepreneurship creates an environment that makes more entrepreneurship possible.

INFORMATION, WISDOM, AND THE PROCESS OF ENTREPRENEURSHIP Entrepreneurship creates new entrepreneurial opportunities, but how do entrepreneurs gain the knowledge to spot those opportunities once they are created? In a static setting, because there is little change, there will be relatively little in the way of entrepreneurial opportunities. Those that might be lying in wait must be relatively obscure to have remained unnoticed, and the static environment precludes the creation of new opportunities. Schumpeter (1934, p. 154), discussing a framework in which all profi is competed away in equilibrium, and in which profi is the return to entrepreneurship, observed, “Without development there is no profit without profi no development.” Economic progress relies on an economy that is not in neoclassical general equilibrium to generate the profi opportunities necessary for development to occur. Schumpeter’s argument attacks the very foundation of equilibrium growth theories built on Solow (1956). A key question is, where do potential entrepreneurs get the knowledge to utilize information about entrepreneurial opportunities? As Holcombe (1999) discusses, one view of equilibrium, shared by Stiglitz (1987) and Kirzner, is that equilibrium implies that there are no unexploited profi opportunities. By definition entrepreneurship is ruled out in equilibrium, and a Solow-type growth

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model is inconsistent with entrepreneurship. Another view of equilibrium, shared by Hayek (1937), Hahn (1984), and Lewin (1997), define economic equilibrium as a condition in which the plans of all individuals in the economy are mutually compatible.5 If this latter definitio of equilibrium is taken, entrepreneurial opportunities can exist in an economy and lie unnoticed for an indefinit period of time as individuals continue making mutually consistent plans, oblivious to the existence of profi opportunities. The potential for entrepreneurship exists, but how would opportunities be observed? Consider a traditional economy described by Heilbroner (1962) in which heredity and institutions assign people their economic roles. Institutional constraints prevent entrepreneurial activity. The same would be true in a centrally-planned economy, where profit are institutionally ruled out. Now consider an economy in general equilibrium. Period after period, economic agents undertake the same activities, earning a normal rate of return for their efforts. There are no economic profits and much like the traditional economy, nothing in the economic environment changes period after period. In such a setting, individuals must be suspicious of any potential opportunity that would appear to be profitable An old joke goes, Economist 1: “Look, there’s a $20 bill on the sidewalk!” Economist 2: “Couldn’t be. If there was, somebody would have picked it up.” The punchline exactly applies to profi opportunities in general equilibrium. If there really was a profi opportunity, why had nobody seized it before?6 Most businesses fail within their firs fi e years because what appeared to the business’s founder as a profi opportunity turned out not to be. In general equilibrium, market participants have the knowledge that apparent profi opportunities are likely to be illusory, and the most profitabl course of action would likely be to ignore them. Consider again the hypothetical example where one discovers the information that something is selling for $0.25 in one location while buyers are paying $0.50 for the same good in another location. Now consider two different scenarios in which that information is revealed. First, imagine a setting of general equilibrium, or as Mises (1966) and Rothbard (1962) call it, an evenly rotating economy. The same economic activities happen period after period, leading the potential entrepreneur to think that if this really was a profi opportunity, someone would have already acted on it.7 If one were to factor in transportation costs, shipping damage, possible price fluctuations and a host of other factors, the apparent profi would probably disappear. When the information about prices is incorporated into a body of knowledge, that body of knowledge weighs against acting on what initially appears to be a profi opportunity. Now, consider another setting where entrepreneurship is rampant: perhaps the microelectronics industry at the end of the 20th century. The innovations of entrepreneurs are creating new entrepreneurial opportunities, and the observer’s body of knowledge now

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incorporates that environment. Many people have spotted and acted on entrepreneurial opportunities, and profite from their actions. In this setting, the same information leads to a different sort of knowledge, and makes it more likely that the apparent profi opportunity really would lead to a profit An entrepreneurial environment changes the knowledge base of potential entrepreneurs, and makes it more likely that information about an entrepreneurial opportunity will actually be spotted and acted upon. If the same information about a potential profi opportunity surfaces in an economy stagnating in general equilibrium versus an entrepreneurial economy characterized by constant change, it will be more likely to be an actual profi opportunity in the dynamic entrepreneurial economy, so the information will be more likely to be acted on by an entrepreneur. The environment within which information presents itself affects the observer’s knowledge base, and an entrepreneurial environment is more likely to develop the knowledge that leads people to act entrepreneurially. Entrepreneurship creates more entrepreneurial opportunities, but it also creates a base of knowledge that makes it more likely that entrepreneurial opportunities will be spotted and acted upon. Knowledge is more than just the sum of the fl w of information that creates it. The market economy itself creates knowledge that would be unavailable in a different institutional setting.

WISDOM AND ENTREPRENEURSHIP A view that opportunities for entrepreneurial insights are produced exogenously and lie in wait for entrepreneurs to notice them would be fundamentally misleading. Furthermore, it would be misleading to think that at any point in time there is an abundance of entrepreneurial opportunities that are unnoticed, waiting to be discovered. Entrepreneurial opportunities constantly arise in a growing economy, and when they do they are, except in rare circumstances, rapidly acted upon. Entrepreneurial insights are produced in the process of economic advancement. More rapid advancement brings more entrepreneurial opportunities, and more entrepreneurial opportunities produce greater incentives for potential entrepreneurs to become more alert to them. The actions of entrepreneurs add to the knowledge base of potential entrepreneurs, so entrepreneurship generates more entrepreneurship. In contrast, a stagnant economy blunts the incentives for entrepreneurial activity, and can remain stagnant because it is more difficul to spot those entrepreneurial opportunities that actually exist.8 Even if the information about a profi opportunity is revealed, a stagnant economy may not generate the knowledge sufficien to prompt an entrepreneur to act. The idea that entrepreneurial activities create more entrepreneurial opportunities endogenizes

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the creation of entrepreneurial opportunities, expanding Kirzner’s model of entrepreneurship to explain the origin of entrepreneurial opportunities as well as the competitive process that results from their existence. Equilibrium economics offers little insight into entrepreneurship, precisely because of its equilibrium character. Twentieth century equilibrium economics in all of its variants has viewed production in a Ricardian production function setting (Holcombe, 1999). In contrast, Bohm-Bawerk (1959) depicted a structure of production that would become more roundabout as more indirect methods of production were used. Bohm-Bawerk’s approach more closely follows Smith (1776), who emphasizes increases in the division of labor as the engine of economic progress. Smith’s division of labor find a parallel in the Bohm-Bawerkian concept of extending the structure of production. Within the neoclassical-Ricardian framework, the new production processes imply changing the functional form of the production function, which means changing the way that inputs are combined into outputs. In the neoclassical framework, this could happen in any way – it is more general than Bohm-Bawerk’s approach – but because of its generality does not focus on the nature of changes (such as increasing the division of labor, or lengthening the structure of production). The Smithian view of economic progress is based on the concept of increasing returns, and 20th century contributors to the Smithian idea, like Young (1928) and Kaldor (1972) have explicitly acknowledged that they were building on Adam Smith’s insights. Yet increasing returns is a problematic concept in an economic framework because it implies that average cost continually declines. Kaldor (1972) notes the problems for general equilibrium models when firm are characterized by increasing returns, but another possibility is that the production functions of firm do not exhibit increasing returns. Rather, firm generate network externalities that lower the costs of production for other firm in close proximity.9 Individual firm do not exhibit increasing returns, but the entire economy does. This is easy to visualize as a Smithian idea. The division of labor is limited by the extent of the market, so additional firm in an area enlarge the market and allow all firm to be more productive by becoming increasingly specialized. Increased specialization is but one way in which firm can become more innovative, so a more general way to envision this idea is that the knowledge created by firm benefit other firm in close proximity. When one fir innovates, other nearby firm fin themselves in a better position to innovate also. Romer (1986, 1990) depicts the process as a knowledge spillover. Knowledge, embodied in human capital, is the factor with increasing returns, meaning that investments in human capital make future investments in human capital more productive. Because human capital must be combined with other factors of production, there will be a tendency for productivity increases to be geographically

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concentrated, which result in some areas manifesting more economic growth than others. Along these lines, Krugman (1991) and Audretsch and Feldman (1996) develop models in which increasing returns occur in geographically concentrated areas. Desrochers (2001) presents an excellent discussion about the way that tacit knowledge, as described by Hayek (1945), is transmitted more effectively by people in close proximity to one another. Some things can be observed more effectively than they can be described, so industries that are more entrepreneurial are more likely to reveal entrepreneurial opportunities to those in their own industry, and geographical areas that are more entrepreneurial are more likely to reveal entrepreneurial opportunities to those in their own area. The wisdom to undertake effective entrepreneurship is not equally available to everyone, and entrepreneurial opportunities that may be easily obtainable for some will be out of reach for others. Much information is readily available to all, but as noted above, people also generate their own private information with the intention of using it entrepreneurially. Information is valuable only within a broader context of knowledge, and information that would have no meaning to some might suggest an entrepreneurial opportunity to others who are able to put that information in the context of their knowledge. Wisdom comes from the effective use of knowledge, and part of this is collecting sufficien knowledge to avoid making bad decisions. This section has suggested the important role of proximity in making wise decisions. Some information is difficul to communicate without first-han knowledge. Those in a particular industry will have more wisdom about entrepreneurial opportunities in that industry, and following the arguments of a substantial literature discussed in this section, geographical proximity generates a substantial amount of this type of knowledge. Desrochers (2001) gives a superb description of knowledge transmission through geographic proximity. Earlier, the paper showed that people can take actions that will increase the likelihood of their discovering entrepreneurial opportunities by, for example, undertaking research or studying industry trends and activities to build a knowledge base. But holding individual action constant, some economic environments generate information for all individuals in the environment that make it more likely that they will recognize entrepreneurial opportunities. An environment where there is a substantial amount of entrepreneurship creates a knowledge base that increases the probability that when people are exposed to information about entrepreneurial opportunities, they will recognize it as such and act on it. The market process itself generates information. Entrepreneurship creates more entrepreneurial opportunities, as Holcombe (1998, 2003) argues, but entrepreneurship also generates information that adds to the knowledge base of potential entrepreneurs, making them more entrepreneurial. The same profi opportunity is more likely to be recognized in an entrepreneurial economic environment than in a stagnant

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one, or in an equilibrium setting. Entrepreneurship requires knowledge, but entrepreneurship also generates information that adds to knowledge, leading to more entrepreneurship.

CONCLUSION Entrepreneurship, following Kirzner (1973), is the recognition of a previously unnoticed profi opportunity, but Kirzner does not consider how profi opportunities are created in an economy. Holcombe (1998, 2003) extends Kirzner’s model of entrepreneurship by showing that entrepreneurship creates new entrepreneurial opportunities. While at firs it might appear that when an entrepreneur acts on a previously unnoticed profi opportunity, there are fewer profi opportunities left as a result, the opposite is true. An entrepreneurial act creates additional profi opportunities, so entrepreneurship generates the opportunity for more entrepreneurship. Entrepreneurial opportunities may not be easy to spot, even if they are lying in plain sight. The information may be available to everyone, but recognizing a profi opportunity will typically require a framework of knowledge to place information about a profi opportunity in a context where the profi opportunity can be recognized. As Hayek (1945) notes, everyone has some specialized knowledge of time and place that enables them to make use of market information in ways not available to others without that specialized knowledge. The same information about a profi opportunity could be revealed to many people, yet only a few with the appropriate knowledge will be able to place this information into a context so that the information suggests to them a profi opportunity. The distinctions among information, knowledge, and wisdom help illuminate the nature of entrepreneurial discovery. Information includes much of the data of the market, but may also include other data not visible to everyone, such as production techniques, or even market data generated by surveys or statistical analysis. In order to yield any insight, information must be placed in the context of other information, and this aggregation of information that an individual possesses is knowledge. Entrepreneurial opportunities, as Kirzner describes them, are information, but Hayek (1945) was talking about how people use knowledge, which requires them to place information they receive in a broader context. Knowledge is insufficien to produce entrepreneurship. The individual must be able to evaluate that knowledge in subjective ways to determine whether an entrepreneurial opportunity actually exists. Wisdom is the product of knowledge, intelligence, and experience. This paper cited several examples showing that when different people have the same information and knowledge, some may

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recognize the information as signaling an entrepreneurial opportunity while others may not. People may gather information themselves to generate a base of knowledge that can enhance their opportunities for making entrepreneurial discoveries. Independent of any individual’s actions, the market environment has a large impact on people’s stocks of knowledge that can contribute to entrepreneurship. Entrepreneurial activity in an economy produces information that creates knowledge of time and place that helps to reveal entrepreneurial opportunities. Entrepreneurship produces information about entrepreneurial opportunities in several ways. An economy with little entrepreneurship, simply because of the lack of entrepreneurship, provides information that few entrepreneurial opportunities are available. In an economy in general equilibrium, all profi opportunities have been competed away, so what appears to be a profi opportunity may actually generate losses if acted upon. Few profi opportunities present themselves as sure things, and a potential entrepreneur will be less likely to take a risk on an apparent profi opportunity if it appears that most apparent profi opportunities are illusory. If entrepreneurship produces more entrepreneurial opportunities, then an extension of this argument is that an entrepreneurial economy will have more profi opportunities than a stagnant economy (or one in equilibrium). If this information is in the entrepreneur’s stock of knowledge, then entrepreneurship itself produces knowledge that leads to more entrepreneurship. Entrepreneurial activity generates more entrepreneurship because opportunities are created, and because knowledge about those entrepreneurial opportunities are created. The knowledge that is created is more than just information. It is a context within which information can be evaluated, and entrepreneurial activity adds to knowledge in several ways. First, it reveals that others have found profitabl opportunities, encouraging potential entrepreneurs to be more alert. Second, it provides information on how previous entrepreneurs have seized profi opportunities, and this information generates knowledge for other potential entrepreneurs. For example, an entrepreneur could observe someone else’s entrepreneurial activity and have the insight that if that person did something a little differently, the activity would be more profitable The new entrepreneur could copy much of the predecessor’s actions, changing only those things that the entrepreneur thought would warrant improvement. Or, an entrepreneur might observe certain changes in one industry and see that they could be adapted to generate profit in another. The point is that entrepreneurship does more than just generate additional entrepreneurial opportunities. It also generates the knowledge that leads people to better be able to take advantage of those entrepreneurial opportunities that exist.

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Hayek noted that knowledge is often not easily transmitted from person to person. A person can have knowledge about a particular industry, process, or market, and yet not be able to articulate that knowledge to pass it along to others. It is at this point that knowledge becomes wisdom, and enables people to make better decisions than others who have all of the same information available to them. People can pick up wisdom from others by observing their actions and by collaborating with them, but this requires that interactions take place in close proximity. This is why areas that become entrepreneurial tend to generate more entrepreneurship This is the knowledge of time and place that Hayek discussed, and place can be an industry, or a geographic area. More entrepreneurship occurs when both industry and geographic location coincide. This explains, for example, the concentration of entrepreneurship in semiconductors in silicon valley, in financin in New York, and in automobile development in Detroit. As Desrochers (2001) describes, people are able to get ideas from others who have specialized knowledge in the same area in a way that would not be possible without the geographic proximity. Because of the geographic proximity, knowledge that is difficul to articulate can still be shared.10 Entrepreneurship creates more entrepreneurial opportunities, as Holcombe (1998, 2003) notes, and this paper extends that argument by showing that entrepreneurship also adds to the knowledge base, providing the knowledge that makes it easier to recognize profi opportunities when they arise. Kirzner depicts entrepreneurs as noticing profi opportunities that nobody has noticed before, which raises the question of why one person notices what others have missed. Hayek emphasizes the importance of individual knowledge of time and place, and this paper shows that entrepreneurship in an economy produces knowledge for individuals that enhances their ability to recognize entrepreneurial opportunities. Entrepreneurial activity generates information that aids future entrepreneurial discovery.

NOTES 1. I do not know the origin of this slogan, but firs saw it painted on the wall of the football locker room at my high school. At the time, it appeared to apply to winning sports contests, and with each passing decade it seems to me more generally applicable to all aspects of life. 2. Kirzner (1979, Chap. 7) argues that there are important differences between his and Schumpeter’s ideas. Elsewhere, however, Kirzner (1985, Chap. 4) develops the idea of entrepreneurship in a manner that encompasses the spirit of Schumpeter’s ideas, and their ideas on entrepreneurship clearly can be reconciled. 3. Actually, the Palm Pilot was developed by the 3Com Corporation, which later spun Palm off into a separate company.

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4. Schumpeter (1934, p. 63) discusses the revolutionary nature of economic growth, and later (1934, p. 65) describes the motive forces as “spontaneous and discontinuous.” 5. Hayek (1949, p. 41) says equilibrium is the condition where “. . . the different plans which . . . individuals . . . have made for action in time are mutually compatible.” Hahn (1984, p. 44) says equilibrium exists when “. . . the intended actions of rational economic agents are mutually consistent and can, therefore, be implemented.” Lewin (1997, p. 245) says “equilibrium is understood to be the consistency of actions and the plans on which they are based.” 6. See Olson (1996) for an interesting analysis of this example. 7. Whether such an unexploited profi opportunity could exist in general equilibrium depends on the view one takes of equilibrium. The Kirznerian view would be that an economy with unexploited profi opportunities would not be in equilibrium, but following Hayek’s view that equilibrium simply means that everyone’s plans are mutually consistent, one could imagine such an unexploited profi opportunity existing unnoticed period after period. See Holcombe (1999) for a further discussion and elaboration. 8. Young (1993) develops a model along these lines. Mokyr (1990) classifie technological advances as “macroinventions” and “microinventions.” The idea is that major inventions like the steam engine and the microprocessor create entrepreneurial opportunities for microinventions that further drive economic growth. 9. Arthur (1989) presents a model showing how increasing returns can lock an economy into an inferior technology. Perhaps the most famous (but questionable) example is related by David (1985). See also David (1975) for a clear recognition of the importance of increasing returns to economic progress. 10. An interesting extension of this idea would be to consider how one’s specifi “place,” in Hayek’s (1945) sense, is enlarged by the development of transportation and communication technology. People can see more, and broaden their knowledge bases further, by being in close proximity to others who may actually be physically distant most of the time. In the same way that Smith (1776) noted that the extent of the market can grow, allowing a greater division of labor, a person’s place in the market system can be enlarged, giving that person greater knowledge about entrepreneurial opportunities.

REFERENCES Arthur, W. B. (1989). Competing technologies, increasing returns, and lock-in by historical events. Economic Journal, 99, 116–131. Audretsch, D. B., & Feldman, M. P. (1996). R&D spillovers and the geography of innovation and production. American Economic Review, 86, 630–640. Boettke, P. J. (2002). Information and knowledge: Austrian economics in search of its uniqueness. Review of Austrian Economics, 15, 263–274. von Bohm-Bawerk, E. (1959) (orig. 1884, 1889, 1909). Capital and interest (3 vols). Spring Hills, PA: Libertarian Press. Boudreaux, D. J., & Holcombe, R. G. (1989). The Coasian and Knightian theories of the firm Managerial and Decision Economics, 10, 147–154. Buchanan, J. M. (1969). Cost and choice: An inquiry in economic theory. Chicago: Markham. Christensen, C. M. (1997). The innovator’s dilemma: When new technologies cause great firms to fail. Boston: Harvard Business School Press.

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David, P. A. (1975). Technical choice, innovation, and economic growth. Cambridge: Cambridge University Press. David, P. A. (1985). Clio and the economics of QWERTY. American Economic Review, 75, 332–337. Desrochers, P. (2001). Geographical proximity and the transmission of tacit knowledge. Review of Austrian Economics, 14, 25–46. Hahn, F. H. (1984). Equilibrium and macroeconomics. Cambridge: MIT Press. Hayek, F. A. (1937). Economics and knowledge. Economica, 4, 33–54. Hayek, F. A. (1945). The use of knowledge in society. American Economic Review, 35(September), 519–530. Heilbroner, R. L. (1962). The making of economic society. New York: Prentice-Hall. Holcombe, R. G. (1998). Entrepreneurship and economic growth. Quarterly Journal of Austrian Economics, 1, 45–62. Holcombe, R. G. (1999). Equilibrium versus the invisible hand. Review of Austrian Economics, 12, 227–243. Holcombe, R. G. (2003). The origins of entrepreneurial opportunities. Review of Austrian Economics, 16, 25–43. Kaldor, N. (1972). The irrelevance of equilibrium economics. Economic Journal, 82, 1237–1255. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1979). Perception, opportunity, and profit: Studies in the theory of entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1985). Discovery and the capitalist process. Chicago: University of Chicago Press. Krugman, P. (1991). Increasing returns and economic geography. Journal of Political Economy, 99, 483–499. Lewin, P. (1997). Hayekian equilibrium and change. Journal of Economic Methodology, 4, 245– 266. Minniti, M. (1999). Entrepreneurship and economic growth. Global Business and Economic Review, 11, 31–42. Minniti, M., & Bygrave, W. (2000). The social dynamics of entrepreneurship. Entrepreneurship: Theory and Practice, 24, 25–36. Mises, L. von (1966). Human action (3rd rev. ed.). Chicago: Henry Regnery Company. Mokyr, J. (1990). The lever of riches. Oxford: Oxford University Press. Olson, M., Jr. (1996). Big bills left on the sidewalk: Why some nations are rich, others poor. Journal of Economic Perspectives, 10, 3–24. Richardson, G. B. (1975). Adam Smith on competition and increasing returns. In: A. S. Skinner & T. Wilson (Eds), Essays on Adam Smith (pp. 350–360). Oxford: Clarendon Press. Romer, P. M. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94, 1002– 1037. Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5, Part 2), S71–S102. Rothbard, M. N. (1962). Man, economy, and state. Los Angeles: Nash. Schumpeter, J. A. (1934). The theory of economic development. Cambridge: Harvard University Press. Smith, A. (1937) (orig. 1776). An inquiry into the nature and causes of the wealth of nations. New York: Random House, Modern Library. Solow, R. M. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70, 65–94.

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Stiglitz, J. E. (1987). The causes and consequences of the dependence of quality on price. Journal of Economic Literature, 25, 1–48. Young, A. (1928). Increasing returns and economic progress. Economic Journal, 38, 527–542. Young, A. (1993). Invention and bounded learning by doing. Journal of Political Economy, 101, 443–472.

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THE ENTREPRENEUR AT A CRUCIAL JUNCTURE IN SCHUMPETER’S WORK: SCHUMPETER’S 1928 HANDBOOK ENTRY ENTREPRENEUR夽 Markus C. Becker and Thorbjørn Knudsen ABSTRACT This essay introduces the first translation of Schumpeter’s article Entrepreneur, originally published in 1928. We describe the background of Entrepreneur and use new archival sources to situate the article in time. Entrepreneur marks a transition of Schumpeter’s conception of entrepreneurship that took place between 1911 and 1926. Entrepreneur also contains Schumpeter’s most profound vision on economic selection, a vision that Schumpeter never elaborated further. We consider the most important implications of the new material in Entrepreneur and the reasons for the apparent shift in Schumpeter’s thought.

夽 First published 1928 as Unternehmer in Handw¨ orterbuch der Staatswissenschchaften by G. Fischer Verlag. The English translation of the title “Unternehmer” is “Entrepreneur.” We use the English title throughout the text.

Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 199–233 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06012-5

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INTRODUCTION Schumpeter was one of the firs to succeed in assigning a role of prominence to the entrepreneur in economic theory, a role that associates the entrepreneur with a dynamic vision of an evolving economy (Baumol, 1968). Following Schumpeter’s lead, it is now commonplace to consider entrepreneurship when we are interested in understanding how the economy evolves over long periods of time, including a never-ending development of institutional arrangements and technological possibilities (Baumol, 1968). Over the last decades, the increasing speed of technological change, the complex interaction among an increasing number of economic agents, and the alleged importance of vision- and knowledge-driven competition have brought home the significanc of entrepreneurship. A number of important approaches that all view Schumpeter’s entrepreneur as their patron saint have emerged, including Nelson and Winter’s (1982) foundational work on evolutionary economics, the emerging theory of economic sociology (Swedberg, 2000) as well as numerous frameworks and theories emerging in the study of strategic management, business organisations, marketing and internationalisation, to mention a few. Even if Schumpeter’s theory of entrepreneurship has overwhelmingly influ enced the ascendance of entrepreneurship in the social sciences (Swedberg, 2000), most people refer exclusively to Schumpeter’s famous second chapter of the translated version (1934) of the Theory of Economic Development (hereafter abbreviated to Theory) that was based on the thoroughly revised second German edition of 1926. The reason is simply that this chapter presents Schumpeter’s most profound statements about entrepreneurship available so far to the English reader. Schumpeter’s essay Entrepreneur to be presented here in English translation for the firs time, presents additional rich material that significantl adds to the statements of the second chapter. Today, most people think of Schumpeterian entrepreneurship in terms of the function associated with the production of new combinations, innovations that alter the routine fl w of the economy and therefore introduce discontinuities. This view of entrepreneurship, however, represents a revision on Schumpeter’s part. From 1926 and onwards Schumpeter no longer viewed entrepreneurship as the personalisation of the almost superhuman powers of energetic will he had presented in the 1911 edition of Theory (Becker & Knudsen, 2002). After a radical revision of his earlier statements, Schumpeter now presented entrepreneurship as a depersonalised1 function that was present only at the particular occasion when some person was engaged in innovative activities. This revised conception of entrepreneurship as a depersonalised function was firs published in the 2nd revised edition of Theory and in the essay Entrepreneur.

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Since Schumpeter remained faithful to his altered conception of entrepreneurship throughout the writings produced in 1926 and onwards, the English speaking reader has not been able to witness the transition of Schumpeter’s entrepreneur.2 The English translation of Entrepreneur presented here thus provides a unique perspective on the birth of the depersonalised Schumpeterian entrepreneur known to the English reader. A glimpse of the earlier entrepreneur can be seen in the translation of Theory 1911 (Becker & Knudsen, 2002). In the following, we will briefl describe the background of Entrepreneur in terms of the context of Schumpeter’s private and intellectual life and use previously unknown correspondence from Schumpeter’s hand to situate the article in time. We further identify the dramatic transition of Schumpeter’s conception of entrepreneurship that took place between 1911 and 1926, single out the most important implications of these changes, and finall , leave the reader with some thoughts of the possible reasons for these changes.

THE BACKGROUND OF ENTREPRENEUR3 In mid-November 1925 Joseph Schumpeter arrived at the University of Bonn, Germany, to take up a chair in Public Finance. Entering the University of Bonn marked his “rebirth” as a scholar after a seven-year period in which he was engaged in politics and business.4 While Schumpeter continued to write and publish during these ventures, he wrote no serious academic articles, and nothing of significanc for his intellectual life came from his practical experiences. Schumpeter later referred to this period as his “gran rifiuto ” or great waste,5 not only because of his failures both as a politician and a businessman, but also because he had lost time6 in research. On top of this, Schumpeter had almost “sacrifice his career in economics, having done almost no serious writing since 1917” (Allen, 1991, p. 189). When Schumpeter entered into his duties in Bonn, he was an extremely happy man, and people who knew Schumpeter at the time describe his mood as buoyant at the end of 1925 and in early 1926.7 No wonder, as Schumpeter had just married his great love, Annie Reisinger, on 5 November 1925,8 and looked forward to plunge into what he did best, namely research, teaching and university life. With a newfound optimism he now turned back to revitalising the personal research program he had outlined before he left academia. Where did Schumpeter pick up the threads that he had left seven years ago? Which topics did he concentrate on in his second academic life? How did he further develop the core ideas of his early years? Swedberg (1991a) reports that three scientifi topics especially fascinated Schumpeter during his time at the University of Bonn (1925–1932): the theory of

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money, the theory of economic change, and the general structure of a broad-based economic science, or Sozial¨okonomik.9 While Schumpeter successfully continued to pursue his earlier writings in economic sociology during the late 1920s and published a sociological essay that he would consider later as one of the two articles deserving to be included in “his most important works,”10 the work on money did not go well. Even if Schumpeter worked furiously to develop his ideas on the theory of money and continued to work on this topic also in his later years, nothing ever came of it.11 With regard to economic change, Schumpeter was interested in the business cycle and changes in the economic system per se,12 but he also pursued a more narrow focus as he set his mind on a particularly important aspect of economic development: the entrepreneur. His teaching and administrative duties apart, Schumpeter had to establish his standing within the community of German economists, all belonging to the dominant German Historical School. This may explain why Schumpeter immediately in one of his firs articles (Schumpeter, 1926b) addressed topics that were important to the German Historical School and further chose to side with Schmoller, one of its most powerful members. Also in Entrepreneur, written soon after Schumpeter arrived in Bonn, it is apparent that Schumpeter, although critical, sides with Schmoller against Sombart and also cautiously against Weber.13 Another early endeavour in his new position was the revision of Theory, which had been out of print for some years.14 This revision still kept him busy at the end of May 1926 and was a nuisance to Schumpeter for reasons that we can only speculate about.15 A matter of fact remains that Schumpeter signed the foreword to the second edition of Theory in October 1926. In parallel to the revision of Theory, Schumpeter had begun to focus more narrowly on entrepreneurship, a line of research he would continue to pursue during the late 1920s. He himself stated, on 22 May 1929, that he had lectured on the topic of the entrepreneur repeatedly over the preceding two years (Schumpeter, 1929b, p. 195). We further know that on 31 March 1927, Schumpeter held a lecture on the topic, The entrepreneurial function and workers’ interests (Unternehmerfunktion und Arbeiterinteresse) and gave a number of lectures on entrepreneurship in Germany during 1927 until he left for a research stay in the USA at the end of September 1927.16 In any case, the overall picture is clear: Schumpeter revised Theory, which covers many aspects of economic development, and also turned his attention to a very detailed examination of entrepreneurship, elaborating on what he had said on this topic in Theory. Schumpeter’s renewed focus on entrepreneurship produced a string of four pieces that were published in the years 1927–1929.17 Of these four, Entrepreneur, the handbook article, stands out as the most “high-profile one. And Entrepreneur is not only outstanding among these four articles. In all of Schumpeter’s writing it is only in the second chapter

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of Theory one find a treatment of entrepreneurship that parallels the scope and detail of the material contained in Entrepreneur.18 When one compares Schumpeter’s description of the entrepreneur in the late 1920s,19 i.e. the above-mentioned four articles plus the revised 2nd edition of Theory, to his earlier conception of the entrepreneur before 1918 (notably, as expressed in the 1st edition of Theory), it is evident that he had changed his mind. Schumpeter’s conception of the entrepreneur was “in transit,” and the major change took place during Schumpeter’s firs year in Bonn. Because it was the firs work on entrepreneurship Schumpeter finishe in Bonn, Entrepreneur deserves special attention since it is the single piece that best carves Schumpeter’s re-conceptualisation of the entrepreneur at its joints. Not only had Schumpeter’s entrepreneur undergone a major transition during his firs year in Bonn, he also experienced a triple blow of fate that dramatically ended his happiness and forever altered his personality. The firs blow was the death of his mother, 22 June 1926. Schumpeter had always been greatly attached to his mother, and her death left him devastated. The shock of his mother’s death also influence Schumpeter’s relation to his now pregnant wife, Annie, and a controversy broke out over a letter from his firs wife (whom he never divorced) threatening to take legal action because of bigamy. Then came the second blow as Annie, nearing the full term of her pregnancy, suddenly died in childbirth on 3 August 1926 at the age of twenty-three. Also the child died within hours, and Schumpeter turned from a man of immense vitality into a mentally and emotionally broken man. One way in which Schumpeter reacted to his grief was by burying himself in work, and one of the firs tasks he worked on must have been the completion of the revision of Theory. Another was the finishin of the article Entrepreneur.

THE WRITING OF ENTREPRENEUR Entrepreneur was published in 1928. However, it has not been known that Schumpeter wrote it some time before 1928 – namely in 1926. We have been able to retrieve Schumpeter’s correspondence with the publisher, G. Fischer in Jena, which allows a very precise dating of the origin of this article. The dating is important, because in the small cluster of articles on entrepreneurship that Schumpeter wrote in the years 1926–1929, the sequence of events obviously matters for reconstructing how the entrepreneur evolved in that critical period when Schumpeter put his mind to this topic a second time.20 The correspondence shows that Schumpeter submitted the fina version of Entrepreneur to the publisher on 7 September 1926. This date makes clear that the article was written extremely close in time to the revision of Theory (the preface

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to which Schumpeter signed in October 1926) – maybe Schumpeter even wrote them, or at least put the finishin touches, in parallel. The date is further significan for the reason that it shows Schumpeter finishe the work on Entrepreneur during the most difficul moments of his life. Pushed for the deadline, Schumpeter intended to deliver the article in the week following 1 August 1926 – that is, the very week his wife and child died. He then finishe the article during the fi e weeks following their death. According to himself and people close to him at the time, Schumpeter was left in a state of boundless despair and depression (Allen, 1991). This state of mind is also clearly present in Schumpeter’s correspondence with the publisher of Entrepreneur. While it is conceivable that his belief in the strong leader (as of Theory 1911) must have already been shattered by his failures as minister and bank president (Becker & Knudsen, 2002), this last blow of fate might very well also have left its mark on Entrepreneur in particular, and subsequently on the Schumpeterian entrepreneur in general. Therefore, we think it is likely that the disappointments and personal tragedies had a cumulative effect on Schumpeter’s previous conceptualisation of the strong leader as a personalised aspect of human nature. To appreciate the precariousness of the moment when the article was finished we have reproduced excerpts of the correspondence below. In a letter dated 28 July 1926, the publisher asks Schumpeter to deliver his essay Entrepreneur by 1 August 1926. The tone of the letter is insisting, and the publisher emphasizes it is urgent that Schumpeter delivers by 1 August since his article alone is delaying the further processing of the encyclopaedia. Several delays had already occurred (most likely in connection with the death of his mother, on 22 June 1926), and the publisher seems to have run out of patience. Four days later, on 1 August 1926, Schumpeter responds that he will not schedule any other work, use every free hour to work on Entrepreneur and submit within a week’s time. He also indicates that the article is finishe already, and that “if needs be, I will leave the article as it is” (Letter to G. Fischer Verlag, 1 August 1926). Two days later, his wife and the newborn child die in childbirth. One week after that tragic day, on 10 August 1926, Schumpeter writes a postcard to the publisher, which we quote in full:21 Unfortunately I have to inform you that due to a bereavement that occurred on the 3rd of the month, and which momentarily shut down my capacity to work, it was not possible for me to submit the article “Unternehmer.” I will neither do anything else, nor leave Bonn, before I have finishe it, but I firs have to see about my state of mind before I can give you a definit date. I hope to be in a condition to start in some days, however, and to then be able to finis the article within another week’s time (Letter to G. Fischer Verlag, 10 August 1926).

The publisher replies the next day with condolences, but is quick to emphasize his gratefulness for keeping an eye on finishin the article (Letter by G. Fischer Verlag to Schumpeter, 11 August 1926).

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A reminder of 21 August 1926, much firme in the tone of voice, presses the message that Schumpeter is holding up the production process of the encyclopaedia. The next day, 23 August 1926, Schumpeter answers the publisher’s letter and the question when he will be ready to submit: I hope to be able to answer: one of these days. In any case, you will receive the article as soon as I can, and muster the necessary energy to work. I know how unpleasant this new delay is for you, and how embarrassing for myself; no reminder can be more impressive than what I feel about it. Should you wish to fin out more on the reason please ask Spiethoff. But, yes, I believe that it will be possible now (Letter to G. Fischer Verlag, 23 August 1926).

This day-by-day tracing of Schumpeter’s work on Entrepreneur allows us to draw the conclusion that he had something important to integrate or refin – after all, according to his own words, Schumpeter already had a finishe version at the end of July that he had considered to submit in case problems arose. If he had not done so in this kind of catastrophy, some important new idea must have been on his mind that he wanted to include in the article. He desperately struggled to make that happen – against his emotional wrestling with the bereavements and their aftermath, against the staunch reminders of the publisher and the fact that his article was holding up the production process of the whole volume, and against his inability to concentrate properly. If we take the two conclusions together, it is likely that he had come across something that he very much wanted to integrate into his notion of the entrepreneur, but that he probably did not succeed to integrate very well in Entrepreneur because of the limited time and his handicaps at that precarious point of time.22 And indeed, there is support for such an interpretation in the letter that accompanied the article when Schumpeter finall submitted it on 7 September 1926. He writes: Work on the art. has, however, been broken off prematurely and much material has not been considered. The execution, too, is lacking, and no one can regret that as much as I do, as I would have very much liked to put the various new vantage points on the topic, which I have to present, in more perfect terms. At any rate, the essential of what has to be stated in the HWB [Handw¨orterbuch] has been said – for the many defects in form I ask you and GHR [Geheimrat] Elster to excuse me (Letter to G. Fischer Verlag, 7 September 1926).

Here we have then, Schumpeter describing how he struggled with perfecting the expression of “the various new vantage points” that he had to report on the topic, which was the entrepreneur. Most commentators have noticed a radical shift in Schumpeter’s conception of entrepreneurship between the 1911 edition of Theory and the English translation of his early work. Yet this observation has never before been supported by Schumpeter’s own words. Three obvious questions arise at this point: What are the new “vantage points” on Schumpeter’s entrepreneur? What are the implications of these new “vantage points” for Schumpeter’s theory of entrepreneurship and economic development? What are the possible sources

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of the shift in Schumpeter’s thinking? The next section will deal with the firs question, and the following sections will turn to the second question. In these sections, we will further address the third question by briefl pointing out that the shift in Schumpeter’s thinking is best viewed in terms of his own description of innovation, as an instance of a new combination of a number of intellectual sources that had influence him.

SCHUMPETER’S NEW PERSPECTIVES ON ENTREPRENEURSHIP OUTLINED IN ENTREPRENEUR Since Schumpeter did not elaborate on the “various new vantage points” he had in mind, we are left with the inference that transpires from a comparative reading of Entrepreneur and Schumpeter’s earlier statements on entrepreneurship. We singled out the 1911 edition of Theory as the obvious source representing his early views on the entrepreneur and then traced the shifts in Schumpeter’s conception of entrepreneurship between this text and Entrepreneur. It is clear from these find ings, reported below, that the most profound change in Schumpeter’s conception of entrepreneurship is the depersonalisation of his earlier entrepreneur, the strong individual of almost superhuman powers of energetic will. This represents a radical revision of Schumpeter’s conceptualisation of entrepreneurship. Shifting focus away from the person of the entrepreneur, Schumpeter now talks of entrepreneurship as a completely depersonalised function that is not associated with any person in particular.23 That Entrepreneur is the work in which Schumpeter firs uses the expression “entrepreneurial function” is further significan as an indication that this article marks the shift in his reconceptualisation of entrepreneurship.24 It may come as a surprise, however, that Schumpeter, as reported in the following, chose to root his entrepreneurial function in a collective level situated in historical epochs. We now proceed to add the details harvested in our comparative reading. One of the most significan changes in Schumpeter’s conceptualisation of entrepreneurship is associated with a new perspective on his part, according to which social interaction cannot be viewed as an instance of causality. In the 1st edition of Theory, Schumpeter explicitly conceives of the entrepreneur as the main cause and hence the explanation of development, not only in the economic sphere, but also in politics, arts, and science (see Becker & Knudsen, 2002). While he would attempt to conceive social interaction and interdependencies as an instance of causality in 1911, Schumpeter had abandoned this approach in 1926 and would now insist

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that “we do not speak of cause and effect where there is an interdependency between two groups of facts.”25 Both in Entrepreneur and Theory of 1926, economic change is brought about by the entrepreneurial function whose essence lies in recognising and carrying out new possibilities in the economic sphere. Yet, Schumpeter now portrays the entrepreneur as “the middleman” between producers and consumers.26 Since the entrepreneurial function now operates in terms of social interaction, Schumpeter would mainly conceptualise this function as an instance of interdependence, but not causality (as he previously did in 1911), a viewpoint that is expressed in Entrepreneur as well as in Theory of 1926. And throughout his writings from 1926 and onwards, Schumpeter would consistently rely on his newfound conception of entrepreneurship as an instance of social interaction that generally evades conceptualisation in terms of cause and effect.27 Here it should be noted that Schumpeter’s distinction between causality and social interaction arises because of deep difficultie in conceiving social interaction in terms of causality, difficultie that continue to plague evolutionary explanations of economic change. The shift in Schumpeter’s thinking, from viewing entrepreneurship as an instance of causality to the much weaker idea of interdependence, is associated with the depersonalisation of the entrepreneurial function in terms of viewing the entrepreneur as “the middleman”28 between producers and consumers. Although the idea of the middleman function is implicit in Theory of 1911, it is in Entrepreneur that Schumpeter firs presents an explicit and detailed account of this idea. And, as two of the other articles from the years 1926 to 1929 show (Schumpeter, 1927, 1929a),29 this idea represents a systematic shift in Schumpeter’s conceptualisation of the entrepreneur. This view of the entrepreneur as “the middleman” is also associated with a significan downplay of the almost superhuman powers of leadership that were imputed to the entrepreneur in 1911. For example, Schumpeter had explained in 1911 that the entrepreneur is characterised by “the disposition to act” in terms of “the ability to subjugate others and to utilize them for his purposes, to order and to prevail, which leads to successful deeds – even without particularly brilliant intelligence.”30 In the seventh chapter of Theory 1911, omitted in the revision of 1926, Schumpeter further explained that “inventions do arise when the entrepreneur needs them, and if the personality of the entrepreneur is not in place in order to make use of every new invention, the inventions will never turn into practice.”31 In Entrepreneur and in Theory of 1926, the entrepreneur had lost much of these previous characteristics, or rather entrepreneurship had become a function that personifie no one in particular, and anyone on some occasions. Starting with Entrepreneur and the firs revision of Theory, both submitted for publication in 1926, Schumpeter would forever abandon his previous views expressed in

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Theory of 1911 that economic relations emanated from two distinct types of human nature, the static type and the dynamic type (the entrepreneur). Thus, entrepreneurship had become a depersonalised function. Note here that Schumpeter retains the explanatory structure of Theory 1911. In Entrepreneur and his later works, entrepreneurship is still define in terms of particular economic relations among human actors, but these economic relations are no longer an expression of differences in types of human nature, as in the static and the dynamic type define in 1911. While only a select few could possibly personify Schumpeter’s early entrepreneur of 1911, anyone could, on some occasions, serve as the middleman of Entrepreneur or Theory of 1926. Nevertheless, Schumpeter retains that leadership is an integral aspect of entrepreneurship. This becomes clear in Entrepreneur when he makes the distinction between leadership, management, and administrative functions. In Entrepreneur, Schumpeter explains that entrepreneurship is associated with the will to dominate or win, a somewhat weaker characterisation of leadership than expressed in his earlier statements in 1911. Schumpeter further asserts that it is the exception for a leader to actually engage in leadership. Most of the time the leader would be occupied by administration and maintaining the daily routine of business. Only on rare occasions would he be engaged in what Schumpeter refers to as the essential function of leadership, the carrying out of new combinations. Leadership and the carrying out of new combinations are inextricably intertwined for Schumpeter. Keeping this in mind, we can explain how his new notion of entrepreneurship – with a somewhat weaker leadership component – is consistent with his earlier notion. What has happened is that in Entrepreneur Schumpeter has shifted emphasis from the leadership aspect to the combinations aspect. The important implication for the conceptualisation of the entrepreneur is that while in Theory of 1911 there was a strong contrast between new combinations (instances of entrepreneurship) and the recurrent use of old combinations (the circular fl w), these two cases now become part of one continuum. As pointed out in the following, this move is nicely related to Schumpeter’s abandoning of the contrast between the dynamic type who was capable of carrying out new combinations and the static type who was not. Rather, the entrepreneur becomes a middleman that, on some occasions, may introduce new combinations provided he is capable of leadership and the circumstances are favourable. Thus, a further move associated with the depersonalisation of the entrepreneurial function is Schumpeter’s downplay of psychological factors as an explanation for the behaviour of the entrepreneur. In 1911, Schumpeter explained that the possible new combinations existed in the psyche of a small group of economic subjects and characterised “the act and the energy to act” in terms of a particular “mental

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constitution.”32 In 1911, Schumpeter viewed entrepreneurship as an expression of a rare dynamic type of human nature, a particular gift bestowed upon a select few individuals. Whereas Schumpeter retained the idea of entrepreneurship as a personal attribute (as can be seen from footnote 20 in Theory of 1926, pp. 119–121), in Entrepreneur he lets go of the idea that differences in economic relations spring from two distinct types of human nature. In Entrepreneur, there is no longer a pure type of entrepreneurship (as in 1911), now there are shades of entrepreneurship. This conceptualisation is crucial in enabling Schumpeter to usher the dichotomy between the “static-hedonic” and the “energetic” types of Theory 1911 into a continuum: anyone can be an entrepreneur at some occasion – but no one will be so all the time. Thus, one of the most important changes in Schumpeter’s previous theoretical construction of Theory (1911) is that he abandoned the typological thinking according to which economic relations emanated from two distinct types of human nature, the static and the dynamic type. It is likely that Schumpeter’s previous typological view was inspired by the thinking of some members of the German Historical School, e.g. Friedrich von Wieser and Karl B¨ucher,33 according to which economic ordering was an expression of types of human nature.34 Thus, Schumpeter’s new depersonalised view of the entrepreneurial function marks a break with the typological thinking of the Historical School. The significanc of this break is to associate entrepreneurship with the indeterminate emergence of economic relations rather than the pre-determined appearance of particular relations as an expression of either the static or the dynamic type. In Entrepreneur and Theory of 1926, Schumpeter thus had abandoned the idea of entrepreneurship as a particular gift bestowed upon a select few individuals, and now evaded individual-level psychological explanations of entrepreneurial behaviour. It is somewhat surprising to notice, however, that Schumpeter refers to social-level mentalities in Entrepreneur. In Entrepreneur Schumpeter introduces the concept of “mentality” as an aspect of private ownership. He explains that private ownership is associated with physical means of production and is “a correlate of the existence of a mentality prone to economic activity, whose most important derivates are an experimentally developed technique of production, a mode of economic calculation geared towards being useful for private enterprising, and a corresponding design of trade law and economic policy.” Later in the text Schumpeter expands on this point in describing how “public administration” and “the competitive economy” would lead to the development of a mentality that detaches the economic agent from emotional and interest-led relations to individual enterprises, changes the motivation, deprives work of its personal character, introduces professionalization and reduces private ownership of production factors to majority ownership. That is, in Entrepreneur “mentality” is a social level concept situated

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in a particular historical situation, and the “mentalities” associated with “public administration” and “the competitive economy” lead to a process that it is common to characterize as “rationalisation.” When we consider Schumpeter’s use of the term mentality in Entrepreneur it is difficul not to think of Max Weber. Yet it is curious that Schumpeter refrains from using the term “rationalisation.” After all, in his essay, The Sociology of Imperialisms, published 1918–1919, Schumpeter had described how competitive capitalism “inevitably democratised, individualised, and rationalised”35 the economic agent. The quoted passage from Imperialisms is one of the few places in his earlier works that Schumpeter provides a reference when he writes about rationalisation.36 The reference, however, is to an article by Lederer,37 not to Weber’s work. Therefore, to draw the immediate conclusion that Schumpeter was merely influence by, or perhaps even was copying Weber is probably unfounded. By writing about the rationalizing effect of competitive capitalism, Schumpeter rather attempted to develop his own views on a topic that had been widely discussed owing to Weber’s work, and because of now long-forgotten contributors to this debate.38 This is not said to belittle Weber’s stature, but merely a caution against drawing too hasty conclusions. And when we consider that Schumpeter in Entrepreneur argued that certain “mentalities” associated with competitive capitalism had a rationalizing effect, the emphasis is shifted so that it is Marx rather than Weber that comes to mind. Whatever its source, it is clear that Schumpeter in Entrepreneur associated entrepreneurship with the social-level concept of “mentalities,” whereas he earlier had emphasised individual-level psychological factors to explain the behaviour of the entrepreneur. It is further the case that this move from an individual- to a social-level explanation for entrepreneurial behaviour is associated with the depersonalisation, or de-personification of entrepreneurship. It is not the point that Schumpeter generally shifted his emphasis from the individual to the social level, however. Such a conclusion is unwarranted. But his re-conceptualisation of the entrepreneurial function clearly led to a shift in this particular unit of analysis, from the individual to the social level. In Entrepreneur, Schumpeter went a step further when he argued that besides a few questions belonging to theoretical economics, “it is advisable at all times . . . to interpret the action of the group as primary and essential, and to understand the autonomy of the economic unit as a derivate that has to be explained in each particular instance.” Even if Schumpeter maintained that the private economic subject was the carrier of the entrepreneurial function, he also insisted that leadership, the most important aspect of this function, “is never purely embodied in concrete persons.” Thus, Entrepreneur presents Schumpeter’s depersonalised entrepreneurial function as representing an underlying collective level, which is expressed through the actual behaviour of the economic units. Moreover, it is clear that Schumpeter views the

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underlying collective level as situated in historical epochs encompassing long periods of time. Theory of 1926 conveys a similar but somewhat downplayed view. Since Schumpeter must have finishe revising Theory immediately after he had submitted Entrepreneur, it is conceivable that he chose to modify some of the statements of Entrepreneur. As we have emphasised, the important new contribution was the introduction of the entrepreneurial function – or rather, a new way to conceptualise this function and thereby highlight what in Schumpeter’s opinion was the essence of entrepreneurship. In Entrepreneur, the function of entrepreneurship consists of two aspects that are closely connected. First, Schumpeter distilled the essence of his earlier conceptualisation of entrepreneurship in stating that “[t]he basic function of the entrepreneur is to combine the production factors into the product.”39 This firml places the entrepreneur at the very centre of the collective production process. Note also that this definitio of entrepreneurship, in contrast to the previous conceptualisation as it appeared in Theory (1911), does not rely on psychology and is firml set in economics. It is the entrepreneur who purchases the production factors, combines them into a product, and sells them to the consumers. The conclusion Schumpeter draws of this conceptualisation is to defin the essence of the market economy in terms of the combining function performed by a “private economic subject,” i.e. an independent economic unit. A further analysis of how the combination-process actually takes place leads Schumpeter to characterise the entrepreneur as a “middleman”40 between the consumers and the owners of the means of production (and productive services).41 The entrepreneur acts as the buyer on the market of means of production and as the supplier on the market for consumption goods. In this sense, he is at the very core of the market-economy, and to Schumpeter the entrepreneur is indeed the definin criterion of the market-economy. A number of important implications that follow from Schumpeter’s depersonalised conception of entrepreneurship, to be considered in the next section, are then further developed in Entrepreneur.

IMPLICATIONS OF SCHUMPETER’S DEPERSONALISED CONCEPTION OF ENTREPRENEURSHIP Immediately after definin entrepreneurship in terms of the function of the middleman, Schumpeter emphasises that this function of mediation between producers and consumers is an “extraordinarily important aspect for the theory of the market economy.” The reason is that Schumpeter define “the essence of the market-economy” as the fulfilmen of the entrepreneurial function by a private economic subject, i.e. any independent economic unit, including the individual.

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In the market-economy, the middleman serves the crucial function of connecting the independent economic units, whereas the central agency would take care of this function in a planned economy. Much later in the text Schumpeter alludes to various forms of economic leadership, of which he only describes one in detail: the market-economic form of economic leadership. He says that the market-economic form of economic leadership is the entrepreneurial function. And, as we already know, the essence of the entrepreneurial function is “to combine the production factors into the product.” But what makes this function the market-economic form of leadership? What distinguishes it from other types of economic leadership? According to Schumpeter, one characteristic of the market-economy is “the way in which the leader, who in such an organisational form does not have any authority, acquires the necessary means of production – namely, by purchasing them on the market for means of production”42 (emphasis in original). In a planned economy he would acquire them by order. What we see here is how Schumpeter has fitte the entrepreneur neatly to the very heart of the economy, but also to the very heart of a specifi historical period, namely the period of the market economic system. At the same time, he has done so in a way that yields a typology of entrepreneurial functions, with clear characteristics definin each type. It is of interest to note that we have only mentioned one characteristic so far. Schumpeter names three characteristics that distinguish types of economic leadership: there are also the focus of self-interest, and the mode of selection of leaders. With regard to the firs point, Schumpeter notes (elsewhere in the text) that the self-interest of the leader does not have to be related to profit Schumpeter does not elaborate on the second point in Entrepreneur, but develops this idea in two other works of his second period, Unternehmerfunktion und Arbeiterinteresse (Schumpeter, 1927) and Der Unternehmer in der Volkswirtschaft von heute (Schumpeter, 1929a). One important implication of changing his earlier conception of entrepreneurship to a depersonalised function is, as we have seen, that Schumpeter is able to centre the entrepreneur at the heart of the economy and make entrepreneurship the definin criterion of the market-economy. This conceptualisation also opens the possibility that entrepreneurship may eventually lead to the demise of the market-economy, a point Schumpeter briefl considers at the end of Entrepreneur and further develops in his later works.43 A further implication is that the conceptualisation of entrepreneurship as a depersonalised function allows Schumpeter to both capture the case of the static and the dynamic economy or, in other words, to formulate the entrepreneurial function in such a way that it fit both cases. The elegant way in which he does this is precisely to afford the entrepreneur the central place in between the owners of means of production and consumers and by emphasizing the financia fl ws and the fl ws of productive services between them, which may be depicted graphically as a circle. What matters here is that the entrepreneur is always involved. He

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literally is at the heart of the collective production process. Now, is this true both for the static and the dynamic case? In order to fin out, we have to answer the question: What is the difference between the static and the dynamic economy? In the present text, Schumpeter characterises the static case as follows: a “static” economy is an economy that is in a balanced state of equilibrium, repeating its life cycle year in, year out. This means that every economic period is similar to the previous one, an incessant repetition with two aspects: on a macro-level the continuous circular fl w of production and consumption recreates the same objective situation; on a micro-level, it means that the economic subjects always approach the economic possibilities with the same mentality, knowledge and experience, openness of horizon, production methods, business habits, tastes, and relations to customers, suppliers, and competitors; “[a]s a rule, under the pressure of the necessities of everyday life, the economic subjects have to approach the opportunities in this way.” In other words, everything remains the same. “The mass of economic activities each move in well-trodden and familiar tracks.” This explains the smooth, almost automatic, course of the normal economic period. Schumpeter’s formulations are very clear: “As if it were happening by itself . . . the means of production offers itself to the producer, the desired consumer good to the consumer” – the entrepreneur, although still at his place in the circular fl w, becomes invisible, insubstantial. There is very little left to do for him, and the little that remains is more in the character of administrative and management tasks than carrying out new combinations. Although the entrepreneur as an economic actor is still in place, in a static economy, he does not have any entrepreneurial functions to carry out but will busy himself with administrative and managerial functions. Yet, since the entrepreneurial function remains in place, even in the static economy, this also carries the potential that some day the circumstances will inspire the economic subjects to carry out new combinations, and thereby induce change in the economic system. Whether this happens depends on the motivations that drive the economic subjects, which in turn depends on the underlying collective mentality associated with specifi historical periods. In the following section, this lead further invites consideration of “mentalities” as one of the key elements in the much-strengthened conception of selection that Entrepreneur presented vis-`a-vis his earlier writings.

THE STRENGTHENING OF SCHUMPETER’S ECONOMIC SELECTION THEORY A further implication relates to a shift in Schumpeter’s emphasis on what we today refer to as the principles of selection and retention. Elsewhere (Becker & Knudsen, 2002), we have argued that Schumpeter in the 1911 edition of Theory

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define a principle of retention in terms of the actual new combinations that happen to be realized by the entrepreneur, who in 1911 was the decisive element in a causal chain explaining how a new combination is carried out. Compared to Entrepreneur, only a very rudimentary selection principle was outlined in Theory of 1911, whereas Schumpeter’s earlier concept of entrepreneurship represented a possible but unsatisfying retention principle (see Becker & Knudsen, 2002). The way in which the entrepreneur is situated in Entrepreneur and Theory of 1926 makes it easier to see how entrepreneurship is associated with a principle of selection, but at the same time it also becomes clear that the depersonalised entrepreneurial function can never serve as a retention mechanism. It seems that Schumpeter has traded retention for selection. That is, he assumes new combinations will somehow be retained, which allows him to focus on how the entrepreneur may both create and winnow new variation. The middleman function allocated to the entrepreneur in Theory of 1926 and Entrepreneur serves both purposes. By being at the very heart of the collective production process, being the “carrier of exchange acts, through which the economic process is realising itself,” every exchange act that so to speak makes the economic process live for another period, makes the economy breathe and move through another economic period, every single such act involves, or “goes through,” the entrepreneur. The entrepreneur is almost like a filte that decides which exchange acts to facilitate and which to block, for instance by demanding a too high price for a consumer-good. It is precisely because all exchange acts, or transactions, run “through” the entrepreneur, that he has such a strong influenc on the decision of which combinations may be carried out and thus “selected,” and which ones not. In order to carry out a new combination, however, the entrepreneur must further be able to assert leadership. That is, he must not only perceive the possibility, but also be able to carry it out. In 1911 this condition was fulfille by Schumpeter’s conceptualisation of the entrepreneur as an energetic and powerful leader. In Entrepreneur it is still the case that entrepreneurship is represented as a particular form of leadership in the economic sphere. It must be remembered, however, that Schumpeter in Entrepreneur explains that the periods in which the leader actually performs leadership make an exception. That is, the new depersonalised entrepreneurial function cannot be viewed as a description of a retention mechanism, but it may well serve as a principle of selection and as the source of new variation. How well this leadership-function is fulfille depends on individual competencies, and it is the competencies associated with practical initiative that counts (taking decisions and carrying them through), like strength of will and the ability to dominate and win. There is a subtle change in the character of the entrepreneur as a strong leader, however, that comes to the fore only when drawing on an analysis of the changes

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in Theory. When revising Theory in 1926, Schumpeter deletes a passage that reads: “The entrepreneur acquires productive services, thus withdraws them from their static uses, uses them without asking their proprietors, and thereby forces the economy into new channels.”44 The deletion of this passage is but one example of a number of changes between the 1911- and 1926-edition of Theory that systematically shifts emphasis from the “pushy” aspect of the entrepreneur’s acquisition of factors, to his role in combining the factors of production. This is in line with a clarificatio from Schumpeter’s hand that emphasises the role of the new depersonalised entrepreneur as a carrier of the mechanism of change, rather than the direct source of change. This passage, added by Schumpeter in the revised edition of Theory (1926) reads: “my description . . . is not at all about factors of change, but about the way in which these have an effect, about the mechanism of change. Here, the ‘entrepreneur’ is neither a factor of change, but the carrier of the mechanism of change.”45 As we have seen, Schumpeter’s new depersonalised principle of entrepreneurship, appearing simultaneously in Entrepreneur and Theory of 1926, not only placed the entrepreneurial function at the centre of the economy, it also opened the possibility of a strengthened conceptualisation of selection to complement the principle of variation he had earlier devised. But Schumpeter went further in the endeavour to strengthen his concept of selection. In the following section, we will point out that Entrepreneur and a few other articles written in the late 1920s, contain a selection principle that was completely absent in his earlier writings and went well beyond what he would write ever since. For some reason, Schumpeter’s conceptualisation of selection and adaptation, at this time, was particularly ripe, perhaps even foreshadowing some of the essential components of the selection model that would later be associated with neo-Darwinian theory.

SCHUMPETER’S VISION OF ECONOMIC SELECTION AND ADAPTATION In Entrepreneur and a few forgotten articles, all written during the late 1920s, Schumpeter presented his most profound vision of economic selection. Although Schumpeter never followed through on these themes they merit attention for a number of reasons. First, it is not widely known that Schumpeter developed a conceptualisation of economic selection at this level of detail, and the material has never been translated into English. Second, it is interesting to note that Schumpeter explicitly disavowed the Darwinism of his day (Schumpeter, 1926a, Chap. 2), but in Entrepreneur approaches a selection argument that bears remarkable resemblance with key elements of the neo-Darwinism that was not yet developed

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at the time. Third, in the light of the material contained in Entrepreneur, a number of the issues that were raised in recent debates whether Schumpeter’s theory is Darwinian or not (Hodgson, 1997; Kelm, 1997) must be revised. Fourth, even at the present day, conceptualisations of economic selection are unclear and need further development. Here Schumpeter’s considerations of selection mechanisms may illustrate important aspects of the difficultie that still need to be addressed in order to develop a unifying concept of economic selection. Fifth, at the time Entrepreneur was written, it was common to conceptualise economic and social evolution as proceeding through a number of distinct stages, a perspective that was closely associated with the German Historical School (Krabbe, 1996). It is remarkable that Schumpeter in Entrepreneur outlines a selection argument that goes well beyond this view. It is therefore important to highlight the ingenuity of the selection argument presented in Entrepreneur and to identify the possible sources of this argument. Putting aside the question of the possible sources for this rather surprising findin for a moment, we begin by briefl reiterating the material contained in Entrepreneur. Schumpeter introduces his argument by rejecting the theories of “economic stages” that were commonly used to conceptualise economic change. Schumpeter argues that previous attempts of situating economic entities in history on the basis of theories of stages are inadequate because they ignore “important similarities in essence” that transgress historical periods. For this reason, Schumpeter argues that any division of history into distinct periods is problematic. Schumpeter further implies that theories of economic stages ignore “the unfolding inner logic” of the invariant essence of particular forms of economic organisation. In particular, Schumpeter focuses on the emergence of the enterprise as a form of production and explains “the enterprise exists in all observable historical states . . . and in its economic essence it always manifests itself in the same way.”46 The “essence” Schumpeter speaks about is characterised as an invariant component of economic life that unfolds into the enterprising form of production. It is described as an “ideologically grounded mentality” situated in history, and Schumpeter further explains that once a mentality exists there are “cultural expressions fl wing from it.” Having emphasized the invariance of the essence of the enterprise, Schumpeter immediately adds, “[t]he enterprise changes so much in the course of history that the outer characteristics of the enterprise of our time, one after another, slip through our finger while we are observing it . . .” And emphasizing that he views the essence of the enterprise and its expressions as ontologically distinct, Schumpeter continues: “while the enterprise changes incessantly, there is no change at all in its underlying principles . . .” If one views Schumpeter’s conceptualisation through the lens of neo-Darwinism, the “essence” would be Schumpeter’s genotype and the actual manifest outer characteristics of the Enterprise would be the phenotype. It

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is clear, however, that it is not Darwin that inspired Schumpeter. The description of the essence of the enterprise as an ideologically grounded mentality rather points to Marx.47 Nonetheless, Schumpeter’s description of the relation between the economic core – the essence – and the unfolding of this core in terms of particular outer characteristics shaped by particular circumstances has some resemblance with the neo-Darwinian model. Even if Schumpeter views the modern enterprise as the unfolded expression of an ideologically rooted mentality, he further argues that the particular circumstances of the enterprise introduce a “determining pressure.” This pressure, in turn, leads to a profound variation in the outer characteristics of the enterprise, across time and across place, and for that reason, Schumpeter argues, the “economic essence” of the enterprise cannot exhaustively explain why the economic organisation of the enterprise changes through history. To uphold the similarity with the neo-Darwinian model, the determining pressure of social facts should, however, adjust the frequency of the particular “essence” of the enterprise within a set of “essences.” Note that we are not keen to enrol Schumpeter as a neo-Darwinian, merely pointing out where the analogy breaks down. Moreover, a blind spot in Schumpeter’s explanation is the source of further disanalogy. At no point in Entrepreneur does Schumpeter attempt to explain the evolution of the mentalities that constitute the essence of the enterprise, or any other distinct form of economic organisation for that matter. The whole point of the neo-Darwinian explanation would be to establish a causal relation between the change in the “outer characteristics” and the change in the distribution of “essences.” Because of this missing causal link, it appears we have merely established a weak analogy, but as pointed out in the following, Schumpeter provides a remarkable selection argument that much strengthens the analogy.48 In arguing why the private enterprise is superior to the public one, he argues that “the private industry is mainly directed by a circle of persons that still today, even when they have not personally gone through the school of the competitive struggle, hold on to its tradition and represents the result of its selection.” Note that Schumpeter in this passage describes the personal qualities of a particular group of people as the outcome of selection associated with the competitive struggle. And Schumpeter adds “[f]or this reason, the one-man-enterprise of the competitive era is a unique method to provide a complete freedom of choice, and at the same time, the strongest assurance against a lack of a sense of responsibility.” Remarkably Schumpeter hints at the missing causal link. And in the next sentence, Schumpeter leaves no doubt that he is explaining some aspect of the essence of the enterprise as a result of selection: “much of the principles of the competitive struggle are still preserved in the modern large enterprise, while the leading man of the public enterprise is paralysed.” So it seems that Schumpeter was after all trying to develop

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a conception of selection that can be reconstructed to bear resemblance with the neo-Darwinian model. This becomes even clearer in the following passage, “[t]he competitive economy meant a complete, and incessantly revived, reorganisation of the productive organism towards what is appropriate for the private enterprise – and in many cases also socially – by the method of competitive ejection of those that were neither adapted from the private enterprise perspective – nor in many cases adapted from a social perspective.” The term “adapted” is not a coincidence. In the preceding passages Schumpeter provided a detailed account of the adaptations that followed in the wake of the emerging private enterprise. At this point we will leave further scrutiny of Schumpeter’s conception of selection to the reader. It is remarkable, however, that apart from a few other articles written within a few years after Entrepreneur, Schumpeter never further developed these thoughts.49 Perhaps, Schumpeter’s reluctance in submitting Entrepreneur was partly motivated by his difficult in developing the selection argument? We do not know if this is the case, but the selection argument is certainly a “new vantage point” compared to Schumpeter’s earlier writing. Before concluding the essay, we will briefl consider the possible sources for Schumpeter’s passing conceptualisation of selection in terms of competitive ejection of the less adapted. Considering the alternative texts in economics and sociology available at the time when Schumpeter wrote Entrepreneur, there is one description of selection that stands out as a particularly likely source. This is a section in Max Weber’s Economy and Society50 titled “Conflict Competition, Selection” in which Weber provides a remarkable description of the contrasts and similarities between “social selection” and “biological selection.” Not only is it one of the clearest texts that existed on competitive selection in the social sciences when Schumpeter wrote Entrepreneur, it is also highly likely that Schumpeter had read it.51 After all, we know from Schumpeter’s obituary of Max Weber that Schumpeter was aware of Weber’s work on selection and adaptation: “His memorandum . . . on a survey dealing with adaptation and selection, the occupational choice, and the occupational fate of workers in large-scale industrial enterprises . . . opened up a comprehensive fiel of fruitful empirical research. However, Weber himself did no further work in this area.”52 This passage refers to an early essay on selection and adaptation that Weber published in 1908,53 and the last sentence sounds as if Schumpeter would have an interest in developing this line of work. Later, when Schumpeter wrote Entrepreneur it is therefore likely that he would also have studied the section on “Conflict Competition, Selection” in Economy and Society. In Economy and Society, Weber (1978, p. 38) provides a definitio of biological selection that is valid even by modern standards as well as a definitio of social selection that presents exactly the solution to Schumpeter’s problem that any kind of evolutionary explanation stemming from biology would be discredited.

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Having define selection, Weber points out that the correspondence between behaviour and personal qualities introduces a “differential advantage in selection for social success” that matters in social selection, but not in biological selection. In Entrepreneur, Schumpeter’s description of selection is very much in line with this thinking, probing whether the personal qualities of the leader matter for the success of his behaviour – and that of the enterprise led by him. And when Schumpeter argues that the personal qualities of a circle of persons directing the private industry are the result of the selection associated with the competitive struggle, there is a very close similarity to Weber’s thoughts. A further parallel between Entrepreneur and Weber’s section “Conflict Competition, Selection” is the remarkable combination of selection and adaptation forces. According to Weber (1978, p. 39), even if all competition were completely eliminated, “conditions would still lead to a latent process of selection, biological or social, which would favour the types best adapted to the conditions, whether their relevant qualities were mainly determined by heredity or by environment.” Recalling Schumpeter’s conceptualisation of selection in terms of competitive ejection of the less adapted, one is struck by the similarity. Returning to the requirement of neo-Darwinian theory, that selection must be define in terms of a causal relation between the change in the “outer characteristics” and the change in the distribution of “essences,” it appears that Schumpeter was indeed trying to achieve this in Entrepreneur.54 And as far as we know, Weber is the only source providing a comparable definitio of selection in the social sciences at the time Entrepreneur was written. Even though further similarities can be identifie between Weber and Schumpeter, such as the concept of “routine” that crept into Schumpeter’s writings during the 1920s, there are also crucial differences.55 The most important is perhaps that Schumpeter in his theory of social classes, which can be viewed as a selection theory, define the family as the elementary unit of social classes (see e.g. Stolper & Seidl, 1985, p. 170). It is clear that Schumpeter also in Entrepreneur retained this view that the family can be a unit of selection, which is a negation of Weber’s definitio of “social selection”: The struggle, often latent, which takes place between human individuals or social types, for advantages and for survival, but without a meaningful mutual orientation in terms of conflict will be called ‘selection.’ Insofar as it is a matter of the relative opportunities of individuals during their own lifetime, it is ‘social selection’; insofar as it concerns differential chances for the survival of hereditary characteristics, ‘biological selection.’ Weber (1978, p. 38), emphasis added.

Even if Schumpeter, as opposed to Weber, included social groups, such as the family, as the unit of selection, the argument here is that Schumpeter’s construction of the selection argument in Entrepreneur bears remarkable resemblance to Weber’s.56

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When considering the sources of Schumpeter’s selection argument presented in Entrepreneur, it also interesting to note why he would engage in this thinking at this point in time. A possible reason is that Schumpeter, as he arrived in Bonn in 1926, needed to position himself within the community of German economists. Since also Schmoller cautiously linked up with Darwin’s ideas on selection (Krabbe, 1996), Schumpeter’s views on selection may be viewed as a further instance of his siding with Schmoller against Sombart and Weber, as previously mentioned. Therefore, we should once more caution against drawing too hasty conclusions that Lederer, Marx, Weber, Sombart or any other single source can be seen as the main inspiration for Schumpeter’s work on entrepreneurship.57 As mentioned above, we are of the opinion that the shift in Schumpeter’s thinking is best viewed in terms of his own description of innovation, as an instance of a new combination of a number of intellectual sources that had influence him.

CONCLUSIONS Each scientifi discipline has a set of definin reference books, a small collection of timeless volumes that establish the rough contours of the intellectual landscape. Schumpeter’s most famous work in economics, Theory of Economic Development, is one of these select beacons of economics, or perhaps an economics yet to come. It got excellent reviews when it appeared in English in 1934, and it is widely recognised as the founding work, perhaps not of the current mainstream, but certainly of the literature on entrepreneurship and economic evolution. As Swedberg (2000, p. 12) notes, Schumpeter is the main figur in the literature on entrepreneurship, and we might add, the second chapter of Theory is the main text on entrepreneurship from Schumpeter’s hand. Theory was firs available for the English reader in 1934 about two years after Schumpeter had emigrated to the USA to take up the position at Harvard that would be his end-station. Yet again Schumpeter would embrace a new position, a new country, new colleagues and friends, and eventually, a new wife. But the optimism from his firs new beginning in Bonn would never return. Schumpeter’s personal tragedy in 1926 would forever leave a shadow on his personal life. In 1926 Schumpeter had finishe revising Theory just a few months after the tragic events that culminated with the death of his wife. And it is this edition that is known to the English reader. It is hard to believe that Schumpeter’s personal sense of despair and failure during the months he put the fina touches to Theory would not have interfered with his earlier conception of the strong, almost super-human entrepreneur presented in Theory 1911. Apart from the intellectual sources we have identifie as possible

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inspiration for the new depersonalised entrepreneur to appear in his writings after 1925, this conception of entrepreneurship must have made sense to Schumpeter also for personal reasons. Rather than viewing entrepreneurship as a personal virtue of the select few, the new depersonalised function of entrepreneurship that personifie no one in particular, and anyone on some occasions, seems much easier to reconcile with his personal experiences at the time he put the fina strokes to the revision of Theory. A few weeks before Schumpeter completed the revision of Theory, he would submit to the publisher on 7 September 1926 the fina revision of Entrepreneur. Since we now know that this was the firs work Schumpeter assumed after the tragic events in the summer of 1926, Entrepreneur marks the birth of the depersonalised entrepreneur that was presented in the revision of Theory finishe a few weeks later. For this reason, and because it is only in Theory we fin a treatment of entrepreneurship that is paralleled in scope and detail, Entrepreneur must be viewed as a companion article to the English translation of Theory. But it should now be clear that Entrepreneur also presents new material that is not found in Theory. In particular, it appears that Entrepreneur contains a profound vision on economic selection that Schumpeter developed in a few forgotten articles during the late 1920s, and then left for a future that never came. We have further mentioned that Schumpeter’s new depersonalised view of the entrepreneurial function retains the previous core idea, that economic development happens because of new combinations introduced by entrepreneurs, but discards the typological thinking of the German Historical School. Thus, Entrepreneur (and Theory of 1926) explains entrepreneurship in terms of the economic relations that appear through the middleman function, a particular instance of social interaction, provided the middleman is capable of leadership and the circumstances are favourable. Whereas entrepreneurship now comes in shades, the previous explanatory starting point in Schumpeter’s earlier writings on economic development was the stylised differences in two types of human nature. Since Schumpeter in Entrepreneur for the firs time explicitly centres on the economic relation between social actors as the explanatory starting point, this article must be viewed as a foundational work not only of economic theories of entrepreneurship, but also of the emerging theory of economic sociology (Swedberg, 2000). In order to introduce Entrepreneur we have chosen to situate this article within Schumpeter’s work on entrepreneurship as it developed through time. A further issue, however, deserves to be mentioned. Schumpeter has been associated with a theory of economic democratisation according to which he was worried about the negative effects of the spread of democratic practices into industry (Medearis, 2001), a theme he had begun to emphasize during the 1920s. As the reader will see, the last paragraph of Entrepreneur considers this theme. Here it is important

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to note that Schumpeter explains that incessant innovation drives a democratisation of entrepreneurship and leadership that tends to weaken these functions. Entrepreneur is therefore further important because it clearly denounces recent theories, according to which Schumpeter attributes the democratisation of industry to the influenc of democratic beliefs and ideology, and the radicalising, dynamic effects of social movements that attempt to realize democratic values and act on democratic ideologies (e.g. Medearis, 2001). Entrepreneur is therefore important, not only as an expression of Schumpeter’s views on entrepreneurship, but also as a foundational article of economic sociology and a clear expression of his views on democratisation. With the new translation of Entrepreneur, one of the two main works on entrepreneurship written by Schumpeter, the English reader can now access this material. And Entrepreneur is significant not only for historical reasons. Even if Entrepreneur has clearly been out-paced on a number of scores, it remains a rich source of inspiration that may help further the conceptual development of the recent literature on entrepreneurship.

A NOTE ON THE TRANSLATION When Erich Schneider and Arthur Spiethoff edited the German translation of Schumpeter’s biographical papers and his papers on the history of thought shortly after his death (Schneider & Spiethoff, 1954), they noted “we would have liked to augment their number, but the difficultie of translation are so great that we had to content ourselves” (Schneider & Spiethoff, 1954, p. v). We cannot but agree. Translating Schumpeter’s German to English is a difficul task as well. Furthermore, as explained in our article, Schumpeter himself was not content with the linguistic expression he had given to his ideas in Unternehmer. And indeed, in this piece we fin some of his most complex and dense language. At times, it is combined with very German sentence structures that are very hard to render in English. We therefore often had to revert to the measure of redesigning the sentence structures. Great care, however, has been taken at all times not to alter the meaning. In order to trace the root of our translations in the original, we have added a list of notes explaining the most important decisions.

NOTES 1. According to the American Heritage Dictionary, “depersonalise” has two related meanings: (1) to deprive of individual character or a sense of personal identity; or (2) to render impersonal. We use the term “depersonalise” in the firs sense to denote that

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Schumpeter’s concept of entrepreneurship became a function that was deprived of its previous character in terms of a particular type of human nature, namely the energetic or dynamic type. As explained in the following, the shift in Schumpeter’s thinking is evidenced in the appearance in Entrepreneur of the expression “entrepreneurial function,” which is here viewed as a depersonalised concept in the above sense. 2. Some commentators (e.g. Langlois, 1998) have claimed that there is no difference between the early Schumpeter and the later Schumpeter. When such claims are limited to a scrutiny of the previously available English translations of Schumpeter, they are problematic, however. According to our argument, based on textual evidence (see Becker & Knudsen, 2002), a number of significan changes can be traced in the writings of the early Schumpeter, before his return to academia in 1925, and the later Schumpeter of 1925 and onwards. Note here, that the firs English translation of Theory of Economic Development, published in 1934, was based on the 2nd German edition that Schumpeter thoroughly revised during 1926. 3. The material in this section is based on the standard secondary sources (Allen, 1991; Stolper, 1994; Swedberg, 1991a). 4. Schumpeter served as a member of the German Coal Socialisation Commission from January to March 1919, as the Austrian Secretary of State of Finance from 15 March 1919 to 17 October 1919, and as Chairman of the Board of the Biedermann Bank from 23 July 1921 to 11 Sept 1924 (Allen, 1991). The banking disaster also left him heavily indebted. 5. This description comes from Allen (1991). 6. In a letter to Wesley C. Mitchell dated 30 August 1926, Schumpeter looks back on his firs year in Bonn and notes that he was “feeling extremely happy” as he entered his duties at the university and was “trying to make up for lost time.” Letter reprinted in Hedtke and Swedberg (2000, pp. 126–127). 7. The characterisation “extremely happy” is Schumpeter’s own – in the letter to Mitchell, reprinted in Hedtke and Swedberg (2000, pp. 126–127). Regarding the report on Schumpeter’s mood, see Allen (1991). 8. The Schumpeters must have left for Bonn straight after their return from their two-week honeymoon in Italy (cf. Allen, 1991). 9. According to Allen (1991), Schumpeter also set to work on a textbook of economics. He never managed to complete this work, however. 10. According to Swedberg (1991a). The articles referred to are Social Classes in an Ethnically Homogenous Environment published in 1927 and The Sociology of Imperialisms published in 1918–1919. 11. Fritz Karl Mann eventually published an unfinishe version of Schumpeter’s planned book on money in 1970. 12. According to Swedberg (1991a), the most important work on this topic from the period is The Instability of Capitalism from 1928. 13. We are grateful to Ulrich Hedtke for this point. 14. Further, in 1926, Schumpeter published the article Gustav von Schmoller und die Probleme von heute (Schumpeter, 1926b), which may have been written before the revision of Theory of Economic Development (Schumpeter, 1926a). 15. See the letter to Gustav Stolper of 29 May 1926: “. . . weil ich die mir unertr¨agliche Arbeit an der 2. Auflag meiner leider vergriffenen ‘Theorie der wirtschaftlichen Entwicklung’ vor allem loswerden muss” (Swedberg & Hedtke, 2000, p. 113). 16. We are grateful to Ulrich Hedtke for this information. Unternehmerfunktion und Arbeiterinteresse (Schumpeter, 1927) is the published stenographic record of a lecture

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with the same title that Schumpeter gave at Verband Deutscher Arbeitgeber (Federation of German Employers) on 31 March 1927. 17. The four pieces on entrepreneurship by Schumpeter, written in the period 1927–1929, are: Unternehmerfunktion und Arbeiterinteresse (Entrepreneurial function and workers’ interests) of 1927, published in the employers’ federation magazine (Schumpeter, 1927); Unternehmer (Entrepreneur), the article in the 4th edition of the Handw¨orterbuch der Staatswissenschaften of 1928 (Schumpeter, 1928); Der Unternehmer in der Volkswirtschaft von heute (The entrepreneur in today’s economy) of 1929, published ¨ in an edited volume (Schumpeter, 1929a); and a speech on Okonomie und Psychologie des Unternehmers (Economics and psychology of the entrepreneur) given to the Federation of German Steel Industry, 22 May 1929 (Schumpeter, 1929b). 18. Schumpeter’s work on entrepreneurship also includes a few articles published in the late 1940s as well as some passages of Capitalism, Socialism and Democracy (1942), but none of these equal Entrepreneur or Theory in scope or detail. 19. Roughly speaking, from 1926 to 1929. 20. The firs time was his Theory of Economic Development of 1911. 21. Except for the greetings. 22. One could also speculate that Schumpeter must have come across whatever new point he had in mind only recently, as otherwise he might have integrated it earlier, in particular if he thought it very important. 23. The precise reasons for such a shift from an emphasis of the personified entrepreneur to the entrepreneurial function are not known. According to an anonymous reviewer, a possible reason is that the Walrasian system he trumpeted in his 1908 book was becoming more widely used within the profession. In response, Schumpeter may well have decided that an analysis that depended too much on individual characteristics made less sense. Or perhaps Schumpeter recognised the conflic between his 1908 and 1911 books (in terms of their conflictin emphasis on the individual or the social level) and this was an attempt to mend it? Above, we have mentioned a further reason, that Schumpeter because of his personal experience may have lost faith in the personifie entrepreneur. 24. The fact that the term “entrepreneurial function” shows up in a section heading supports the idea that it represents a shift in Schumpeter’s thinking. 25. Schumpeter (1926a, p. 97), our translation. 26. In few instances, the term “middleman” is also used in contemporary studies of entrepreneurship. Burt (1992, 1997) for instance has pointed out that networks rich in structural holes present opportunities for entrepreneurial behavior, and interprets the manager as “an entrepreneur in the literal sense of the word – a person who adds value by brokering the connection between others.” In this perspective, entrepreneurs are people skilled in building the interpersonal bridges that span structural holes (Burt, 1997, p. 342; see also Bonacich, 1973, for an analysis of the causes for the existence of middleman minorities). Note that Schumpeter’s notion of the entrepreneur as fulfillin the middleman function is quite different from this contemporary notion, as is explained below in the text. 27. For an example in Schumpeter’s later writings, see Comments on a Plan for the Study of Entrepreneurship (reprinted in Swedberg, 1991b). 28. Throughout the remainder of the present article, we are quoting passages from Entrepreneur. These unquoted passages are all excerpts from our translations of Entrepreneur. 29. These two articles were based on lectures held by Schumpeter. As mentioned in fn. 16, Unternehmerfunktion und Arbeiterinteresse (Schumpeter, 1927) was based on a talk

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Schumpeter gave at Verband Deutscher Arbeitgeber (Federation of German Employers) on 31 March 1927. Der Unternehmer in der Volkswirtschaft (Schumpeter, 1929a) appears to be the original version of a lecture with the same title that Schumpeter held at the Deutsche Vereinigung f¨ur Staastwissenschaftliche Fortbildung (German Association for Education in Political Economy) on 5 September 1927. It is important to note that although the latter article was published only in 1929, Schumpeter actually had completed it by September 1927. We are grateful to Ulrich Hedtke for supplying us with this information. 30. Schumpeter (1911, p. 165), our translation. 31. Schumpeter (1911, p. 479), our translation. 32. Schumpeter (1911, p. 165), our translation. 33. In 1914, Schumpeter published Epochen der Dogmen- und Methodengeschichte as a chapter in the firs volume of Grundriss der Sozial¨okonomik. This volume of Grundriss further contained a chapter by B¨ucher and von Wieser. 34. We thank Ulrich Hedtke for this insight. 35. Swedberg (1991b, p. 190). 36. In History of Economic Analysis, Schumpeter (1954) would later point to a number of sources for the idea of rationalisation. 37. Swedberg (1991b, n. 24, p. 217). Schumpeter and Emil Lederer both served on the German Socialisation Commission. Emil Lederer was a Marxist economist of high standing, but despite being ideological adversaries, Schumpeter and Lederer were on friendly terms (Stolper, 1994; Swedberg, 1991a). 38. Note also that Schumpeter (1954) in his own work traces the emergence of rationalism in social thought to numerous sources. 39. This function is also described in Schumpeter (1927, p. 166). 40. That aspect is also present in Schumpeter (1929a, p. 231). 41. Schumpeter is quick to point out that the two categories of “owners of means of production” and “consumers” in the end collapse into one, and the entrepreneur thus can be seen as a middleman between different groups of “suppliers of means of production,” i.e. workers, landowners and capitalists (p. 481). 42. With financia means provided by the capitalist. 43. This material in Entrepreneur can be associated with Schumpeter’s “transformative thesis” of democracy, as Medearis (2001) has termed it. 44. Theory of Economic Development (Schumpeter, 1911, p. 189); deleted in 2nd edition. 45. Theory of Economic Development (Schumpeter, 1926a, p. 93). 46. Note here that this quote, and Entrepreneur in general, clearly shows it is mistaken to argue that Schumpeter always shunned metaphysics. 47. Possible sources of Schumpeter’s use of the concept of collective level “mentalities” include Rudolf Hilferding, Karl Marx, Werner Sombart (one of the two in-text references in Entrepreneur), and Gabriel Tarde. Note, in passing, that the discussion whether Schumpeter knew Tarde’s work can be settled unambiguously with textual evidence we have not yet seen employed in this discussion: In Wesen, Schumpeter writes that he does not consider it useful to emphasize the analysis of human behaviour from the perspective of motivations as much as Tarde has done (Schumpeter, 1908, p. 79). While Schumpeter rarely mentions Tarde, he was evidently strongly influence by Marx’s writings (M¨arz, 1991; Swedberg, 1991). The conception of mentalities rooted in ideology that Schumpeter presents in Entrepreneur reads very much like Marx. This impression is supported by Schumpeter’s later assessment of Marx in History of Economic Analysis (e.g. Schumpeter, 1994 [1954], pp. 35–38). In a section of History, “The Marxian Exposition of Ideological Bias,” Schumpeter (1954,

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p. 36) agrees with Marx that “Social location undoubtedly is a powerful factor in shaping our minds” (emphasis in original), but immediately adds that “Marx and especially the majority of his followers assumed too readily that statements which display ideological influenc are ipso facto condemned thereby.” Schumpeter (1954) then goes on explaining that ideologies are rooted in specifi historical periods and will inevitably colour the mental schema of any person. Even the scientist’s vision would, according to Schumpeter (1954), be subject to ideological influence but due to empirical falsification the scientist’s model would gradually improve its validity or perhaps be rejected. According to M¨arz (1991, p. 15) the depersonalised entrepreneurial function goes back to Marx, and can be traced to Hilferding and Sombart. 48. Schumpeter’s conceptualisation of economic development as a process of unfolding a particular set of core features that is influence by the impression of the social circumstances at the time of founding was later re-invented by Hannan and Freeman (1989) as a conceptual basis for work on organisational ecology. Ironically, Hannan and Freeman (1989) would acknowledge the influenc of Darwin but not Schumpeter. 49. The selection argument is developed more fully in Schumpeter (1927) and Schumpeter (1929a), but the combination of selection and adaptation exists only in Schumpeter (1928). 50. Translated into English from Wirtschaft und Gesellschaft. 51. From 1916 to 1920, Schumpeter was co-editor of Archiv f¨ur Sozialwissenschaft und Sozialpolitik together with Max Weber, which would have involved some mutual awareness of their individual work. About the general relationship between Schumpeter and Weber, we know that Schumpeter got on well with Weber (Swedberg, 1991a), that their personal acquaintance “was much too limited” (Schumpeter, 1920, p. 221), and that Schumpeter had never heard Weber speak himself (Schumpeter, 1920, p. 226). We further know of two documented encounters between the two men, one in a Vienna coffeehouse, resulting in a quarrel on the Bolshevik revolution and Lenin (this encounter has been preserved by Somary; see Faucci and Rodezno, 1998; Perlman, 1994; Swedberg, 1991a). The second encounter featured Schumpeter arguing for the independence of economic science and the results of “a hundred-year toil by economists” in opposition to Weber, who argued that this should be sacrifice to further the course of unificatio of the social sciences (this encounter has been preserved by Tritsch, 1953; see Faucci & Rodezno, 1998). 52. Schumpeter (1920), reprinted in Swedberg (1991b, p. 225). 53. Weber’s early text firs published in 1908 is Methodologische Einleitung f¨ur Erhebungen des Vereins f¨ur Sozialpolitik u¨ ber Auslese und Anpassung (Berufswahlen und Berufsschicksal) der Arbeiterschaft der geschlossenen Grossindustrie (reprinted in Weber, 1988). Schumpeter (1954, p. 817) would later praise this work as an example of “the freshness and the originality” of Max Weber’s ideas. 54. In the light of the material contained in Entrepreneur (and other articles written by Schumpeter in the 1920s), a number of the issues raised in recent debate whether Schumpeter’s theory can be viewed as Darwinian or not (Hodgson, 1997; Kelm, 1997) must be revised. 55. Here, it is interesting to note that Schumpeter in Entrepreneur consistently used the term “routine” to describe the contrast of “innovation.” Also in Theory of 1926 Schumpeter makes generous use of the term “routine,” whereas this term is used in very few places in Theory of 1911. For some reason, Schumpeter started using the term “routine” in Entrepreneur and Theory and continued to do so in his later writings, but he did not consider routines in terms of a possible retention mechanism. Nelson and Winter

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(1982) would later propose that “routines” might be viewed as the component of a social mechanism of retention that is somewhat analogous to the gene. 56. It is no contradiction between the two conceptualisations that Weber define selection to take place within the lifetime of the individual, however. The effect of selection may well last much longer, as considered by Schumpeter. 57. Similarities between Weber and Schumpeter’s entrepreneur are commonly stated in the secondary literature (as are similarities in attitude as to the methodology and the idea of a broad-based economics, or Sozial¨okonomik; see MacDonald, 1965; Salsano, 1993; Shionoya, 1997; Swedberg, 1991a). Usually, however, the similarities between Weber and Schumpeter that are identifie are those between Weber’s type of “traditional capitalism” and Schumpeter’s circular fl w (MacDonald, 1965, pp. 375–376), their use (or rather, Schumpeter’s adoption) of ideal types – the entrepreneur and the circular fl w being the prime examples (Carlin, 1956; MacDonald, 1965), in the case of the 1st edition of Theorie also the hedonistic or “rational” motives which animate the “Kreislauf” (Faucci & Rodezno, 1998), and finall Weber’s charismatic leader and Schumpeter’s entrepreneur, both strong leaders that make others follow them (Swedberg, 2000). As Swedberg (2000) points out, the commonly received idea about this similarity might however be “largely mistaken” (Swedberg, 2000, p. 25). According to Swedberg, Weber makes a much more differentiated point about charisma, namely that charisma is much less important in capitalist than in pre-capitalist society. The reason is that in the former, economic change is driven mainly by enterprises. There are, however, similarities between Weber’s and Schumpeter’s entrepreneur that are less visible, for the reason that “what Weber says on entrepreneurship nearly always gets garbled, due to the complexity of his thought,” and it is also scattered throughout his work (Swedberg, 2000, p. 25). If one combs through Wirtschaft und Gesellschaft, however, more subtle parallels can be found. 58. The letters are in the Th¨uringisches Hauptstaatsarchiv Weimar (ThHstAW), Archiv Verlagshaus Gustav Fischer Jena, Korrespondenz 1926, Akte “Schu.” 59. English translation ours. We will be pleased to provide copies of the German originals on request. 60. A “∗” indicates a handwritten word very difficul to read. The text here renders our best guess, which, however, is still a guess. 61. Square brackets inserted by us.

ACKNOWLEDGMENTS The authors are grateful to Ulrich Hedtke, Roger Koppl, Richard Swedberg and two anonymous reviewers for helpful comments. The authors wish to thank Meta Andr´es for linguistic assistance with the translations of Entrepreneur, and Minna Skafte Jensen for assistance with a particularly contrary Latin expression in Entrepreneur. The authors would like to express thanks to Mr. J¨org Swidersky and Mr. Bernd Rolle of Urban and Fischer Verlag, and Mr. Marek of Th¨uringisches Hauptstaatsarchiv Weimar for helpful assistance in retrieving the correspondence between Schumpeter and the publisher of Entrepreneur. The authors and the

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publisher would like to thank Urban and Fischer Verlag for permission to print the translation of Unternehmer, and for permission to print the letters on Unternehmer that were written by Schumpeter and the publisher.

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APPENDIX The Correspondence Between Schumpeter and the Publisher of Entrepreneur (our translation)58 (1) F.Mo. 28 July 1926 Professor Dr. J. Schumpeter Bonn a. Rh. ——————University Dear Sir!59 As I come to know from Geheimrat Elster, you have, to Exzellenz von Wieser, announced the delivery of the article “Unternehmer” for the “Handw¨orterbuch der Staatswissenschaften” for 1 August of the present year. Because of the latter’s death I would like to ask you to send the manuscript to me. I will then present it to Geheimrat Elster before going to press. It is very important this deadline is not disrespected, however, because the succeeding entries have already been set for some time but printing plates can not be produced due to the lack of your entry. For this reason I most respectfully ask you to stick to the deadline and let me know on the attached postcard when I can expect the arrival of the manuscript for certain. Thank you very much in advance for fulfillin my request, with the very best regards your most humble servant (2) Bonn, Coblenzerstr. 39 1. VIII. 26 Dear Mr. Frohe,∗60 The manuscript of the article “Unternehmer” will be sent to you in the course of this week. I do not schedule any other work and will use every free hour to work on it. It is very embarrassing that disruptions arise again and again and I ask you to be convinced of the fact that I do push myself just as much as anyone could do. If needs be, I will leave the article as it is, so that you can expect it within a few days. With the very best regards, your humble servant Schumpeter (3) Bonn, 10.VIII.26 Dear,∗ Unfortunately I have to inform you that due to a bereavement that occurred on the 3rd of the month, and which momentarily shut down my capacity to

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work, it was not possible for me to submit the article “Unternehmer.” I will neither do anything else, nor leave Bonn, before I have finishe it, but I firs have to see about my state of mind before I can give you a definit date. I hope to be in a condition to start in some days, however, and to then be able to finis the article within another week’s time. Respectfully, Schumpeter (4) Jena, 11 August 1926 Professor Dr. J. Schumpeter, Bonn ———————————Dear Professor! I have just received your kind postcard of the 10th of the month. I regret very much that you have experienced a bereavement and understand that you have been obstructed by it in your work on the article “Unternehmer.” I am very grateful, however, if in the firs place you could keep an eye on the completion of this contribution and let me have the article, which indeed is needed very urgently, as soon as that is possible for you. With the expression of my very best respect I sign most humbly, F. J. (5) F. J. 21 August 1926 Professor Dr. J. Schumpeter, Bonn Coblenzerstrasse 39 Dear Professor! I very much hope that in the meantime you have been able to take up again the work on your small contribution “Unternehmer” for the Handw¨orterbuch der Staatswissenschaften. As you know, we have been waiting for it for a long time and cannot proceed with the making of the printing plates for volume eight. I therefore would be very grateful if you could finis the article, in particular because according to your informations it was already finishe by the end of July. In advance, I thank you very much for fulfillin this request and would like to ask you to let me know on the attached postcard when I can expect, this time with certainty, to receive the manuscript. With the very best regards, I am Your very humble servant (6) Dear Sir, I hope to be able to answer: one of these days. In any case, you will receive the article as soon as I can, and muster the necessary energy to work. I know how unpleasant this new delay is for you, and how embarrassing for myself;

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no reminder can be more impressive than how I feel it. Should you wish to fin out more on the reason, please ask Spiethoff. But, yes, I believe that it will be possible now. With the very best regards, your humble servant Schumpeter. (7) Prof. Dr. J. Schumpeter, Bonn, 7/9 1926, Coblenzerstr. 39 [printed letterhead]61 Dear Sir, Today, I finall submit the article Unternehmer. I once more ask you to apologize for the indeed inexcusable delay, which is all the more unpleasant as I always held You and Your fir in the highest esteem and do not like to be the source of incommodities in particular on Your part. Work on the art. has, however, been broken off prematurely and much material has not been considered. The execution, too, is lacking, and no one can regret that as much as I do, as I would have very much liked to put the various new vantage points on the topic, which I have to present, in more perfect terms. At any rate, the essential of what has to be stated in the HWB [Handw¨orterbuch] has been said – for the many defects in form I ask you and GHR [Geheimrat] Elster to excuse me. Please allow the following remarks that I ask you to kindly take note of: 1. From tomorrow onwards, I shall be absent from Bonn for 10–14 days, during which time I can best be reached at the address: Wien IX. Strudlhofstr. 17. 2. The late v. Wieser expressed the request that the references should cover also the topic entrepreneurial profit That has been done. Should the plan have been changed the reference list would have to be revised. 3. Should the article exceed the allocated space (16 colums), which I do not believe, however, pp. 8–16 (the historical overview) can be set in small print, however excluding the last paragraph on page 16, and in the extreme also the whole third section. With the very best regards, your humble servant Schumpeter (8) Jena, 9 September 1926 Professor Dr. J. Schumpeter, Wien —————————————– Dear Professor! Most gratefully, I have received Your kind letter of two days ago and the manuscript of Your article “Unternehmer.” I shall immediately have the

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printing plates produced and will send the corrections to Vienna within the next fourteen days. Regarding the references I will inform Geheimrat Elster. I hope the article will not exceed the allocated space of 16 columns. With the very best regards I sign most humbly Br. J.

ENTREPRENEUR Joseph A. Schumpeter translated by Markus C. Becker and Thorbjørn Knudsen ENTREPRENEUR 1. 2. 3. 4. 5.

The essence of the enterprise. Historical overview of its forms or types. Development of the scientifi analysis of the economic subject1 “entrepreneur.” The entrepreneurial function. Types of modern entrepreneurship. Particular questions.

1. THE ESSENCE OF THE ENTERPRISE. HISTORICAL OVERVIEW OF ITS FORMS OR TYPES The collective2 economic process is always a coherent phenomenon whose lines can be comprehended by the interlocking of its distinguishable elements. Not always, however, does the social whole – be it a modern nation or a “culturally poor” horde – run directly according to a comprehensive, conscious plan, carried out, for the whole, by the whole: Where this is the case – in a completely pure form, it would be in a socialist community – distinguishable tasks, facilities, etc. exist, even if the expression of economic life has not achieved any particular form.3 If, on the contrary, the social whole is leaving the responsibility for economic activity to subgroups or individuals, then the collective production process is separated into units that, seen from the outside, appear independent, autonomous, in principle left Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 235–265 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06013-7

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to themselves, and forthwith only oriented towards their own concern for survival – enterprises. But also in the latter case, that of a market economy, production is not “anarchistic.” Rather, the noted concern for survival is subject to the pressure of the given circumstances4 on the one hand, and highly limited behavioural options on the other. These highly limited behavioural options, expressed primarily in the facts of demand, force an interlocking and adjustment to the – in this sense only “seen from the outside” and “apparently” – independent units under the penalty of economic annihilation, so that also in this case a collective economic plan is automatically actualised, although not consciously devised as such, but only inferred by analysis. However, even despite important differences compared to the deliberate5 economic plan of an “exchange-less economy,”6 the two forms of plan are indeed analogous with respect to their essential economic principles and results. This insight, basically simple, but forgotten again and again, also reduces the importance of another contrast that we could have made our starting point here: the contrast between subsistence-economy and profit-makin 7 economy. Yet another type of constraint must be distinguished from the fundamental behavioural constraint of the apparently independent units, which is similar in nature to the constraints of a productive unit in a socialist collective, forced upon it by the orders of the central directorate. This additional constraint limits the “autonomy” of the units even further and makes them relative, similar to the way in which the concept of sovereignty is relative: First, the social whole never completely delegates the care of the collective economic process to the apparently independent units – not even when this would be part of the ideology of national politics, for example according to the spirit of the liberal principle – but always, only a limited domain is delegated that changes according to time, place, situation etc., and whose boundaries cannot be determined8 “notionally,” “generally,” or “factually.” Second, every epoch exhibits its characteristic constraints related to private enterprising,9 of which the following are particularly important today: surviving guild-like cooperation and new forms of cooperative exchange; activities of interest groups that extend beyond the sphere of lobbying for economic policy interests; agreements and cartels within industries; the domination of individual units by a central power (“trustification” or by other individuals (external shareholders’ acquisition of units that remain formally independent – one way of building a concern); the banking world influ encing the units finance by it, which can lead from mere acting in the interests of the creditor to de facto management – another way of building a concern; finall , power positions in the area of buyer- and supplier-relationships (e.g. the breweries’ domination of pubs). From the perspective of economic freedom, these phenomena run counter to the norm. They are in fact of such importance that, besides a narrow circle of questions belonging to theoretical economics, it is advisable at all

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times, even for “liberal epochs,” to interpret the action of the group as the primary and essential, and to understand the autonomy of the economic unit as a derivate that has to be explained in each particular instance. In scientifi parlance, however, such apparently independent units are usually and preferably only then called “entreprises” (while the French term “entreprise” is equivalent, there is, apart from the use of this term, particularly in America, no good English term for it – “business” might come closest), if they are exclusively oriented towards market opportunities and capital accounting (M. Weber), and are bearers of business processes differing from those of the private economic subject (Sombart). According to this usage the notion of enterprise coincides with a particularly sharp expression of its content, the “capitalist” enterprise, which, however, neither conceptually nor historically, can be distinguished from other expressions of the same basic phenomenon by purely economic characteristics, unless one considers financin by bank-credit to be showing important economic particularities that are characteristic of the capitalist enterprise, and of the capitalist economic system in general. Obviously, the capitalist enterprise – in the usual sense – already presupposes sufficien population density, security, division of labour, sufficien wealth etc. Apart from these requirements, the origin and functioning of the capitalist enterprise is a correlate of two groups of social facts: first of the existence of private – contractual – possibilities of command over the means and outcomes of production. Private ownership is usually associated with the existence of the physical means of production, even if this is not in principle a necessity. In important historical cases, private ownership is also associated with labour power. Second, it is a correlate of the existence of a mentality prone to economic activity, whose most important derivates are an experimentally developed technique of production, a mode of economic calculation geared towards being useful for private enterprising, and a corresponding design of commercial law and economic policy. It is clear, however, that in any culture of this type, the “enterprise” as a form of production is more than simply one of many cultural elements. Without doubt, it is the “cause” of some and the “requirement” of other essential cultural characteristics. The only point to be questioned is whether the enterprise, which can be explained in pure economic terms, is the main cause of the expressed cultural forms (economic interpretation of history), or whether – it itself being a product of a fundamentally independent, viz. ideologically grounded, mentality – it just has a counter-effect10 on this mentality (once it exists) and the cultural expressions fl wing from it. This question cannot be dealt with here. It is also clear, however, that merely recognizing the economic essence of the enterprise does not suffic to exhaustively explain the historical shaping of the enterprise as a form of production through which the economic process is

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characterised. Rather, the enterprise as a form of production is exposed to the determining pressure of social facts that are completely accidental with regard to the economic essence of the enterprise. The extra-capitalistic structural elements of society have shaped the history and the present situation of industry. Such extra-capitalistic elements are: [1. pre-capitalistic:]11 for example, the relations of land-ownership belonging to the pre-capitalistic epochs; [2. extra-social:] extra-social factors: inventions, discoveries, fortuity associated with the production of precious metal; [3. not purely economic:] unintelligible circumstances, or circumstances that are not entirely understandable in purely economic terms, leading to the monopoly- and mercantilist policies of early capitalism – primarily the formation and the struggle of the nation states and their colonial policy; [4. brought about by state intervention:] the financia policy of the state, in particular the mostly undesired inhibitions following from fisca policy on the one hand, and the very different policies leading to power positions of financia groups, on the other – positions that can only be explained by the way in which the state’s demand for credit was satisfied the state regulation of monetary and banking matters and of the employment relation, [5. due to individual influences: the personal, national and social quality of the people who actually founded enterprises and worked there. Such extra-capitalistic structural elements of society have shaped the history and the present situation of industry, and have, to a higher degree than the process, which we can call the unfolding of the inner logic of the entrepreneurial production, made the industry what it is, socially and culturally. But the fact that these structural, extra-capitalistic elements had a shaping influenc should not mislead us to ignore the very real process of the unfolding inner logic of production as a form of enterprise.12 In the formation of theories of “economic stages,” it is nowadays common to construct historical epochs, and to associate these epochs with “economic systems” and “economic mentalities” of a toto coelo13 unique character (cf. mainly Sombart). It is further common to locate the enterprising form of production in general within such epochs, or such forms of it that presumably differ completely in their economic essence. Although necessary for purposes of historical synthesis, and useful for purposes of attaining a fresh perspective, such attempts of constructing historical epochs are never completely satisfying: As pictures of life, they exhibit a uniformity and sharpness that are not found in the stream of social life. As a means of analysis, however, they block the view of important similarities in essence. Against this it must be maintained that the enterprise – apart from the case of the most primitive hunt for food – in principle only would be absent in the socialist form of organisation. Actually, the enterprise exists in all observable historical situations – just like the existence of regular trade, if ever so little, can only be questioned for prehistorical times – and in its economic essence it always manifests itself in the same way. The

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enterprise changes so much in the course of history that the outer characteristics of the enterprise of our time, one after another, slip through our finger while we are observing it, and very quickly the eye, focused on the wealth of the empirical phenomenon, no more recognizes any familiar traits. While the enterprise changes incessantly, there is no change at all in its underlying principles, i.e. it is not to say that in the distinguishable, changing “epochs,” revolutions in the nature of economic activity14 take place, which correspond to principles that are distinct in their economic core. Rather, that the changes in economic activity15 in general, and to the productive apparatus in particular, ensue from the development of their respective data: The merchant of the 11th century who imported silk, animal skins, jewels, wine, oil, tusk, copper, tin, glass, silver etc. to England, is different from the merchant of today, or the merchant of the times of Tacitus, neither because his economic sense16 was any different, his thoughts were of a completely different economic kind, nor because his acts followed different principles, but because he faced different circumstances, and with that, different tasks. Therefore, we also fin that economic sociology distinguishes its epochs and types especially according to non-economic characteristics, and to characteristics of very different kinds, such as technical characteristics (use of machines, presence of orderly accounting), political characteristics (type of economy of city and country17 ), cultural characteristics (lifestyle of the economic subjects) or social characteristics (relative position of employment18 in the hierarchy of occupations). As an example of a divergent opinion let us point to Schmoller’s sentence, which is deep, although it only relates to one aspect of the problem, that (Grundriß I, p. 462) “the merchant guilds of the 9th–12th centuries, the commercial trade guilds of the 13th–15th centuries, the new merchant corporations of the 14th–18th centuries were in principle the same as today’s cartels and labour unions.” With these limitations,19 the following historical survey of forms and types can be given: (1) Conclusive evidence for the business cycle, which is characteristic of the system of enterprise as a form of production, can, for England, only be provided since the Napoleonic wars, and, for Germany, only since the 1840s. Insofar as the business cycle represents a symptom of the relatively complete carrying out of the production process through the enterprise, we thus seize a classificatio criterion that is non-trivial with regard to the facts. Ever since the appearance of the business cycle, the enterprise represents the mode of production to such an extent that: first the enterprise completely permeates all the branches of economic activity, no matter what their object – production, transportation, marketing, financing risk management etc. – so that also the social whole, where

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it directly engages in economic acts,20 makes use of this form – fiscal municipal, cooperative, and mixed economic “enterprise”; second, also establishments21 that did not originate as enterprises, in particular the peasant farm, transform themselves or are transformed, into enterprises; third, where the enterprise did not encounter any other kind of stratifications which is mainly the case in the United States of America, it created a social structure in its own image to the effect that the social positions arranged themselves according to the functions that the individual economic subjects fulfi in the scheme of the enterprise. And where the enterprise encountered structures of a different kind, it triggered a process of rebuilding those structures, so they tended towards reproducing the structural form of the enterprise;22 fourth, adapted to the enterprise, the technical and organizational methods and forms developed more rapidly and would also become a common good more rapidly than before; fifth little by little, the national- and ultimately the world-economy would, through the system of interlocking elements of the exchange relationship, become a “market” in the theoretical sense of the word, and sixth, a payment- and credit-system23 encompassing the entire economic life, and having the banking system at its centre, adapted itself to the vital requirements of the enterprise as it arose along with the money- and capital-market. Within this epoch, one can further distinguish between (a) the enterprise of the competitive economy, which broke through the old constraints24 during the period of economic liberalism. The competitive economy meant a complete, and incessantly revived, reorganisation of the productive organism towards what is appropriate for the private enterprise – and in many cases also socially – by the method of competitive ejection25 of those that were neither adapted from the private enterprise perspective – nor in many cases adapted from a social perspective. For purely technical – that is, extra-social – reasons, the factory and earlier yet, the large enterprise established themselves in this process as the typical forms of production of physical goods, just as bank credit and association of capital established themselves as the typical forms of financing Given somewhat larger dimensions, the de-coupling of the “household” from the “firm ” which for similar reasons had already happened earlier, now generally proved to be appropriate in technical accounting and absolutely necessary when credit was used to a considerable extent. Parallel to this development, there was the endeavour to achieve legal autonomy, for

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which purpose the law of the profit-makin companies,26 and in particular the so-called fi e trading companies, was adapted and developed accordingly. However great the importance of the elaboration of these legal institutions, namely the stock company and the limited liability company, for the development of the enterprise, and in particular for the supply of capital, the little does the chosen legal form decide on the nature of the enterprise and the de facto power relationships that concern it: The legal form, which is sometimes based on empirically inaccurate legal theories, does more to distort than to express the essence of the matter. Despite the strong development of corporate law, the enterprise of “liberal” times was usually the enterprise of one man, and one family, as the case might be. (b) and the enterprise, as it may be said with even greater reservation, of Neomercantilism. Actually, the name only fit the element of this time that was a mere setback, a reaction carried by the circles whose existence discouraged the unfolding of the competitive economy, above all the craftsmen and the small “factory owners,” as well as the farmers. To this category belong the formations of some cartels, above all of the agricultural industry. But this current gained substantial and firs of all long-lasting importance, just as it gained its hostility against the form of production and life of the enterprise, only by way of having – essentially superficia – points of contact with a different current that transformed the competitive economy and, what is solely of interest here, the form of enterprise appropriate for the competitive economy. First of all, the establishment expanded many times over and, at a characteristically increasing pace, rose above the size compatible with free competition and also above the size of the establishment – notably, this latter event came about organically, and not merely in the sense that one and the same fir led several, similar or altogether different, establishments, which had always occurred. For the two most important forms of merger, trust and concern, typical organizational and administrative practices have quickly developed, and suitable legal structures less quickly. These two forms of merger tend to develop from the mere merging of autonomous units (cf. above), into the real units of the production process that contain the decisive impulses – into enterprises. They further tend to make what had previously been the enterprise of the competitive epoch, a mere technical establishment, a mere proxy,27 whose attributes cannot be inferred from the entity itself. This “movement toward concentration” – in the widest sense – is not as it was formerly common to assume, in particular in association with Marx, the necessary implication of the competitive economy. It is quite rare that normal

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competition wipes out all but one or two28 establishments of an industry. Rather, it was typically and as a rule deliberate activity, focussed on conquering and shaping anew, that agglomerated the establishments into the new big units. As far as competition played a role as one of the tactical means – always only one of many – it was not the competition of the “liberal” system, which is tied to the law of cost and thereby find a limit, but “cut throat competition.” Already the mere dimensions of the new units29 give them a quality different from that of the units of the competitive economy. From the perspective of economic theory, the framework intended to capture the competitive economy is bound to the assumption that the individual enterprise is but “a drop in the sea,” and the bulk of results of this framework, in particular the fundamental proposition that in equilibrium, all prices and quantities of goods are uniquely determined, is the conclusion of this very assumption. From the perspective of economic policy, the behaviour and fate of units of such dimensions necessarily become a public matter, in many cases of national, perhaps even international relevance; even for a state with an extremely “liberal” attitude – if such a state could exist under such circumstances – a laissez-faire30 – approach towards the individual enterprise therefore becomes practically impossible. From the perspective of economic sociology, the modern enterprise transcends the driving forces and the kind of people associated with the enterprise of the competitive economy, and in its essence, structure and methods increasingly approaches the character of a public administration.31 In part from this source, but mainly from other sources, which already appeared in the competitive economy, the economic subjects develop a mentality that detaches them from emotional and interest-led relations to individual enterprises and individual persons, changes their old motivation, deprives their accomplishment of its personal character and moves their psychological focus away from family life towards professional life, dilutes private ownership of the means of production to majority ownership and tends to strip private ownership of its lively content and its cultural-sociological importance.32 (2) In retrospect, the firs time we can identify all the mentioned elements, without exception, is in the 18th century, and they only differ in their forms from the present ones by the degree to which they have been unfolded. We fin the factory, the manufactory that quickly lost importance – if one wants to make the difference between those production units oriented towards a mechanical process and those that are mere agglomerations of labour at a production site – and the putting out enterprise, which disappeared even more quickly, ejected33 by factory and manufactory since the centres of consumption attained the strength the latter two required. The further we go back – and the lower a population density we meet – the more factory and manufactory fade

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away, until they disappear completely in the 14th century whereas the putting out system gains importance. Even if the putting out system does not require strong markets to the same extent, it can still be a large enterprise, but a large establishment only in strictly commercial terms.34 Since the 13th century, the putting out enterprise and the household industry emerge alongside the trades,35 which primarily means the trades are superseded according to the possibilities of the time, i.e. in utilising the widening commercial reach, where the trades, according to their nature, fail completely. In the second place, the putting out enterprise often also represented the financia and commercial organisational form of the crafts, which were already deteriorating. The crafts of a medieval city are nothing but the organisational form of the enterprises of a poor and small society. That the crafts survived until the present day can be explained by social inertia, and by a partial change of function. The very pronounced cultural expression that the crafts have produced is more important from a sociological and cultural-historical perspective than an economic perspective: The professional spirit of the crafts, the master’s pride in the product, is an essential element of any type of professional work, even in modern industrial work. Not that the attitude towards market opportunities would be absent – but these opportunities were just so narrow and unchanging that utilising them did not constitute a particular function. In principle, all production is production for consumers, the only difference is that in the case of a small number of customers you know the individual customer personally – but that is not essential. A small number of customers leads to primitive technique, limited possibility of expanding sales, and a simple and transparent commercial combination. In this instance, the rate of profi is therefore commonly known and subject to control by the peers and by the public. This, in turn, leads to the idea of a “civil earning of your keep,”36 which does not constitute a particular principle of economic activity, nor a symptom of an absent, or a fundamentally different, profit-makin instinct. It is for these reasons that a commonly known profi rate explains the policy of f xed prices as well as the constraining of the individual’s freedom by his peers or by the authorities. Finally, the small number of customers and the precarious position of the city in a hostile environment explain the strong cohesion in the guild, where the behaviour associated with individual situations has crystallised into stable37 rules, into objective life-forms, so that we now get the impression that the crafts were a unique entity, fundamentally different from what came later. In the firs place, the trade enterprise always co-exists with the industrial enterprise that it complements, and that it is complemented by: the regularly traded merchandise must be produced somewhere and with a consideration of the demand of the merchants, the only exception being the case of trade

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in stolen goods. The relative importance of both the trade enterprise and the industrial enterprise, and also the type of trade enterprise (namely the degree of its technical sophistication38 and specialisation – e.g. wholesaleor retail-trade enterprise, trade- or transport-enterprise) simply depend on the necessities of the particular case. The further back in time we go, the more the trade enterprise gains in importance compared to the industrial enterprise. As a large enterprise it persists longer than the industrial enterprise, and as a small enterprise it extends beyond the times in which we can trace industrial production as the basis of important social formations, such that the trade enterprise appears to be the “original” form of enterprise. We can thus say that “trade has created the enterprise.” The sole sources of this effect were the lack of security in trade, and the difficultie associated with crossing space, both of which used to assign an importance to the function of trade in the economic process, an importance it could not possibly have at the present day: The character of the enterprise and of entrepreneurial activity is always determined by the particular task39 that presents most difficulties Accounting for the total mass of economic activity, the importance of the trade enterprise is nonetheless decreasing the more we go back in time because – particularly advantageous cases apart (for instance a production location at the seaside or next to a river) – transportation costs disqualifie goods produced in large quantities from trade across large distances. Furthermore, transportation costs made the other goods much more expensive. Even relative to the lower overall population, the potential customer segments were thereby invariably shrinking. That medieval trade was relatively negligible is explained only by this40 argument, not by some un-commercial way of thinking that the economic actors of the day might have had. This would have to be explained in a different way. Moreover, relative to the population, medieval trade and the importance of trade enterprises was not as small as it was previously common to assume. Neither the landowner’s manor estate,41 nor the medieval farm estate were enterprises. The life-form of the manor- and the medieval farm estate42 certainly rests on principles very distinct from those of the enterprise. That is not to say that such a life-form would be as different from the enterprising organisation of the economic process as, for instance, the socialist organisation of the economic process. This is because the manor estate and the enterprise are rendered incommensurable because of an extra-economic factor. The manorial organisation, developed for a ruling class of warriors, is more than an economic organisation. According to its underlying idea, the manorial organisation has to fulfi tasks that are nowadays considered tasks of the state. Its methods and ideals are comprehensible only from such a vantage point. To the extent that the manorial organisation was an economic organisation,

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it was incomplete and never able to completely shake off the trade enterprise and the industrial enterprise. Similarly, the other way round, the manorial organisation has always produced “for the market” to a modest degree, i.e. to the best of its possibilities it sold agricultural products where the situation and the modest capabilities43 of the warrior lord and his servants made it possible. Far-reaching – but never complete – autarchy of the manorial estate was a consequence of the circumstances,44 and not a consequence of a particular economic principle. Moreover, the manorial estate’s trade with merchants was a trait of its essence, and not a completely uninteresting aberration from its essence. In this connection, we want to refer especially to the research of A. Dopsch. Whether this also applies to the economy of antiquity and for peoples outside the Mediterranean culture cannot be dealt with here, neither can special forms of the enterprise, in particular the colonial- and the war-enterprise. We further want to point to a second meaning of the term “enterprise” in science, which from a linguistic point of view is the original one: “Enterprise” does not just refer to the unit of production, the shop,45 the fir itself. It also refers to the process by which this unit, the shop, the firm emerges, the activity of certain economic subjects that create it. As we will see, only in that sense the entrepreneur is the subject of the enterprise.

2. DEVELOPMENT OF THE SCIENTIFIC ANALYSIS OF THE ECONOMIC SUBJECT “ENTREPRENEUR” The historical and sociological analysis of entrepreneurship is of a recent date and was originally developed by the historical school, and the tendencies stemming from it. The economic analysis of the economic subject “entrepreneur” has earlier origins, however. Scientists of the late 17th century developed a notion – completely superficial but not inappropriate – of the entrepreneur (who is usually called “merchant” according to the empirical material of the time, e.g. by Locke). In particular, they captured the entrepreneur in his characteristic juxtaposition to the investor.46 Scientists of the 18th century and the classics did not hold on to this idea, but – in accordance with the ever more spectacular emergence of the industrial entrepreneur – they saw the entrepreneur mainly as the employer (master, employer) on the one hand, and the owner of “physical capital” on the other. Already the classics had sharpened the notion of the entrepreneur as employer into that of the exploitation of labour. The English socialist theorists of the firs three decades of the 19th century and particularly Karl Marx then continued this approach. Although the existence and importance of a capitalist

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class that is not engaged in any entrepreneurial activity was not overlooked, and could indeed not be overlooked, Smith always argues as if the possession of capital and the entrepreneurial role would be inseparable. In principle more correctly than this idea of his, Smith repeatedly mentions the entrepreneur’s administration and utilisation47 of capital (e.g. Wealth, ed. Cannan I, p. 53) – Ricardo and his followers up to the younger Mill, who represents a remarkable progress, emphasised the distinction between administration and utilisation of capital even more. Finally, Marx exclusively contrasted the labour class with the capitalist class – and only with the capitalist class. That was completely wrong, however, and spoiled the understanding of the mechanism of the market economy and its social consequences, of the essence of interest and entrepreneurial profit of the real structure of how oppositions of interests and communities are textured, and of the tendencies inherent in the capitalist form of economic organisation. It is the substantial merit of continental science to have taken no part in this. In France, the chief merit of this belongs to J. B. Say, in Germany to Hermann. Even if their works recognise and identify the character48 and function of the entrepreneur,49 these issues are still analysed in an unsatisfactory way. Moreover, character and function of the entrepreneur are not completely separated from the feature of capital possession. The doctrinal development of the 19th century has increasingly led to an emphasis on the particular personal performance of the entrepreneur and the particular competences50 necessary for that. The analysis of such performances has made very slow progress beyond general insights, however. Still today, heterogeneous elements are summarised under an “umbrella” term the meaning of which is best conveyed by the English term “management.” Initially, this term described a simple super-ordinate position in the organism of the enterprise, as well as the functions of control, representation, and maintenance of discipline, etc. The function of all kinds of current administrative work is connected with the above functions, but has to be conceptually distinguished from them. Everything that is thought to be included in these functions is obviously work like any other form of work, and would clearly not be suited to characterise a particular type of economic subject. Moreover, when removing the still remaining associations between the possession of capital and the notion of the entrepreneur (in particular the function of risk-bearing – which concerns the entrepreneur legally, but not economically, apart from the case where he also is a capitalist), we are left with the function of combining the production factors into the product. The fulfilmen of this function by a private economic subject also represents the essence of the market economy: According to this interpretation, the entrepreneur is the carrier of the exchange acts through which, in the case of an economy organised as a market economy, the economic process is realising itself. On the market

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for means of production, the entrepreneur carries out the production-process in his role as buyer, and on the market for consumer goods, he carries out the distribution-process in his role as supplier.51 He does so uno actu, as the transactions52 by which he acquires the means of production at the same time give rise to the income of these factors. The entrepreneur is therefore simply the middleman between the owners of productive services and the consumers, or, because the two categories will eventually merge into one, he can also be seen as the middleman between different groups of “suppliers of means of production,” thus ultimately: a middleman between workers and land owners (according to most theories also: capitalists). Only one point of this extraordinarily important aspect for the theory of the market economy is of interest here: in an economy in a balanced state of equilibrium, repeating its life cycle year in, year out (a “static” economy), no long-lasting profi that could be distinguished from labour wage could under perfect competition possibly be secured by the fulfilmen of this middleman function. Although occasional profit and losses would occur, the profi rate in the equilibrium state would be zero: such an entrepreneur would, essentially and also by inclination, be an entrepreneur faisant ni b´en´efice ni perte (Walras). Therefore, the true importance53 of the function of the entrepreneur consists, not in the mere running, but only in the creation of an enterprise; in other words, in the second meaning of “enterprise” referred to in the above.54 In that meaning, the function of the entrepreneur is a special case of the social phenomenon of leadership. This function will now be analysed in brief from this position, the only one that renders it understandable.

3. THE ENTREPRENEURIAL FUNCTION In all spheres of social life we observe the distinction between leaders and those that are led, a distinction that in the end rests on differences in individual competencies. Because of the stability of social positions once they are created, and the possibility of their frequent inheritance, however, the distinction does not always immediately rest on the just mentioned differences in individual competencies. Intellectual characteristics (breadth of horizon, “alertness,” etc.) are only of secondary importance, strength of will55 is, however, of primary importance. Formal56 characteristics of social positions and positions of other kind apart, this distinction manifests itself both in the character57 of the functions of the leaders and of those that are led, and in the way they behave. The essence of leadership is initiative, not – or at least not necessarily – in the sense of mental initiative, i.e. for instance the conception of new ideas. It is rather initiative in the sense of practical initiative, of deciding what should take place, and carrying it out. In contrast, to receive orders

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and carry them out is the essence of being led. Moreover, although leadership is an activity, it is an activity to be called labour (we do not do this in the following) only if we acknowledge it is a special kind of labour, which in its character stands out against any other kind of labour. The leader is not simply a more able fellow or a kind of foreman.58 Even when he is acting primarily, or maybe even exclusively, by way of his example (as for instance in the arts and in science), it is not his achievement as such that is decisive, but its effect on others. This effect per se is not an integral part of his performance. Not the work on the desired object matters, but the influenc on and the domination over others. Others, whose activity, in turn, is characterised as working according to given objectives, and according to given rules. While the motivations that the leader-role is based on belong to the sphere of the “urge to act,” of the will to dominate and win, the motivations of those that are led, can essentially be described either as hedonic, or59 by means of concepts like “devotion to duty.” Leadership only has a function when something new60 has to be carried out, not something already established by experience and routine. Precisely for this reason, no leader is merely, and nothing but, a leader; he is not even then merely a leader when he lacks a formal61 position and solely has an impact through his personal weight, for the reason that in between the moments in which he “leads” – and such moments are in principle the exception – there are always additional things that he must take care of. It is much less the case that a leader is merely a leader and nothing but a leader when he, as is the rule, is holding a formal position in some kind of organism, the leader-function thereby being blurred with the execution of the current tasks of that position. For this reason, leadership is never purely embodied in concrete persons, and its essence therefore has to be carved out of a more or less complicated conglomerate by way of analysis.62 But it is easy to convince oneself that only the above mentioned function is essential for the leader, while all other functions usually63 associated with the leader-function are accessory, non-essential and conceptually separable from it. If only the execution of routine activity would do when an army is in action, and it did not also depend on the making and implementation of ever new projects and decisions; if a political body would never encounter new situations, but rather what happened in the previous year would just repeat itself; if science would not always run into new problems but just had to apply a known stock of knowledge according to known rules, then, generally speaking, an organisation would still be required, which in the firs two cases also would require an administrative hierarchy. Finally, one would also need a somehow structured individual or collegial apex for such a hierarchy – but there would be no need of any “leading men.” The administrative tasks to be taken care of would not be substantially different from other tasks, and their fulfilmen would be trivial labour of implementation that does not represent a function sui generis.

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The entrepreneurial function is nothing but such a leader-function in the sphere of the economy. At every point in time the economy works with a stock of given experiences and is based on given data that are familiar by virtue of recurring routinely. Every economic period is similar to the previous one, as well in its basic outline as in the mass of details. In essence – producing and consuming – it fulfil the same tasks as the previous one. This is the case not only because the continuous circular fl w of production and consumption times and again creates the same objective situation – so to speak year in, year out – a situation that always offers essentially the same opportunities and excludes others. It is also the case because the economic subjects always approach them64 and, as a rule, under the pressure of the necessities of everyday life, have to approach them, with essentially the same ingrained and slow-changing mentality, the same knowledge and experience, the same openness of horizon, the same production methods, business habits, tastes, and the same relations to customers, suppliers, and competitors. The fact that the mass of economic activities each move in well-trodden and familiar tracks on the one hand explains the relative promptness that characterises behaviour in the economic sphere, which otherwise would require a much higher degree of rationalism, alertness and energy than the average person can draw on. On the other hand, it explains the failure of the average economic subject whenever it faces new situations, such as a crisis for instance. It also explains the smooth, almost automatic course of the normal economic period: Every element of productive power65 follows in principle the same path year in, year out. As if it were happening by itself, i.e. with the help of a relatively minimal addition to the mental performance that has been pre-performed by decades and even centuries, and has become subconscious and habit, the means of production offers itself to the producer, the desired consumer good to the consumer. In each economic period, the producers use technical manipulations and commercial calculi that for the most part remain forever unaltered. Finally, in each economic period the consumers employ, on the whole, the very same demand- and value-estimations, and they exhibit the very same actions constituting demand. Now, there are three ways in which the transition from such a given state of the economy to another state takes place, in which the “data of the equilibrium state” change, and in which “economic development” takes place: first through continuous growth, in particular of the population and the apparatus of produced means of production. Second, through extra-economic events that permeate the economy, such as events of nature, social upheavals, and political interventions. Third, because some individuals recognise and carry out new possibilities within the given circumstances of economic life, possibilities that extend beyond economic experience and tried and familiar routine. The third type of development is by far the most important, it is further the case that the firs

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two types become partly effective through it – that is, they give occasions for the emergence of new possibilities. The essence of the entrepreneurial function lies in recognising and carrying out new possibilities in the economic sphere. Such an economic leadership thus occupies itself with tasks that can be summarised in the following types: (1) (2) (3) (4) (5)

the production and carrying out of new products or new qualities of products, the introduction of new production methods, the creation of new forms of industrial organisation (for instance trustification) the opening up of new markets,66 the opening up of new sources of supply.

All these are cases of carrying out a different use of national productive forces from the previous one, of taking them away from their previous uses and putting them into the service of new combinations. The nature of the achievement to be accomplished in this process is characterised first by the objective and subjective difficult of taking new paths, and second, by the resistance of the social environment against doing so. For instance, the data required for the production and marketing67 of a so far unknown product are obviously not known from experience in the same sense that they are known for the organisation of production and marketing, which for all practical purposes involves the same tasks as in the previous year. Rather, the data have to be estimated (expected demand, for instance), or even created.68 The sources of error are therefore not just marginally, but substantially larger. The relationship between pre-performed activity that just has to be mechanically repeated on the one hand, and new performance that still has to be consciously executed, on the other hand, is likewise not just marginally, but substantially more unfavourable. Furthermore, from a subjective point of view it is more difficul to do something new than something familiar. In doing something new we are not supported by the same feeling of solid reality, and we have to overcome our mental and behavioural habits and have to liberate ourselves from the dictation of routine. Finally, our environment opposes unfamiliar behaviour. In the yearly circular fl w of what is familiar, however, people cooperate automatically, and on a whole willingly. The worker opposes new methods, the consumer new products, and the public opinion, public administration, the law, and creditors oppose new forms of establishments. It lies in the nature of routine work following well-trodden tracks that the average intelligence and will power of the actors of a particular place and period is sufficient Overcoming the difficultie just mentioned, on the other hand, requires characteristics that are only possessed by a small percentage of the population. In order to pull the whole of a national economy into such new tracks and give new shape to the stock of economic experience, the economic leadership of such individuals is therefore required. For a comprehensive justificatio

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see the author’s “Theorie der wirtschaftlichen Entwicklung,” 2nd ed. 1926. (Cf. also entry on “Leadership,” Vol. IV, p. 530ff.)

4. TYPES OF MODERN ENTREPRENEURSHIP Economic leadership has to exist in all forms of economic organisation.69 In organisational forms other than the market economy, economic leadership would either be tied to an administrative position70 – for instance in the socialist economy – or to a position of dominance that has its base outside the economy – in which case it would make use of feudal authority. The form of economic leadership associated with the market economy is the entrepreneurial function. It is distinguished from the other types of economic leadership by its focus on self-interest, by the mode of selection of leaders, and by the way in which the leader, who does not have any authority in such an organisational form, acquires the necessary means of production – namely, purchases them on the market for means of production. The basic function of the capitalist is to provide the financia means for this purpose, which in this case cannot be provided by current income stemming from already completed production. The firs two characteristics mentioned above, however, cannot always be found in pure form in the multi-facetted types of entrepreneurship, of which we want to underline four. (a) The dominant type of the competitive era, still common today, was the factory owner and merchant. In his person, he united so many heterogeneous functions – which in his person were combined into a whole71 – so what is most essential often completely disappears from sight. Above all, he was very much a capitalist. As such he had a definit social position that the entrepreneur as such lacks: the entrepreneurs per se do not form a social class – in accordance with the personal character of their function. The successful ones amongst them nevertheless build a basis for themselves and their families,72 in order to have a position in the capitalist-, maybe also in the landowner-class. Even if this was the case then, and even if the entrepreneur had usually achieved his success by struggling on through his debts,73 it occurred much more frequently than today, that an individual, and particularly, in the course of generations, a family, rose to the entrepreneurial position. In this picture, we should also include the role of other positions of dominance in the development process of the entrepreneurial position (factory foundations by landowners). Property and entrepreneurial position thus coincided to a higher degree than today, such that the entrepreneurial position also offered an impression of inheritability – only an impression, however, because inherited property facilitates the entrepreneurial role in the sense

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described here, but it does not already represent it (as opposed to the capitalist role). While that does not change the essence of the matter at all, it nonetheless explains the social and psychological habitus of this type and its culture. The dominant type of the competitive era is in the centre of the bourgeois economic and mental universe, whose strongest element he represents. He embodies and endeavours ideals of bourgeois properness, business acumen, and life form. He is the man with family spirit and the autocrat of “his” establishment, with a tendency to consider any intervention by law and administration not only as unpleasant but also pointless. His self-interest is mainly oriented towards the care of the family, now and in the future, and towards a non-rational love for the firm and his social feeling is oriented towards acts of voluntary “care.” Today, we have a better overview of those matters and of the processes of rise and fall of the entrepreneurial personality – or more correctly, the entrepreneurial family – than it appeared in the literature of the 19th century, especially the literature coloured by a socialist perspective. However, only the detailed research commencing now will be able to provide full clarity, in particular also on the question precisely to which extent – without doubt it was the case to a very high degree – this entrepreneurial type grew out of the working class74 and basically only represented its upper stratum – a very instable upper stratum. Furthermore, this type was the manager75 of the current business of the enterprise. As a rule, he was his own technician and commercial manager, and in current business, often also his own lawyer. His education was mainly technical and commercial, but sometimes also legal. It is, however, important to note that this fact did not pertain to the entrepreneurial function. In particular, it is simply a chance encounter if the entrepreneur also happened to be the technical inventor, or if the plan that he implemented was in any way his own intellectual creation. That all these functions can be distinguished from the basic function of the carrying out of new economic combinations is proven by the fact that, in practice, the various functions are also found to be separated from the basic entrepreneurial function, and are often provided as a service against separate payment. Nevertheless, as described above, these elements of technical and commercial competence also pertain to the entrepreneurial type as a real phenomenon. (b) The type of the modern captain of industry is not only distinguished from the factory owner and merchant type described above in terms of the lack of such accessory functions, which makes him a “purer” type of entrepreneur. As a rule, his position as entrepreneur depends on the possession of, or the authority over majority shareholdings, and in the latter case, his position will ultimately depend on a personal influenc on the capitalists, and in particular on the banks which own majority shareholdings. The main outer expression

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of the entrepreneurial position lies in the positions that the development of the law on stock companies has created (president, managing- or executive supervisory board member,76 administrateur d´el´egu´e, etc.). A man of this type does not necessarily have a relationship to a concrete factory or labour force. He merely coordinates the general direction of the business policy of his companies, he creates something new from them and with them, and he decides in dangerous situations. He is not simply the representative of his own interests, or his family’s interests. Were this solely his function, it would be considered inappropriate by him, and by others. He is not the typical bourgeois77 that in the firs place takes care of his family, and whose motivation is rooted in his family home. For him, it is “problems” more than “business” that matter. He has a characteristically different relationship to labour than the factory owner, and even if, on certain occasions, he often has the opportunity to consider a trade union as an opponent, he could not make it without labour unions because of his mode of operation. His self-interest is not simply oriented towards profi as such, but towards power, performance, the will to win, and the urge to action. He is, against his will, the pioneer of the planned economy. (c) Because the person that actually carries out the entrepreneurial function is entrepreneur, also a “manager” who enters this position by way of an employment contract can be entrepreneur. Although in this case, self-interest, in the sense of a connection between success and monetary profit is not absent, it is an example of an intermediate form that is particularly interesting, precisely for this reason. Apart from the striving for sufficien income, it is mainly a case of orientation towards the ideal of good professional performance, towards the applause of the colleagues, the stakeholders and the public, and towards personal reputation. These ideals, rather than entrepreneurial profit are the decisive motives of behaviour. Lifestyle and attitude to life are adjusted to this orientation, and a far-reaching indifference towards the involved capitalist interests is a frequently observed effect. The ascent follows a path that often is more like the career of a public servant than that of a factory owner. (d) Finally, by its purpose, the “founder” (promoter)78 is a type who is completely focused on the entrepreneurial function. This type is characterized above all by the lack of a social reference point, the focus on seeking and carrying out new possibilities, and the lack of enduring relationships to individual establishments. Even if he also regularly carries out legal work and tends to matters of technical finance this only plays a minor role. Furthermore, the often low social and moral status of this type has the effect that practice and science show a reluctance to recognize him as a normal element of modern business life, and in particular, as an economic “leader.” Nevertheless, when all is said, what is called an economic “leader” is often nothing more than a middleman.

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This observation notwithstanding, one can best epitomize the entrepreneurial role as such by this type – even if the higher-situated representatives of this type are not known by the denomination of entrepreneur.

5. PARTICULAR QUESTIONS Despite all discussion, much research on the following fundamental questions regarding social forecasting and economic policy still has to be done. Even so, at least a preliminary answer is possible: (1) In how far is self-interest and private property of the means of production an indispensable driving force and a requirement, respectively, for the successful accomplishment of the entrepreneurial function? The previous description shows that self-interest – which hardly ever can be understood as merely hedonic, rational and individual egoism – can adopt many different forms. It shows that self-interest can adapt to very different social circumstances, and in its most simple forms – the striving for maximal personal monetary profi – very often, even today – for some types more than for others – is substituted by objectives of a different kind. It is possible that a progressing conformity of everyday habits and a progressing decline of the importance of the family for individual life might, in times to come, still further loosen the link between entrepreneurial profi and activity, something that no legislation could enforce on actual entrepreneurial types without paralysing their activity. As opposed to that, the importance of private profi as a fund available for further expanding the reach of the entrepreneur-personality’s activity – and it is indeed for this purpose, for further investments, that it is mainly used – is not influence by the tendency to loosen the link between entrepreneurial profi and activity. The case is similar with regard to the entrepreneur’s private property, and the freedom of the employment contract. The practice of the stock company, and of collective contracts, shows that they could be missing. It would also be conceivable that land belonging to the state, and labour force paid by the state, would be delegated to the entrepreneur. But thereby, the possibility of prompt and frictionless disposition would be reduced, just as the disappearance of the particular property relation between the entrepreneur and the apparatus of physical production, already at the present time, is a source of passive entries on the balance sheet, because they trigger a particular behaviour that does not at all merely depend on profi interest. (2) What is the origin of the superiority of the private enterprise over the public enterprise? This superiority is remarkable, not seriously questioned, and even

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greater than it seems because the example of the private enterprise is viewed in direct comparison to the public enterprise, and because new methods – e.g. in the form of new machines – are perpetually offered to, and even forced upon it, by the private enterprise. Considering what has been said above, it is clear that this cannot simply be explained by claiming that everyone works better when he does so on his own account. Neither can a higher level of professional knowledge in the private industry be the explanation, because the state can always acquire the best available knowledge. The explanation rather seems to lie in the following two facts: In effect, the private industry is mainly directed by a circle of persons that still today, even when they have not personally gone through the school of the competitive struggle, hold on to its tradition, and represents the result of its selection. Moreover, the one-man-enterprise of the competitive era is a unique method to provide a complete freedom of choice, and at the same time, the strongest assurance against a lack of a sense of responsibility. As a rule, the modern large enterprise, and in particular the trust – trusts and concerns that are absolutely dominated by one man still exist – have grown beyond the possibilities awarded by this method. Nevertheless, much of the principles of the competitive struggle are still preserved in the modern large enterprise, while the leading man of the public enterprise is paralysed. He is paralysed, not so much because of the awareness that only a small share, if any, of the pecuniary success of an innovation will be his, but because of the need, in each and every case, to convince numerous constituents. (3) Is the importance of the entrepreneurial function increasing or decreasing? It is beyond doubt that the question has to be answered in the latter sense,79 notwithstanding the impression to the contrary that the figur of the “big” entrepreneur has become a particularly noticeable element of modern economic and social life because of the increasing size of the unit of the enterprise. This is because the social whole is getting ever more used to incessant innovation within the realm of the economic process, and it is becoming ever more taken for granted that every new insight, as soon as it presents itself, is also carried out into economic practice. Just as the bounds of what is strictly calculable – technically as commercially – are expanding to intrude ever further into other field of activity, they are intruding into the fiel of economic activity. Both circumstances80 not only facilitate and democratise the leader function in general, and the function of the entrepreneur in particular, but also decrease their importance: a number of the difficultie that were, and still are, essential tasks for the entrepreneur to overcome, tend to disappear. And oftentimes, what earlier required – and to a large extent still today requires – “eye” and “personality,” is today becoming specialised professional work that can be learned. The only thing that can be questioned is how far this process,

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which in its nature cannot be stopped, has already progressed, how fast it will progress, and whether a rational economic policy can reasonably build on the present results of this process. Literature: also for the entry on “entrepreneurial profit ” H.v. Mangoldt, Die Lehre vom Unternehmergewinn, Leipzig 1855. – J. Pierstorff, Die Lehre vom Unternehmergewinn, Berlin 1875. – V. Mataja, Der Unternehmergewinn, Wien 1884. – G. Groß, Die Lehre vom Unternehmergewinn, Leipzig 1884. – E. A. Schroeder, Das Unternehmen und der Unternehmergewinn, Wien 1884. – Wirminghaus, Das Unternehmen, der Unternehmergewinn und die Beteiligung der Arbeiter am Unternehmergewinn, Jena 1886. – Zuns, Zwei Fragen des Unternehmereinkommens, Z¨urich 1881. – A. Sch¨affle, Die Anwendbarkeit der verschiedenen Unternehmungsformen, Z. f. St., Vol. XXV, 1869. – v. Schmoller, Die geschichtliche Entwicklung der Unternehmung, Jb. G. G. V., Vol. XIV, No. 4, 1890. – M. Pork, Entrepreneurs et profit industriels, Paris 1901. – W. Sombart, Der kapitalistische Unternehmer, Arch. f. S., 1909, No. 3, Vol. XXIX. – K. Wicksell, Vorlesungen u¨ ber National¨okonomie, I. Vol. Jena, 1913, p. 814. – K. Wiedenfeld, Das Pers¨onliche im modernen Unternehmertum, Jb. f. G. V., 1910, Nos 1 and 2. – R. Ehrenberg, Sozialreformer und Unternehmer, Jena 1904. – A. Sch¨affle, Kapitalismus und Sozialismus, T¨ubingen 1870. – Wolf Julius, Sozialismus und kapitalistische Gesellschaftsordnung, Stuttgart 1892. – L. Pohle, Unternehmerstand, Vol. III, No. 1 of Vortr¨age der Gehe-Stiftung, 1911. – Liefmann, Unternehmungsformen, Stuttgart 1912. – Liefmann, Beteiligungs- und Finanzierungsgesellschaften, Jena 1909. – R. Ehrenberg, Das Wesen der neuzeitlichen Unternehmung, Th¨unen-Arch., I. Vol., 1906. – Pinner, Felix, Deutsche Wirtschaftsf¨uhrer, Charlottenburg 1925. – Geiler, Gesellschaftl. Organisationsformen des neueren Wirtschaftsrechts, 2nd ed., Mannheim 1922. – L¨offler, Werner, Die moderne Konzernierung. Das Konzentrationsproblem in der deutschen Großunternehmung unter besonderer Ber¨ucksichtigung der Sp¨at- und Nachinflationszeit Frankenstein 1926. – Schmitt-Schowalter, A., Die Organisationsform der modernen Wirtschaft. Eine Studie zu Konzern und Kartell, Eßlingen 1926. – Bonn, M. J., Das Schicksal des deutschen Kapitalismus, Berlin 1926. – Hermannsdorfer, Fritz, Versicherungsunternehmungen und Konzentration. Eine Studie u¨ ber die Stellung der Versicherungsunternehmung im heutigen Wirtschaftsleben, Berlin 1926. – Stieler, Karl, Der internationale Eisenbahnverband und die Entwicklung a¨ lterer internationaler Eisenbahnorganisationen seit Kriegsende, Berlin 1926. – Trotzki, Leo, Kapitalismus oder Sozialismus? Eine Betrachtung der Sowjet-Wirtschaft und ihrer Entwicklungstendenzen, German ed., Berlin 1925. – Walter, A. G., Die geschichtliche Entwicklung der rheinischen Mineralfarben-Industrie vom Beginn des 19. Jahrhunderts bis zum

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Ausbruch des Weltkrieges, Ver¨offentlichungen des Arch. f¨ur RheinischWestf¨alische Wirtschaftsgeschichte, VI. Vol., Essen 1922. – Fitch, John Andrews, The causes of industrial unrest, New York 1924. – Rockfeller, John D., The personal relation in industry, London 1924. – Arndt, Paul, August Thyssen und sein Werk, Z. f¨ur handelswissenschaftl. Forschung, Leipzip 1925. – Ochelh¨auser, Die Nachteile des Aktienwesens und die Reform des Aktiengesellschaftsrechts, Berlin 1878. – Steinitzer, Oekonomische Theorie der Aktiengesellschaft, Leipzig 1908. – Liefmann, Die Unternehmerverb¨ande, ihr Wesen und ihre Bedeutung, Freiburg i. Br. 1897. – Liefmann, Kartelle und Trusts, Stuttgart 1905, 6th ed. 1924. – v. Schmoller, Das Verh¨altnis der Kartelle zum Staat, im Jb. f. G. V., XXIX, 1905. – J¨orgens, Finanzielle Trustgesellschaften, Stuttgart 1902. – Rotth, August, Wilhelm v. Siemens. Ein Lebensbild. Gedenkbl¨atter zum 75j¨ahr. Bestehen des Hauses Siemens u. Halske, Berlin 1922. – Ufermann, Paul, and Carl ¨ Huglin, Die AEG. Eine Darstellung des Konzerns der Allgemeinen Elektrizit¨atsgesellschaft, Berlin 1922. – Watts, Frank, Die psychologischen Probleme der Industrie, Berlin 1922. – v. Beckerath, Herbert, Kr¨afte, Ziele und Gestaltungen in der deutschen Industriewirtschaft, Jena 1922. – Jenny, Heinrich, Die wirtschaftliche Charakteristik industrieller Unternehmen, Z¨urich 1922. – Lee, John, Industrial organisation: development and prospects, London 1923. – Zschimmer, Eberhard, Die Glasindustrie in Jena. Ein Werk von Schott u. Abbe. Entstehung und Entwicklung in den ersten 25 Jahren, Jena 1923. – McVey, Frank le Rond, Modern industrialism, an outline of present-day industrial organisation, New York 1923. – Robertson, D. E., The control of industry, London 1923. – Bruns, Hans, Der Eisenwirtschaftsverbund. Beitr¨age zur Lehre von den industriellen, Handels- und Verkehrsunternehmungen, Jena 1922. – v. Tugan-Baranowsky, Geschichte der russischen Fabrik, Berlin 1900. – v. Schmoller, Ein Beitrag zur Lehre vom Wesen und Gewinn der modernen Großunternehmung, Jb.f. G. V., 1907. – Rießer, Zur Entwicklungsgeschichte der deutschen Großbanken mit besonderer R¨ucksicht auf die Konzentrationsbestrebungen, Jena 1905. – Wiedenfeld, Zur Charakteristik englischen Unternehmertums, Jb. f. Nat., 3rd series, Vol. 38, p. 681ff. – Sieveking, Geschichte der gewerblichen Wirtschaftsformen, Gr. d. S., Dept. VI, T¨ubingen 1914. – Stumpfe, Der landwirtschaftliche Groß-, Mittel- und Kleinbetrieb, Berlin 1902. – Levy, Entstehung und R¨uckgang des landwirtschaftlichen Großbetriebs, Berlin 1904. – Sch¨onberg, Zur wirtschaftlichen Bedeutung des deutschen Zunftwesens im Mittelalter, Jb. f. Nat., 1st series, Vol. 27, p. 1ff. – Fagniez, Etudes sur l’industrie et la classe industrielle a` Paris au 13. et au 14. si`ecle, 1877. – Lamprecht, Von der Kameralverfassung und Verwaltung der Handwerke, Fabriken und Manufakturen, 1797. – v. Schmoller, Ueber Wesen und Verfassung der großen Unternehmungen, Soz. u. Gew. P., 1890. – Sombart, Werner, Der Bourgeois, Zur Geistesgeschichte

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des modernen Wirtschaftsmenschen, M¨unchen 1923. – Heimann, Eduard, Mehrwert und Gemeinwirtschaft. Kritische und positive Beitr¨age zur Theorie des Sozialismus, Berlin 1922. – Marx, Karl, Das Kapital, Hamburg 1909. – Graziadei, Antonio, Preis und Mehrpreis in der kapitalistischen Wirtschaft, Berlin 1923. – Hermann, Friedrich Benedict Wilhelm, Staatswirtschaftliche Untersuchungen u¨ ber Verm¨ogen, Wirtschaft usw., new edition, Leipzig 1924. – Passow, Richard, Betrieb, Unternehmung, Konzerne, Jena 1925. – Walker, F. A., The source of business profits New York 1877. – Eckert, Unternehmereinkommen. Entwicklung der deutschen Volkswirtschaft, Vol. I, Leipzig 1908. – A. ¨ Gunther, Arbeitslohn und Unternehmergewinn in der Gegenwart, Jb. f. G. V., Vol. 43. – Goldschmidt, J., Alte und neue Formen der Handelsgesellschaft, Berlin 1892. – Aveburg, Staat und Stadt als Betriebsunternehmer, Berlin 1909. – Passow, Die gemischt privaten und o¨ ffentlichen Unternehmungen auf dem Gebiet der Elektrizit¨ats- und Gasversorgung und des Straßenbahnwesens, Jena 1912. – Passow, Gemeindebetriebe, Schr. d. V. f. S., Vols 128–130, 132. – Hugo, St¨adteverwaltung und Munizipalsozialismus in England, Stuttgart 1897. – Hugo, Die deutsche St¨adteverwaltung, Stuttgart 1901. – Lindemann, Arbeiterpolitik und Wirtschaftspfl ge in der deutschen St¨adteverwaltung, Stuttgart 1904. – ¨ Bucher, Karl, Die gewerblichen Betriebssysteme in ihrer geschichtlichen Entwicklung, in “Die Entstehung der Volkswirtschaft” 9th ed., T¨ubingen 1913. – L. Sinzheimer, Ueber die Grenzen der Weiterbildung des fabrikm¨aßigen Großbetriebes in Deutschland, Stuttgart 1893. – Strieder, Studien zur Geschichte kapitalistischer Organisationsformen, M¨unchen 1914. – Ramsay, Alex, The greater problems of industry, London, Journal, 1924. – Nertinger, Josef, Die Ermittlung des Gesch¨aftsgewinns, Stuttgart 1925. – Kelleter, Heinr., Geschichte der Familie J. A. Henkels in Verbindung mit einer Geschichte der Sohlinger Industrie, Leipzip 1924. – Helfferich, Karl, Georg von Siemens, Berlin 1923. – Schwann, Mathieu, Ludolf Camphausen, Essen 1915. – Bourgin, Humbert, L’industrie et le march´e. Essai sur les lois du d´eveloppement industriel, Paris. – Rousiers, Paul de, Les grandes industries modernes, Paris. – Ehrenberg, Richard, Die Fugger, Rothschild, Krupp, 3rd ed., Jena 1925. – Auerbach, Felix, Das Zeißwerk und die Carl-Zeiß-Stiftung in Jena, ihre wissenschaftliche, technische und soziale Entwicklung und Bedeutung, Jena 1925. – Palewski, Jean, Paul, Le rˆole du chef d’entreprise dans la grande industrie. Etude de psychologie e´ conomique, Paris 1924. – Raphael, Gaston, Krupp et Thyssen, Paris, Soc. d’´ed., Les belles lettres. – Brookings, Robert, Industrial ownership, its economic and social significance New York. – Thieß, Karl, Die Bedeutung industrieller Bet¨atigung durch den Staat, K¨oln 1925. – Craig, David R., and W. W. Charters, Personal leadership in industry, New York. – Lansburgh, Richard, Industrial management, New York 1923. – Salzman, L. F., English industries of hte

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middle ages, London 1924. – v. Below, Probleme der Wirtschaftsgeschichte, 2nd ed., T¨ubingen 1926. – v. Schmoller, Grundriß I, Leipzig 1909, p. 245ff., 456ff. – Brentano, Der Unternehmer, Berlin 1907. – T¨anzler, Das gewerbliche Unternehmertum, seine Bedeutung f¨ur Volkswirtschaft und Staat, Berlin 1909. – Tille, Armin, Zur Geschichte der Unternehmung, in der Ehrengabe f¨ur Lamprecht, 1909. – Weber, Adolf, Der Kampf zwischen Kapital und Arbeit, 1910, p. 86ff., 1920, p. 329ff. – Isay, Das Recht am Unternehmen, Berlin 1910, p. 41ff. – Stillich, O., Die wissenschaftliche Erforschung großindustrieller Unternehmungen, in den Schriften des Deutschen Volkswirtschaftlichen Verbandes, III, No. 6, Berlin 1910. – Keller, Unternehmung und Mehrwert, K¨oln 1912. – Hawley, F. B., Enterprise and the Productive Process, 1907. – Schumacher, Hermann, Unternehmertum und Sozialismus in Jb.f. G. V., XLIII, ¨ 1919, p. 405ff. – Muller, Franz, Funktionen und Psychologie des modernen Großunternehmertums, in Soziale Revue, 1924, No. 1/3, p. 32ff., No. 4/6, p. 65ff. – v. Gottl-Ottlilienfeld, Fordismus? 3rd ed., Jena 1926. – Siew, Die Arbeitgeber und Arbeitnehmer im Lichte von Adam Smith, in den Jb. f. Nat., III. ´ F., Vol. XXXVIII, p. 372ff. – Brants, Les grandes lignes de l’Economie politique V, 1904, pp. 124–132. – Seligman, Principles of Economics, 1906, pp. 84–98. Schumpeter.

NOTES 1. Schumpeter uses the expression “economic subject” to denote what we today would call an “economic agent.” 2. The original term is “soziale.” Throughout the text, we translate this as “collective” as Schumpeter contrasts this level with the individual level. 3. The original term is “wirtschaftliches Sonderleben.” The meaning of the term is “economic, as opposed to general, life.” 4. The “pressure of given circumstances” not only parallels the contemporary use of the term “selection pressure” in behavioural economics and theories of economic evolution, but more importantly also Schumpeter’s own use of the term Auslese (selection) to characterize the process of competition in a string of works during the late 1920s (Schumpeter, 1927, 1929a, b). Thus, among the most important topics Schumpeter focussed upon after resuming his academic career in 1925 was the role of the entrepreneur in economic development, and related, the characterisation of competition by the severe behavioural limitations of economic agents; the latter point leading to the understanding of competition as a selection process. Weber had a few years earlier, partly on grounds of empirical realism, conceptualised (economic and social) competition as a selection process, and explicitly related this conceptualisation to the idea of biological selection (see e.g. Weber, 1978, pp. 38–40). Moreover, Weber (1978) consistently emphasized the importance of behavioural limitations. 5. Although the original German term “bewußt” has been translated as “conscious” a few words before, it here has a different meaning in referring to plans: “deliberate.” 6. That is, a planned economy.

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7. The original term is “Erwerbswirtschaft.” We have chosen to translate this as “profit making economy” because it emphasizes the opposition with “subsistence economy.” In the translation of Weber’s Economy and Society (1978), “Erwerb” is also rendered consistently as “profit-making ” Thus, we view Schumpeter’s contrasting categories of “profit-makin economy” versus “subsistence-economy” as a close parallel to Weber’s distinction between Capitalism associated with “profit-making (Erwerben) and Economic Traditionalism associated with the pursuit of immediate wants (Swedberg, 1998). This statement is, therefore, quite important since Schumpeter in proposing selection pressure and behavioural limitations downplays the importance of the fundamental dichotomy used consistently by Weber in a number of works including Economy and Society. 8. The original term is “feststellen.” It could also have another meaning, which is “fix ” “set in a f xed position.” 9. The original term is “privatwirtschaftlicher Natur.” We use “private enterprising” for “privatwirtschaftlicher” and subsume “Natur” in the qualifie “related to.” 10. The original term is “zur¨uckwirken.” We have translated it as “counter-effect” in line with our translation of Schumpeter (1911), see Becker and Knudsen (2002). 11. Here and in the following, we have added the square brackets and their content in order to give the reader some help in the long enumeration of extra-capitalistic elements that follows. The classificatio into fi e categories of extra-capitalistic elements is ours. 12. In the original the expression “diesen letzteren” unambiguously refers to “Of the unfolding inner logic of production.” “Of the unfolding inner logic of production” is therefore inserted for clarity. 13. Toto coelo is the local ablative form of the Latin word coelum, which means “sky” or “heaven.” The expression literally means “the whole sky.” In the present context, it qualifie the term “unique.” After consultation with a Latin scholar, we arrived at the conclusion that the meaning of the term here is “completely unique.” 14. The original term is “Wirtschaften,” we have stayed close to the Weber translation (Weber, 1978) of the term as “economic action” but have amended it to “economic activity” for reasons of elegance. 15. The original term is “Wirtschaften,” we have stayed close to the Weber translation (Weber, 1978) of the term as “economic action” but have amended it to “economic activity” for reasons of elegance. 16. In deviation from the translation used throughout the text for “Erwerb,” “profit making,” we chose to translate the term “Erwerbssinn” as “economic sense” because it refers to a broader concept here. 17. The original term is “Stadt- und Territorialwirtschaft.” Our translation refers to the famous title of Henry George’s essay “City and Country” firs published in 1883 in his book “Social Problems.” 18. The original term is “Erwerbst¨atigkeit.” The translation used in Weber (1978) is “Acquisitive activity.” We use the freer translation “employment.” 19. The limitations mentioned refer to whether the survey reports changes in the expressions of economic life (the phenomenal level) or rather in its underlying principles. This becomes clear in the above passage, where Schumpeter describes two different opinions about what it is that you can observe when tracing the change of economic life. 20. We have translated “wirtschaftet” as “engages in economic acts” rather than choosing the more ambiguous “acts economically” or “economically acting.” 21. We translate “Betriebe” as “establishments,” following the Weber translation (Weber, 1978).

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22. The original reads “nach ihrem Ebenbilde hin.” Schumpeter here uses the words of Gen. 1:27, a point we thank our referee for. A verbatim translation would be “towards its own image.” Referring to the American Heritage Dictionary, we defin “image” as “A reproduction of the form of a person or an object, especially a sculptured likeness.” This leads to the above translation. 23. The original term is “Kreditwesen,” which literally means a credit system, even if has found use as (modern) technical term for “banking.” 24. The term “Bindungen” has been translated as “constraints.” The term can also have the meaning of “links” or “connection.” However, in our interpretation the constraining character of links is in the focus here. 25. The original term is “Niederkonkurrieren.” 26. “Erwerbsgesellschaften” has been translated as “profi making companies” where “Erwerbsbetrieb” has been translated as “profit-makin enterprise” (Weber, 1978). 27. The original term is “Expositur.” The usual translation is a “wing,” for example to a school or a church. In the Austrian vocabulary, however, “Expositur” also takes on the meaning of a “proxy.” We have chosen the latter translation because it fit the meaning of the sentence, and because Schumpeter was an Austrian, and would therefore be inclined to use “Expositur” in the sense particular to the Austrian. 28. A precise translation would be the slightly more awkward “all but one or few.” 29. I.e., trusts. 30. The original term is “der Grundsatz prinzipiellen Sichselbst¨uberlassens.” 31. The original term is “¨offentlichen Verwaltungsk¨orpers.” In the context that the term is used in here, “K¨orper” also shows up in “K¨orperschaft,” which denotes a public institution (e.g. ministries, district attorneys, etc.). Therefore, the translation as “institutions” seems to be the most appropriate one. It would also have been possible (at least in modern German) to say “¨offentliche Verwaltung” in German, dropping “K¨orper.” The term “public adminstration institution” is somewhat clumsy in English, however. 32. The original term “Bedeutung” has a double meaning: “importance” and “meaning.” We chose “importance” here as it captures the implication of a loss of meaning, and thus encompasses both terms in their implications. 33. The original term is: “niederkonkurriert.” 34. As mentioned above, the point is that the enterprise and the establishment are distinguished on the basis of technical and commercial aspects of economic organization. In the particular instance of the putting out system, Schumpeter points out that the constraints on size appear when it is viewed as an establishment, not when it is viewed as an enterprise. 35. The terms “trades” and “crafts” are used interchangeably. 36. The original term is “b¨urgerliche Nahrung.” In the context of the present discussion of the medieval – and small – city, Schumpeter emphasizes in particular the fact that economic life is taking place in small circles of participants. For this reason, we have chosen to translate “Nahrung” with “earning of income,” referring to the meaning of “Nahrung” as “Ern¨ahrung,” or “Erwerb.” In the present context, “b¨urgerliche” seems to refer to a principle of how to do that. Again, for us the term refers primarily to the small number condition, i.e. the fact that economic activity takes place in small circles. This implies taking into consideration the others to some extent, behaving in a “civilised way” define by the rules of the civilisation in question. 37. The original term is “fest,” which could also mean “fi ed” (hinting towards the institutional support for the stable behaviour pattern rather than this phenomenon itself).

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38. The original term is “Ausbildung” which means “expression.” In the present context, the degree of expression is best rendered by “degree of sophistication.” Note that “Ausbildung” could also mean “education” or “formation.” The two meanings are connected, in that higher sophistication requires higher education to operate. 39. The original term is “Teilaufgabe.” The precise meaning is “sub-task,” a part of a bigger one. This component of the meaning has been omitted. It should be kept in mind that Schumpeter refers to a task that is part of a bundle of tasks. 40. Italics added in order to convey the emphasis on the word in the original. 41. The original term is “grundherrlicher Fronhof.” The precise meaning of this term is that of a (large) farm the owner of which not only owned the land, but also had some kind of property rights over the employees (“Leibeigene,” those “whose body is owned by someone else”). These have to perform labour not out of their own decision, i.e. they have to perform forced labour. 42. Schumpeter subsumes both manor estate and farm economy under one life-form. 43. The original term is Eignung. 44. The original term is “Verumst¨andung,” which is different from “Umst¨ande” (which means circumstances). However, this difference – a participle, i.e. a process – is very difficul to render in English. A word like circumstantificatio would be needed. 45. The original term is “Gesch¨aft.” This term could also have the meaning of “affairs,” but in our understanding in the present context Schumpeter emphasises physical aspects of business activity. 46. In the sense of “money lender.” 47. Italics added to better bring out the contrast to the sentence before, i.e. between possession vs. administration and utilisation of capital. 48. Original: “Typus.” We have chosen to render this as “character,” as this is what Schumpeter is talking about: the character and the function of the entrepreneur. In the passage under consideration, he does not develop a typology of the entrepreneur, but reviews different opinions regarding the character (essence) and function of the entrepreneur. A typology is then presented towards the end of the article. 49. “Of the entrepreneur” added for clarity. Considering the previous as well as the following passages, there is no doubt that “Typus” refers to the entrepreneur. 50. We have chosen to render “Eignungen” with “competences” because they are linked to performances. 51. Similarly, the original term here is “Anbietender.” Thus, Schumpeter describes the actions of demanding and offering something to and from the market, not the fulfilmen of these demands and offers through market exchanges, as our translation implies. However, the translation has been chosen because to make what has just been said clear is a task not possible simply by choosing other terms. 52. The original term is “Kaufakte.” This term is more specifi than “transaction,” referring to “purchasing transaction.” As they refer to means of production (factors), it is clear that the transactions in question are the acquisitions of the factors, not their sale. 53. The original term is “Bedeutung,” which can mean “meaning” as well as “importance.” We choose “importance,” because it also encompasses the implications of “true meaning,” too. Surely, the implications are not to be ignored, and thus the translation as “importance” is the safer choice here. 54. Schumpeter here refers to Section I of this text, where he distinguished two meanings of the term “Unternehmung”: the institution, or “unit” in his parlance, and the activity of entrepreneurs that leads to the emergence of enterprises.

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55. The original term, “Willenseigenschaften,” is more encompassing: “characteristics of will.” Our translation emphasizes the strength of will as its most important characteristic, an interpretation in line with Schumpeter’s early writings (see Becker & Knudsen, 2002). 56. The original term is “¨aussere” – this literally means “external” in the sense of superficia or at firs sight. As becomes clear on the next page, this does not make very much sense, because Schumpeter talks about “¨aussere Position in irgendwelchem Organismus” – so it is internal, not external. We think that Schumpeter here means another connotation of “¨aussere,” the fact of being recognizable from the outside. This meaning is best conveyed by the term “formal,” as in a formal hierarchy. 57. Although the original term “Wesen” also carries the meaning of “essence,” we believe Schumpeter does not talk about the essence of the function here, but about its phenomenal expression. 58. The original term is “Vorabeiter.” The usual meaning is a man who serves as the leader of “ordinary” workers of a workcrew. 59. Our translation of “sei es . . . sei es’ is a little stronger than the original term, as it introduces – at least implicitly – an element of opposition in the pair that is not emphasised by Schumpeter. 60. Italics added to better bring out the contrast with “something already established.” 61. See footnote on “external” above. 62. Schumpeter here refers to a complicated intertwining of factors, not a conglomerate in the sense of “trust,” i.e. an organisation. 63. The original term is “mehr oder weniger regelm¨assig,” and the straight translation of that would be “on a more or less regular basis.” It renders the translation a bit clumsy, though, and it can be argued that “usually” also encompasses, if however does not emphasise, the “more or less”-aspect. 64. These possibilities. 65. The original term is “Produktivkraft.” 66. The original term “Absatzm¨arkte” emphasises that it is markets for the sale of products, not markets for purchasing of supplies. 67. “Absatz” has been translated as marketing, giving the term a wider interpretation than the alternative, “sales.” 68. The original says: “oder selbst erst geschaffen werden.” There are three possibilities of how “selbst” could be used here: (i) it refers to the subject, i.e. the one who has to estimate: “or yet have to be created by oneself”; (ii) it refers to the object of the estimation: “or yet have to be created themselves”; (iii) it has a mere gap-filling/sentence-f w function, and thus can be dropped in the translation. 69. When Schumpeter talks about “organisational forms” (“Organisationsformen”), he thinks about the organisation of an economy – and not, as a modern perspective would imply, firms This becomes clear when considering the alternative organisational forms available: market economy and socialist economy. Therefore, the term “organisational forms” has the meaning of “forms that an economy can be organised in.” 70. The original term is “Organstellung.” Note how the word “Organ” is close to the “Organism” that Schumpeter talks about elsewhere in the text. In our interpretation – and translation of the term “Organstellung” as “administrative position” – (at least) one important meaning of “Organism” for Schumpeter is what we today would call hierarchy. 71. The original term here is “Einheit.” We have chosen to translate this as “whole,” because we think what is emphasised here is not the meaning of “Einheit” as a “unit” (that

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can be counted for example), but the fact that this it forms a recognisable whole (Ein-heit, literally “one-being”). 72. The original term is “die Ihren.” Strictly speaking, this could mean all persons that are somehow attached to the entrepreneur. However, the family seems to be the most important group of such persons. 73. The original term is “durch seine Schulden hindurch den Erfolg erstritt.” 74. The term “Arbeiterschaft” has been translated as “working class” although the term “class” might introduce a new emphasis here. It has been chosen because it is the best term available for a collective of workers, on whom the emphasis is here. 75. The original term “Leiter” is best translated as “leader.” This, however, is also the best translation of the term “F¨uhrer” and has been used as such in our translation. In order not to confound “Leiter” and “F¨uhrer,” we decided to translate “Leiter” as “manager,” in the sense that this is the person who directs others. Another possibility would be “Director.” In contemporary use, “manager” rather than “Director,” however, better captures the meaning associated with the use of the term “Leiter” in the present text. 76. This is the precise translation of the term “leiternder oder gesch¨aftsf¨uhrender Aufsichtsrat.” From a modern perspective, the executive and management positions would be located on the executive board, while the supervisory board would have supervisory tasks. It seems that in the context Schumpeter wrote in, this was different. 77. The orginal term is “B¨urger,” which also, more generally, means “citizen.” 78. The original line reads “des Gr¨unders (promoter).” 79. I.e., in the negative, the importance of the entrepreneurial function is falling. 80. (i) That the social whole is getting ever more used to incessant innovation within the realm of the economic process; and (ii) that it is becoming ever more taken for granted that every new insight, as soon as it presents itself, is also carried out into economic practice because the possibilities for calculation are improving.

ACKNOWLEDGMENTS The authors and the publisher would like to thank Urban & Fischer Verlag for the permission to print the translation of Unternehmer (Entrepreneur). The authors are very grateful to Meta Andr´es for linguistic assistance with the translation, to Minna Skafte Jensen for assistance with a particularly contrary Latin expression, to Richard Swedberg for the inspiration that led to the translation, and to Ulrich Hedtke, Roger Koppl and an anonymous reviewer for very useful comments on a draft of the translation.

REFERENCES Becker, M. C., & Knudsen, T. (2002). Schumpeter 1911: Farsighted visions of economic development. American Journal of Economics and Sociology, 61(2), 387–403. George, H. (1953) [1883]. Social problems. New York: Robert Schalkenbach Foundation.

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Schumpeter, J. A. (1911). Theorie der wirtschaftlichen Entwicklung (1st ed.). Duncker & Humblot, Leipzig. Schumpeter, J. A. (1927). Unternehmerfunktion und Arbeiterinteresse. Der Arbeitgeber, 17, 166–170. Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 160–173). Schumpeter, J. A. (1929a). Der Unternehmer in der Volkswirtschaft von heute. In: B. Harms (Ed.), Strukturwandlungen der Deutschen Volkswirtschaft (2nd ed., Vol. 1, pp. 303–326). Berlin: Verlag von Reimar Hobbing. Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 226–247). ¨ Schumpeter, J. A. (1929b). Okonomie und Psychologie des Unternehmers. Vortrag vor der 10. Ordentlichen Mitgliederversammlung des Zentralverbandes der deutschen Metallwalzwerke- und H¨utten-Industrie e. V. am 22. Mai 1929 in M¨unchen. Leipzig: Haberland. Reprinted in: C. Seidl & W. F. Stolper (1993) (pp. 193–204). Swedberg, R. (1998). Max Weber and the idea of economic sociology. Princeton, New Jersey: Princeton University Press. Weber, M. (1978). Economy and society (2 Vols). In: G. Roth & C. Wittich (Eds). Berkeley: University of California Press.

SCHUMPETER’S “ENTREPRENEUR” IN HISTORICAL CONTEXT Geoffrey M. Hodgson Markus Becker and Thorbjørn Knudsen have rendered a valuable service by bringing the attention of the English-speaking academic world to Joseph Schumpeter’s important 1928 article on the entrepreneur. One of the important features of this article is the acknowledgement of the influenc of the German historical school on Schumpeter’s writing. The German historical school was prominent in Germany from the 1840s to the 1940s (Hodgson, 2001). It was also internationally influential Leading economists such as Alfred Marshall, Richard Ely, Edwin Seligman, John Bates Clark and others traveled to Germany to study under leading members of that school (Herbst, 1965). The idea that the German historicists made no contribution to economic theory is a modern myth. Marshall (1890, 1919), for example, praised the contribution of the German historicists in his Principles and his Industry and Trade, where numerous references were made to members of this school. Schumpeter acknowledges their influenc when he writes: “it is nowadays common to construct historical epochs, and to associate these epochs with ‘economic systems’ and ‘economic mentalities’ .” The construction of systems of historical periodisation was characteristic of the German historical school from its inception. This led to important methodological debates concerning the methods and criteria of classification to which Max Weber among several others made a significan contribution. Weber regarded himself as a member of the German historical school and Schumpeter (1954, pp. 815–816) acknowledged him as such. The article under discussion makes approving references to German Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 267–270 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06014-9

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historicists such Gustav Schmoller, Karl B¨ucher, Albert Sch¨affle Max Weber and Werner Sombart. Schumpeter’s links with the German historical school are thus worthy of emphasis (Ebner, 2000; Streissler, 1994). In this article Schumpeter also makes a very important statement concerning the German historical school, which we should note well: “The historical and sociological analysis of entrepreneurship is of recent date and has developed exclusively through the historical school.” Although Schumpeter did not regard the work of the historical school as “pure economics” he makes a very important concession here. Indeed, Nicholas Balabkins (2000) has shown that several of Schumpeter’s views concerning entrepreneurship have their origin in the work of Sch¨affle The enduring influenc of Karl Marx on Schumpeter’s thought is also evident here, for example in his approving discussion of the “movement toward concentration” and monopoly or oligopoly with an industry. However, a tension existed in Schumpeter’s thought between, on the one hand, what he described as “pure economics” and on the other hand, the historical approach. Schumpeter (1908, 1926) had attempted to resolve the ongoing Methodenstreit by arguing that the two approaches were logical compatible with one another, as long as it is recognized that they are addressing different problems. Pure economics addressed supposedly universal principles of individual choice and allocation. Historicism addressed matters of historical specificit . But the tension occurs when Schumpeter wavers to some degree over whether to make categories such as “the enterprise” universal or historically specific This tension is evident in the article under discussion. When addressing the enterprise, Schumpeter attempts to claim it for “pure economics” by proclaiming without discussion that “the enterprise exists in all observable historical states . . . in its economic essence it always manifests itself in some way.” It is rather obvious that no historical state is literally “observable” because it is impossible to travel into the past. But if Schumpeter had the means in 1928 to visit New Guinea, northern Canada or the African interior he would have found it very difficul to fin any institution remotely resembling the capitalist enterprises of Europe or the United States. He could, of course, have described Inuit fishin expeditions or Masai cattle herding as “enterprises” but this would be stretching the word to the point where its important capitalist substance is lost. Clearly, in asserting an ahistorical “economic essence” for the enterprise, Schumpeter was making a genuflectio to Carl Menger’s (1883) famous position in the Methodenstreit. Yet in other passages of this same article, Schumpeter clearly and specificall associates “the enterprise” with the modern capitalist period. He thus also turns and bows to the German historical school. Schumpeter’s discussion of entrepreneurship and leadership, its relationship with Walrasian equilibrium analysis, and its stress on the vision and capacity

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of the entrepreneur to break with convention, is largely familiar already in the English language literature on Schumpeter (Hagedorn, 1996; Santarelli & Pesciarelli, 1990). Another related part of the Schumpeter story is less well known, and presents a serious problem for historians of economic thought, as well as for those interested in Schumpeter’s ideas for other reasons. I have raised this problem elsewhere (Hodgson, 2001) but for convenience I also relate it briefl here. The article under discussion is typical of a period when Schumpeter was acknowledging the importance of the historical school and trying to fin them a place alongside, but not within, “pure economics.” Hence Schumpeter (1926, pp. 3, 18, 22, 24 n., 46) in an article published two years earlier wrote of Schmoller’s “great achievements,” of his “greatness,” of his work being “the programmed for the future,” of “his overall achievements” and of his “success.” By 1930, however, Schumpeter was to shift the balance of his assessment of historicism and institutionalism, towards criticism alone. Sometime after his firs visit to Harvard in 1927, Schumpeter became more openly critical of the historical school and highly dismissive of the institutionalist tradition. In the Harvard-based Quarterly Journal of Economics Schumpeter (1930, p. 158) referred scathingly to the intellectual capacities of both Schmoller and Thorstein Veblen, and to “the serious and even glaring defects in their equipment, both natural and acquired.” This atrocious personal abuse was supplemented with sweeping dismissals of much of historicism and institutionalism. Schumpeter (1930, p. 159) thus complained of the “unsatisfactory state of economic science in Germany.” Also, in a talk in Japan in 1931, Schumpeter (1991, p. 292) referred to the “methodological errors of German historians.” He also described institutionalism as “the one dark spot in the American atmosphere.” Overall, there was a remarkable transformation from Schumpeter’s 1926 and 1928 articles with their sympathetic mentions of the historical school, to the hostile statements of 1930–1931, in which Schumpeter was seemingly keen to dismiss – and to detach himself from – the entire German historical school and American institutionalism. The question I raised elsewhere (Hodgson, 2001) was the explanation of Schumpeter’s motivation for this strange and sudden switch of attitude. We have to consider the unpalatable possibility that Schumpeter was trying to curry favor with a group of anti-institutionalist American economists in order to obtain his professorial appointment in Harvard in 1932. The timing is too close to ignore this possibility. I do not claim to have proved this hypothesis. It should also be noted that even within Harvard there were some with institutionalist sympathies. But the possibility remains, to be proved or disproved, that Schumpeter was acting with a measure of careerist motivation.

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If so, the appearance of Schumpeter’s 1928 article on the entrepreneur would not be without irony. Did Schumpeter himself take on an “entrepreneurial function” involving an amount of “self-interest” when he suddenly and subsequently changed his public views on the importance and worth of the German historical school? Is there an element of self-referentiality here? In any case, Schumpeter was not without a good measure of entrepreneurial spirit when he uprooted himself from Germany to move to the United States. Schumpeter remains, as always, a magnificen enigma.

REFERENCES Balabkins, N. W. (2000). Schumpeter’s “creatively adapted” innovator. Paper prepared for the 13th Heilbronn Conference on Schumpeter’s German Works, June 23–25, unpublished mimeo. Ebner, A. (2000). Schumpeter and the “Schmollerprogramm”: Integrating theory and history in the analysis of economic development. Journal of Evolutionary Economics, 10(3), 355–372. Hagedorn, J. (1996). Innovation and entrepreneurship: Schumpeter revisited. Industrial and Corporate Change, 5, 883–896. Herbst, J. (1965). The German historical school in American scholarship: A study in the transfer of culture. Ithaca, NY: Cornell University Press. Hodgson, G. M. (2001). How economics forgot history: The problem of historical specificity in social science. London and New York: Routledge. Marshall, A. (1890). Principles of economics: An introductory volume (1st ed.). London: Macmillan. Marshall, A. (1919). Industry and trade. London: Macmillan. Menger, C. (1883). Untersuchungen u¨ ber die methode der sozialwissenschaften und der politischen ¨ Okonomie insbesondere. T¨ubingen: J. C. B. Mohr. Published in English in 1985 as: Investigations into the method of the social sciences with special reference to economics. New York: New York University Press. Santarelli, E., & Pesciarelli, E. (1990). The emergence of a vision: The development of Schumpeter’s theory of entrepreneurship. History of Political Economy, 22, 677–696. Schumpeter, J. A. (1908). Das wesen und der hauptinhalt der theoretischen national¨okonomie. M¨unchen und Leipzig: Duncker und Humblot. Schumpeter, J. A. (1926). Gustav v. Schmoller und die probleme von heute. Schmollers Jahrbuch f¨ur Gesetzgebung, Verwaltung und Volkwirtschaft im Deutschen Reiche, 50, 1–52. Schumpeter, J. A. (1954). History of economic analysis. Oxford and New York: Oxford University Press. Schumpeter, J. A. (1991). The economics and sociology of capitalism. In: R. Swedberg (Ed.). Princeton: Princeton University Press. Streissler, E. W. (1994). The influenc of German and Austrian economics on Joseph A. Schumpeter. In: Y. Shionoya & M. Perlman (Eds), Schumpeter in the History of Ideas. Ann Arbor, MI: University of Michigan Press.

A TRANSLATION TOO FAITHFUL? Nicholas W. Balabkins Schumpeter is popular these days among the economic policy makers and politicians in Washington, DC. In “high tech” America, Schumpeter’s felicitous phrase “creative destruction” is on many lips. The recent meltdown of numerous dot.com firm on the NASDAQ exchange has taught formerly optimistic baby boomers how hard the “creative destruction” process can hit their pocketbooks and wipe out their accumulations of “shareholders value.” Yet for many, “creative destruction” is still the guidepost to a better and more prosperous future. The translation of Schumpeter’s German article “Unternehmer” into English is a belated addition to the rapidly growing literature on Schumpeter. During the “Schumpeter Renaissance” of the last two decades, hundreds of articles have been written on various aspects of his work. The Library of the Institut f¨ur Weltwirtschaft in Kiel, Germany, has the most complete listing of this literature. All translations are difficult but Schumpeter’s writings are particularly challenging. The late Gottfried Haberler wrote in 1951 that Schumpeter’s German writing style resembled Baroque. He wrote in long sentences, with many qualifying phrases, and sometimes extravagantly ornate dangling participles. His paragraphs were veritable monuments to his incredible erudition and elitist intellect. For these reasons, Markus C. Becker and Thorbjørn Knudsen faced a daunting task in converting the original German text into an acceptable, present-day English. Sometimes they may have erred on the side of excess fealty to Schumpeter’s German style. Some parts of the translation have become what might be called Mexican Churriguresco, which is an overloaded Rococo. For this reason, some parts of the translation appear to be anachronistic. English is the language of economists these days, but this translation would offer more accessibility Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 271–273 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06015-0

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to the reader if the two translators had cast their product into a staccato English form of presentation, with a simple sentence structure of noun, verb, object, and adverb sequences. The firs section of the translated essay is called “The Essence of the Enterprise. Historical Review of its Forms or Types.” To understand why Schumpeter’s baroque writing style has become Mexican Churriguresco, try to read and understand these firs 10 pages! This wordy section could have been omitted by translators. It adds virtually nothing to the understanding of the essence of Joseph A. Schumpeter’s innovator. The second section pp. 13–16, dealing with the concept of entrepreneur in the economic literature, is more accessible to the modern reader. The third part, pp. 16–20 presents the essence of Schumpeter’s notion of the entrepreneur. Here the leadership phenomena in the form of “something new” is imbedded in the “circular fl w” setting. Page 19 lists the fi e forms of innovations, well-known from Schumpeter’s The Theory of Economic Development of 1934 (Reprint of 1969, p. 66). For Schumpeter, innovations take the form of producing new commodities, organizing technological changes in the production of commodities already in use, opening up new markets, discovering new sources of raw materials, and setting up new management organizations, such as the creating or breaking up of a monopoly. By carrying out all of these innovations, singly or in combination, the entrepreneur earns more than just the customary return on his business operations. This extra profi represents his reward for doing new things in economic life. Schumpeter gave three reasons why the entrepreneurial function is rare and why it is difficul to become an innovating entrepreneur. To produce a new commodity, one must act outside customary channels and depend more on intuition than on facts or custom. Secondly, one must break through very fi ed habits of thinking, and their energy-saving function, that have become subconscious. This requires personal force and vigor, which are rare in life; and this makes the entrepreneur something that is sui generis. Thirdly, in order to introduce a new product on the market, the entrepreneur has to “overcome” the reaction of the social environment and convince people that his product is of superior quality. To Schumpeter, it is innovation, not routine, that enables the entrepreneur to make pure profits All this is faithfully and elegantly translated in the third section. Students of economics will love this section for its brevity, clarity and precision. Section IV, pp. 20–24 deals with the multifaceted types of entrepreneurship and shows how the 19th century innovator has slowly become the pioneer of the planned economy. Unlike Section III, this section is wordy and confusing. Section V raises three questions about entrepreneurship and discusses briefl why private enterprise is superior to public enterprise and why the entrepreneurial function is decreasing. Pages 26–30

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contain the literature on entrepreneurship extant in the 1920s. The footnotes on pp. 31–35 are full of fascinating examples of why the two authors chose particular English terms to represent Schumpeter’s expressions. The translators reflec thorough knowledge of the two languages and should be congratulated for making Schumpeter’s article available to the tongue-tied economists of the present day. Finally, it may be proper to raise the question of the genesis of the innovator’s concept. What were the spiritual roots of Schumpeter’s innovator? Which thinkers led Schumpeter to the fertile concept of the innovating entrepreneur, who unleashed the process of “creative destruction”? There is substantial literature on this topic. Eduard M¨arz wrote that the innovator idea was not a bolt out of the blue and cited Marx, Wieser, Sombart, Wirth, Tarde and Pareto. Erich Streissler added Gottlieb Hufeland, Karl H. Rau, Riedel and Wieser as possible influences Nicolo DeVecchi felt that Philippovich, Sch¨affl and Schmoller influence him. One of the most overlooked influence in Schumpeter was by Albert Sch¨affle Sch¨affle who was born in 1831 and died in 1903, was government official journalist, professor at the Universities of T¨ubingen and Vienna, a minister of commerce in the Austro-Hungarian Empire in 1871, author of numerous books, and the editor of the Zeitschrift f¨ur die gesamte Staatswissenschaft for more than three decades. In 1981, when I was a visiting professor at the University of Frankfurt in West Germany, I read an essay by Professor Knut Borchardt, who was teaching then at the University of Munich. Published in 1961, in the Zeitschrift fur die gesamte Staatswissenschaft, Borchardt’s essay asserted that Sch¨affl was the most Schumpeterian economist of the 19th century. In the German version of “Entrepreneur,” Schumpeter cites Sch¨affle s article of 1869 and his 1870 book, Kapitalismus und Sozialismus. Schumpeter does not mention Sch¨affle s 1867 work, Die national¨okonomische Theorie der ausschliessenden Absatzverh¨altnisse, insbesondere des literarisch-artistischen Urheberrechts, des Patent-Muster, u. Firmenschutzes nebst Beitr¨agen zur Grundrentenlehre.1 The translators could have mentioned this work by Sch¨affle

NOTE 1. On p. 268, Sch¨affl differentiated between two kinds of innovations: (1) what he called commercial innovations, consisting of the discovery of new sources of inputs, such as raw materials, and new marketing outlets; and (2) what Sch¨affl called industrial innovations, referring to the introduction of new products and/or new production methods for an existing commodity. The genesis of Schumpeter’s innovator was not a part of Schumpeter’s original essay.

SCHUMPETER ON ENTREPRENEURSHIP Young Back Choi The English translation of Schumpeter’s essay on entrepreneurship, written around the time when he prepared the second edition of Theorie der Wirtschaftlichen Enwicklung (1926), from which the English translation The Theory of Economic Development (1934) was made, contains many of the ideas found in The Theory of Economic Development and in Capitalism, Socialism and Democracy (1942). Since the essay, “Entrepreneur” (1928) is relatively short, yet contains most of the central ideas developed in his later works, the essay can be regarded as a blueprint for his life’s work. The task of evaluating the significanc and the value of the translation in addressing the questions of whether or not, and the extent to which, Schumpeter had changed his ideas on entrepreneurship since the firs edition of Theorie (1912), however, falls on Schumpeter scholars (e.g. Elliott, 1983; Shionoya, 1997). My comment here, instead, will be limited to Schumpeter’s concept of entrepreneurship as stated in the essay. For Schumpeter, the entrepreneur, stripped of various historical manifestations, is a leader in the economic sphere, carrying out new combinations. Repeatedly, Schumpeter emphasizes that the essence of entrepreneurship is not so much the discovery of profitabl opportunities as the will, and the provision of leadership, to carry out new combinations to take advantage of the opportunities, in the face of various obstacles (against innovation) present in the stationary state. The entrepreneur is meant as a means of explaining the process of economic development, including business cycles. Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 275–278 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06016-2

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The entrepreneur, however, is a distinct type grafted on to the traditional economic theory, leading some critics to doubt whether Schumpeter’s conception of entrepreneurship adds anything to economic theory, other than colorful descriptions of what economists normally call exogenous shocks (e.g. Demsetz, 1983). Schumpeter’s treatment of the entrepreneur as a distinct type is not only unsatisfactory from the point of view of formulating a theory of economic development, but probably is a reflectio of a faulty understanding of the market processes, leading to some questionable statements he makes in the essay, especially when he tries to answer “particular questions.” For example, in several places (pp. 9, 21, and 25) Schumpeter speaks of competitive economy as a thing of the past (in contrast to the “modern economy” of 1926, characterized as being dominated by large corporations and trusts). In keeping with the preceding view, Schumpeter predicts gradual marginalization (or professionalization, or routinization, or even the eventual disappearance) of entrepreneurship with the advent of large corporations, a theme Schumpeter is later to develop more fully in Capitalism, Socialism and Democracy. Schumpeter’s keen interest in demonstrating the dialectical process of capitalism (perhaps, meant as a substitute for Marx’s laws of the motion of capitalism), which might have been of interest in his contemporary intellectual milieu, now appears to be misdirected. Finally, his reasoning for the superiority of private enterprises (or the inferiority of public enterprises), that the entrepreneur in a private enterprise has complete freedom of action, whereas the leading man in a public enterprise is paralyzed by having to answer numerous constituents, is also indicative of deficiencie in his understanding of the market processes. Does Schumpeter presume that a public enterprise run by a despot who does not owe any explanation to anyone will be as productive as a private enterprise? The real difference, I believe, is not whether or not the leader is restricted in his freedom of choice, but competition and the feedback it provides. Despite his colorful descriptions of the function of the entrepreneur in the market economy, Schumpeter seems to have under-appreciated the fact that in the market, competition is perennial and even in “modern economy” – dominant firm are constantly challenged by entrepreneurs and often supplanted by them. The deficien y of Schumpeter’s concept of the entrepreneur, grafted onto the apparatus of competitive equilibrium as a means of understanding the market process, is abundantly clear when Schumpeter’s concept is compared to that of Kirzner. Kirzner (1973, 1979) argues that the concept of competitive equilibrium is deficien in capturing the essential feature of the market process, on the ground that the competitive equilibrium portrays a state of the exhaustion of profitabl opportunities and, therefore, permits no room for the entrepreneur, the real driving force of the market process. Kirzner believes that economic agents should be portrayed not as maximizing satisfaction given the means-ends framework, but as

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groping for a serviceable means-ends framework so that different individuals may come to perceive a situation differently and behave accordingly. By discarding the competitive equilibrium apparatus, Kirzner takes as given the existence of profitabl opportunities, represented by price inconsistencies or by the possibilities of deploying resources and goods at higher valued uses. It is as if there are free hundred dollar bills lying on the street to be picked up by those who merely notice them. For Kirzner, therefore, entrepreneurship consists of alertness to (and exploitation of) profitabl opportunities neglected by others. Compare to Schumpeter’s entrepreneur as innovator, Kirzner’s conception of entrepreneur as arbitrageur, seems to be in the mold of the age-old idea of profi making. It appears that Schumpeter and Kirzner have in mind different types of entrepreneurs. The examples they use reinforce the impression. But it should be noted that Kirzner’s concept of the entrepreneur is not inconsistent with epoch-making innovations; For Schumpeterian entrepreneur’s new combination to be profitable the going prices of the input the entrepreneur acquires must be such that the revenue from the enterprise results in profit In this sense, Schumpeter and Kirzner can be seen as presenting different perspectives on the self-same entrepreneur (e.g. Choi, 1995; Hebert & Link, 1982). Yet, their conceptions of entrepreneurship are different enough to imply different views on the prospect of the market; Kirzner would never have said that competition is pass´e, or that entrepreneurship will be routinized, or even marginalized. This is not to say that Schumpeter’s ruminations on the sociology and psychology of the entrepreneur are of no interest. On the contrary, they point to some of the missing elements in contemporary economic analysis. In emphasizing the leadership role of the entrepreneur Schumpeter highlights the difficultie of innovation, i.e. successfully deviating from conventional practices – the difficult of conceiving profitabl new combinations, of summoning courage to carry them out in the face of resistance, and of acquiring necessary cooperation of others, including consumers. Schumpeter’s evocative descriptions of the entrepreneur point to possibly fruitful areas of inquiry concerning the processes of belief formation and knowledge-sharing. Schumpeter’s attempt to fin connections between the predominance of stock companies and the composition of entrepreneurs, and their selection, is also of great interest from the point of view of social mobility. Whether or not Schumpeter’s sociological and psychological insights into the entrepreneur is original to him (which may be a question of interest to Schumpeter scholars, but not necessarily to others), whether or not he succeeded in integrating the entrepreneur into economic theory (which many feel that he fell short), there is little doubt that his conception of entrepreneurship has excited the imagination of many economists and other students of society. Schumpeter was an entrepreneur.

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REFERENCES Choi, Y. B. (1995). The entrepreneur: Schumpeter versus Kirzner. Advances in Austrian Economics, 2A, 55–65. Demsetz, H. (1983). The neglect of entrepreneurship. In: J. Ronen (Ed.), Entrepreneurship (pp. 271–280). Lexington, MA: D. C. Heath. Elliott, J. E. (1983). Introduction. In: J. A. Schumpeter (Ed.), The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. New Brunswick, NJ: Transaction Publishers. Hebert, R. F., & Link, A. N. (1982). The entrepreneur: Mainstream views and radical critiques. New York: Praeger. Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press. Kirzner, I. M. (1979). Perception, opportunity and profit. Chicago: University of Chicago Press. Shionoya, Y. (1997). Schumpeter and the idea of social science. New York: Cambridge University Press. Schumpeter, J. A. (1983) [1934]. The theory of economic development: An inquiry into profits, capital, credit, interest, and the business cycle. New Brunswick, NJ: Transaction Publishers. Schumpeter, J. A. (1942). Capitalism, socialism and democracy. New York: Harper.

SCHUMPETER’S “ENTREPRENEUR” AND WHY WE NEED ECONOMIC SOCIOLOGY Richard Swedberg Let me start by thanking Markus Becker and Thorbjørn Knudsen for making this important article available to us all and for providing such a careful translation. “Entrepreneur” is a central piece in Schumpeter’s production, and it is a sad fact that it has not been available in English till now. This article, to be more precise, is one of Schumpeter’s key writings on entrepreneurship. It is only rivaled, in this respect, by Chapter 2 in Theory of Economic Development (1911, 1926, 1934), some passages in Capitalism, Socialism and Democracy (1942), and a few articles from the late 1940s. The sections on entrepreneurship in the two books I just mentioned are subordinate to the wider themes of these books and integrated into these; and the articles from the late 1940s represent primarily an attempt from Schumpeter’s side to forge a union between the economic theory of entrepreneurship and the economic history of entrepreneurship. When it comes to a single, comprehensive work that is exclusively devoted to entrepreneurship, “Entrepreneur” is unique and alone. As to translations of Schumpeter into English, I am sure that Becker and Knudsen have much to say on this account because Schumpeter as a master of the German language, and Schumpeter as a master of the English language are two very different people. Or to put it in more plainly: it is very hard to translate Schumpeter from German into English. There are essentially two options available to the translator, according to Stolper and others who have attempted to render Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 279–282 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06017-4

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Schumpeter into English. Either one keeps Schumpeter’s long German sentences, which means that one keeps close to the original, even if this will produce a strange effect in English. Or one can chop up Schumpeter’s sentences into short Anglosaxon sentences, and lose quite a bit of the bite and charm of Schumpeter’s original formulations. Becker and Knudsen have made their choice, and a wise one: a compromise. An abundance of notes have also been included to assist the reader who has questions. In commenting on “Entrepreneur” one can obviously pick different topics. One of these would be to set this article into the general context of the development of Schumpeter’s theory of entrepreneurship, from 1911 and onwards. This is what Becker and Knudsen have done in their introduction. Another way to proceed would be to highlight the importance of this article for Schumpeter’s economic sociology, something which I will try to do. Other topics as well are naturally possible, as illustrated by the other comments in this issue. All of these different perspectives clearly point to the richness of “Entrepreneur.” There is also the fact that Schumpeter, like all the classics, always has some extra wealth to spread around – and this is also true for “Entrepreneur.” There is as always the vibrant formulation, the brilliant aside, and the new idea that Schumpeter suddenly springs on the reader. The reader of “Entrepreneur” has no doubt found this out for herself. I will nonetheless cite a few of my own favorites, before concentrating on what I think constitutes the main contribution of this article, from the viewpoint of economic sociology. One of these fin points is to be found in a passage on the difficult of being entrepreneurial, from the viewpoint of the actor. Schumpeter pinpoints the difficult as that of every creator: on the one hand there is the social reality of what already exists (and which is not very good); and on the other hand there is the unreality of what is what has not yet come into being (but which is better). I quote: From a subjective point of view it is more difficul to do something new than something familiar. In doing something new we are not supported by the same feeling of solid reality (p. 19).

Another handsome point can be found in Schumpeter’s discussion of self-interest. For most economists self-interest means maximizing profi or utility. In a sentence that deserves to be much cited, Schumpeter says something different: Self-interest can adopt many forms. Self-interest can adapt to very different social circumstances, and . . . its most simple form – the striving for maximal personal monetary profi – is substituted by objectives of a very different kind (pp. 24–25).

Several other examples could be cited, but I would now like to say something about the significanc of “Entrepreneur” for economic sociology. Schumpeter,

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as we know, is the firs economist to have realized the contribution that economic sociology can make to the understanding and explanation of economic phenomena; and he repeatedly emphasized that economic sociology should be part of the economist’s “tool box.” The main reason for this, he said, is that economists and economic sociologists look at different parts of the same economic process; economic theory looks at the economic mechanisms, and economic sociology at their institutional frame. Both, in other words, are needed to supply a full picture of what is going on. As we know from History of Economic Analysis, contributions from the historian and the statistician are needed as well. But there is more. Sometimes the institutional element in the economy can take over and interfere with the workings of the economic mechanisms, instead of supporting their functioning. This is the great theme of Capitalism, Socialism and Democracy – and it is also the great theme of “Entrepreneur,” produced some fiftee years earlier. Both works raise the question “Why do we need economic sociology?”, and both give the same answer: “Because otherwise you will not understand what is going on at the very heart of the economy.” Capitalism, Socialism and Democracy makes this argument louder and in much more detail than what “Entrepreneur” does. But Schumpeter also serves the reader so many other treats in Capitalism, Socialism and Democracy that this particular one tends to get lost. This work, to recall, contains a history of socialism (including a masterful analysis of Marx), a path-breaking new theory of democracy, a theory of economic competition, a theory of political entrepreneurship, and quite a bit more. In “Entrepreneur,” in contrast, Schumpeter had been assigned one specifi topic and a limited space in which to discuss it – and this means that we get his argument about economic sociology in a more straightforward version. Since “Entrepreneur” can be found in the same issue as this comment, it is not necessary for me to go through Schumpeter’s argument in any detail. A quick summary may nonetheless be helpful, and would go as follows. Economic sociology essentially looks at the impact of institutional or non-economic forces on economic topics. This type of analysis can be of great assistance in analyzing entrepreneurship, or more precisely, in analyzing firm led by entrepreneurs. The fir is the key unit in a capitalist economy. As long as the entrepreneurial function (leading the fir in an innovative way) coincides with the goal of capital (making a profit) there is no problem. In modern capitalist society, however, there is an agency problem, or in Schumpeter’s terminology “the link between entrepreneurial profi and activity [of the leader of the firm] (p. 25) tends to be loose. The reasons for this are the ones that we are familiar with from Capitalism, Socialism and Democracy and have much to do with the emergence of the giant corporation. Entrepreneurship, in all brevity, is becoming more and more accepted, and managers are becoming more and more like civil servants. The

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entrepreneurial energies of today’s managers have been drained, and this poses a threat to capitalism. Was Schumpeter right that capitalism was threatened? The conventional answer these days is “No – socialism has clearly failed and capitalism is stronger than ever.” As far as it goes, this answer is correct. Schumpeter’s argument about the giant corporation, however, would seem to be essentially correct. The enormous firm that started to come into being in the late 1800s, and which Alfred Chandler has praised in book after book, may well have had a deadening impact on entrepreneurship. One indicator of this is the problems of IBM and many similar giant companies have had in renewing themselves. Schumpeter was also correct in pinpointing the agency problem between investor and manager as being central to a vital capitalism. And he surely was correct in his main thesis, insofar as methodology is concerned: we need economic sociology if we are to understand what is happening at the very heart of the economy.

SCHUMPETER AND THE OBSOLESCENCE OF THE ENTREPRENEUR Richard N. Langlois ABSTRACT This paper argues that the well-known “two Schumpeters” thesis, as understood in the Anglo-American literature on technological change, is clearly wrong. Equally wrong is the idea that the fundamentals of Schumpeter’s thought on entrepreneurship were influenced importantly by his observation of large firms in the United States after 1931. The obsolescence thesis speaks to a distinction between early capitalism and later capitalism, perhaps, but not to an earlier and later Schumpeter. A more important point is that the obsolescence thesis is wrong. It rests on a confusion – or perhaps a bait-and-switch – between two quite different kinds of economic knowledge.

I. INTRODUCTION From relative obscurity, the name of Joseph Schumpeter has leapt to prominence in recent years. In part, this reflect the blossoming of entrepreneurial studies as a distinct fiel of research1 (Shane & Venkataraman, 2000). Schumpeter’s famous discussion of the role of bold entrepreneurs in creating new combinations and redirecting the means of production into new channels is an important founding stone for any study of entrepreneurship. During the three or so decades after Austrian Economics and Entrepreneurial Studies Advances in Austrian Economics, Volume 6, 283–298 Copyright © 2003 by Elsevier Science Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06018-6

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Schumpeter’s death in 1950, however, a quite different set of Schumpeterian ideas had entered public consciousness, largely through the popular writings of John Kenneth Galbraith (1967). Far from exalting the role of individual initiative in economic change, this literature foretold – or even claimed to be chronicling – the demise of the entrepreneur. Innovation would become – or even had become – a matter of routine in the large bureaucratic corporation. Perhaps astoundingly, these two seemingly incompatible sets of ideas do both emanate from Schumpeter. The Anglo-American literature of technological change is one of the few areas of economic writing in which Schumpeter maintained a following and in which he has long been accorded some modicum of the attention he deserves. This literature was quite naturally forced to deal with the problem of the obsolescence thesis and its relationship to the theory of (individual) entrepreneurship. The result has been a standard interpretation of the mechanization-of-progress thesis that has become an unexamined conventional wisdom. It goes something like this. The argument in Schumpeter’s early writings is really quite different from that in his later work. There are, in effect, two Schumpeters: an “early” Schumpeter and a “later” Schumpeter. It was the former who believed in the importance of bold entrepreneurs, while the latter envisaged their demise and replacement by a new mode of economic organization. Moreover, the reason Schumpeter changed his views is that he was reacting to the historical development of capitalism as he saw it taking place around him. As he moved from the world of owner-managed firm in turn-of-the-century Vienna to the world of large American corporations in the 1930s and 1940s, his opinions changed appropriately. The paper attempts to make two points. The firs is that, as a doctrinal matter, the “two Schumpeters” thesis, as it is understood in the Anglo-American literature on technological change, is clearly wrong. Equally wrong is the idea that the fundamentals of Schumpeter’s thought on entrepreneurship was influence by any observation of large firm in the United States after 1931. Schumpeter’s ideas were remarkably consistent from at least 1928 (three years before he came to the U.S.) until his death. The obsolescence thesis speaks to a distinction between early capitalism and later capitalism, perhaps, but not to an earlier and later Schumpeter. The second, and more important, point is that the obsolescence thesis is wrong. It rests on a confusion – or perhaps a bait-and-switch – between two quite different kinds of economic knowledge.

II. THE SCHUMPETERIAN DICHOTOMY The conventional-wisdom analysis of Schumpeter’s obsolescence thesis is in part a matter of oral tradition among (mostly) English-speaking writers whose

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interest in Schumpeter traces to a concern with innovation and technical change. But documentation in print is far from lacking. There are, in fact, several related versions of this conventional analysis. One of the clearest and best known traces to Almarin Phillips (1971), who focuses primarily on Schumpeter’s view of technological innovation.2 To Phillips, Schumpeter’s early writings – by which he means the 1934 English translation of The Theory of Economic Development – present a very different picture of the logic of technological change in industry than do his later writings – by which Phillips means Capitalism, Socialism, and Democracy. In the “early” Schumpeter – Schumpeter I – the innovation process might best be characterized as a linear one. Christopher Freeman (1982) describes it this way. Basic inventions are more or less exogenous to the economic system; their supply is perhaps influence by market demand in some way, but their genesis lies outside the existing market structure. Entrepreneurs seize upon these basic inventions and transform them into economic innovations. The successful innovators reap large short-term profits which are soon bid away by imitators. The effect of the innovations is to disequilibrate and to alter the existing market structure – until the process eventually settles down in wait for the next wave of innovation. The result is a punctuated pattern of economic development that is perceived as a series of business cycles. “The main differences between Schumpeter II and Schumpeter I,” says Freeman, “are in the incorporation of endogenous scientifi and technical activities conducted by large firm . . . . Schumpeter now sees inventive activities as increasingly under the control of large firm and reinforcing their competitive position. The ‘coupling’ between science, technology, innovative investment and the market, once loose and subject to long time delays, is now much more intimate and continuous” (Freeman, 1982, p. 214, emphasis original). There is no doubt that Capitalism, Socialism, and Democracy was far more concerned with the large corporation than was The Theory of Economic Development. Furthermore, it may even be that the former contains a more developed “model” of the process of technological change in industry than does the latter. But saying this still leaves us with at least two distinct interpretations of the early/late thesis. The weaker interpretation would be that, although Schumpeter’s theory of innovation and development remained essentially the same in his later as in his earlier work, the “later” Schumpeter simply chose, for various reasons, to elaborate more fully on the nature of the large corporation and its role in his theory. And this weak form may well be what some writers have in mind. But it also seems quite clear that a good many other writers have a far stronger version of the early/late thesis in mind. The change from the “early” to the “later” Schumpeter reflect not a mere shift in his emphasis but a fundamental alteration of his underlying economic vision.

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A principal manifestation of this change is held to be Schumpeter’s revised assessment of the role of – and of the necessity for – market competition in the process of innovation. Richard Nelson’s discussion is representative. The early Schumpeter certainly did not view the economic problem as that of the control of clerks. His belief was that not only preferences and resources, but also technologies, change over time. Schumpeter, and Marx before him, saw the real power of a capitalist market system in terms of the ability of that system to spur innovation. He also believed that competitive markets provided an environment (monitored by fina consumers and powered by competition) that controls the processes of technological change and spreads benefit widely. In his later writings, he recanted the proposition that market competition was necessary for the generation of innovation, positing that in large corporate enterprises, innovation itself has become largely routinized. Therefore, he foresaw no particular disadvantages from socialization of the innovation process, as well as the more routine activities of the economy (Nelson, 1977, pp. 134–135).

Moreover, Schumpeter’s “recantation” of his earlier position is sometimes traced to or associated with a fundamental shift in philosophical orientation. “As it happens,” writes Burton Klein, “Schumpeter expressed very different views in his later writings than in his earlier works, so much so that one has the impression there were two Schumpeters: Schumpeter the revolter against determinism, and Schumpeter the determinist” (Klein, 1977, p. 133). A corollary to this conventional-wisdom interpretation is the notion that Schumpeter “changed his mind” because of what he saw developing in the contemporary economy. As Freeman puts it, the “shift of emphasis from the early Schumpeter . . . to the late Schumpeter . . . reflecte the real change which had taken place in the American economy between the two World Wars and the rapid growth of industrial R&D in large corporations during that period” (Freeman, 1982, p. 8). This is certainly not an implausible interpretation. Schumpeter did believe that economic history influence economic theory – not in a historicist sense, but in the sense that some essential theoretical features are always outlined more sharply at some periods than at others. “Personally,” he wrote, “I believe that there is an incessant give and take between historical and theoretical analysis and that, though for the investigation of individual questions it may be necessary to sail for a time on one tack only, yet in principle the two should never lose sight of each other” (Schumpeter, 1951, p. 259). Ultimately, however, this conventional interpretation – that Schumpeter changed his fundamental position on the nature of innovation, and that he did so because of trends he saw developing in twentieth-century American capitalism – is, I’m afraid, clearly wrong. First of all, one can fin examples from Schumpeter’s work written after 1942 that present very much the same theory of entrepreneurship as does The Theory of Economic Development (Schumpeter, 1947, 1951). More significantl , the idea

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that the entrepreneur will eventually become “less important” or “obsolete” is already present in the 1934 translation of The Theory of Economic Development. The historical trend in favor of large firm that is theme of Capitalism, Socialism, and Democracy also turns up in the earlier book. And if the competitive economy is broken up by the growth of the great combines, as is increasingly the case today in all countries, then this must become more and more true of real life, and the carrying out of new combinations must become in ever greater measure the internal concern of one and the same economic body. The difference made is great enough to serve as the water-shed between two epochs in the social history of capitalism (Schumpeter, 1934, p. 67).

The contrast – or, rather, lack of contrast – between the English version of The Theory of Economic Development and Capitalism, Socialism, and Democracy can perhaps best be seen in the juxtaposition of the following passages. The firs is from the “later” Schumpeter. This social function [entrepreneurship] is already losing importance and is bound to lose it at an accelerating rate in the future even if the economic process itself of which entrepreneurship was the prime mover went on unabated. For, on the one hand, it is much easier now than it has been in the past to do things that lie outside the familiar routine – innovation itself is being reduced to routine. Technological progress is increasingly becoming the business of teams of trained specialists who turn out what is required and make it work in predictable ways. The romance of earlier commercial adventure is rapidly wearing away, because so many things can be strictly calculated that had of old to be visualized in a flas of genius (Schumpeter, 1942, p. 132, emphasis added).

Schumpeter quickly goes on (p. 133) to liken the changes he foresees in the entrepreneur’s role with those that have already taken place in the function of military commander. Now consider the following passage from the “early” Schumpeter. The more accurately, however, we learn to know the natural and social world, the more perfect our control of facts becomes; and the greater the extent, with time and progressive rationalisation, within which things can be simply calculated, and indeed quickly and reliably calculated, the more the significanc of this function decreases. Therefore the importance of the entrepreneurial type must diminish just as the importance of the military commander has already diminished (Schumpeter, 1934, p. 85, emphasis added).

These passages are important, and I shall return to them presently. In their translation of Schumpeter’s 1928 essay “Entrepreneur,” Becker and Knudsen (in this volume) show clearly that Schumpeter’s mature theory of entrepreneurship was already in place by 1926, when he revised the firs German edition of Theory of Economic Development. That 1926 edition formed the basis of the 1934 English translation, which, as I have shown, is fully consistent with the obsolescence thesis in Capitalism, Socialism, and Democracy. This immediately puts to rest the notion – which has never been based on any textual evidence

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anyway, as far as I can tell – that Schumpeter was somehow influence by his observations of large American corporations in the 1930s. Becker and Knudsen see a real change in Schumpeter’s theory of entrepreneurship between 1911 and 1926.3 Rather than conceptualizing entrepreneurship as a psychological characteristic of a subset of the population, he came to portray entrepreneurship in a “depersonalized” way as an ideal type.4 In the post-1926 theory, entrepreneurship needn’t fil the vessel of any actual person; it reflect instead a category of action into which individuals (organizations?) may fall at various times and places. To Becker and Knudsen, this change enables the obsolescence thesis, since it makes the entrepreneur less “pushy” and therefore permits an easy movement to an institutionalized version of entrepreneurship. As they put it, the entrepreneur has become a carrier of change rather than a cause of change. However one interprets this transition from the “old” Schumpeter to the “new,” however, it is not the transition that writers in the Anglo-American literature of technological change think they see. That one never happened.

III. THE SCHUMPETERIAN TENSION Why then are so many writers inclined to see “two Schumpeters”? The simple answer is that Schumpeter has the distinction of being the principal source for the notion that entrepreneurship (a word that is shorthand for a complex set of theoretical ideas) is crucial to the economic process and – at the same time – the principal source for precisely the opposite conception: that entrepreneurship is no longer (or will soon no longer be) of any consequence whatever for the economic process, having been replaced entirely by rational calculation. There are two identifiabl strands of thought in Schumpeter; they are self-consistent, but they cannot be reconciled with one another. Reading him is thus a kind of litmus test: picking out one of the strand leads in one direction; picking out the other leads in precisely the opposite direction. Schumpeter I gives you such neo-Schumpeterian writers as Nelson and Winter (1982) and Klein (1977). Schumpeter II gives you John Kenneth Galbraith. But if, as I’ve argued, this coexistence does not reflec a change of opinion, then what is the source of Schumpeter’s litmus effect? The answer, I believe, is that the “Schumpeterian tension” arises from the unreconciled coexistence in his writings of two incompatible epistemic theories, to use the suggestive term of G. L. S. Shackle (1972) – two inconsistent views of the role of knowledge and ignorance in the economic process. Perhaps the best way to explicate this claim is to recast it in terms of another – closely related – tension in Schumpeter. It is well known that Schumpeter was

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a great admirer of Walras. “[S]o far as pure theory is concerned,” he wrote in his History of Economic Analysis, “Walras is in my opinion the greatest of all economists.” He goes on to suggest that Walras’s work “will stand comparison with the achievements of theoretical physics” (Schumpeter, 1954, p. 827). Yet, while his professed scientifi attitude and aesthetic sensibilities may have been Walrasian, his own theory is in substance very un-Walrasian. Indeed, many have portrayed Schumpeter – with a good deal of justificatio – as representing a theoretical perspective and tradition alternative and antagonistic to the Walrasian approach that, by all accounts, dominates modern economic thought (Nelson & Winter, 1982, pp. 39–40). More precisely, one might say that Schumpeter’s theory is in substance Mengerian rather than Walrasian. There are really only two attitudes with which to approach economic doctrine. One can take the position that, beneath the inevitably discordant pronouncements of the various theorists with whom one is concerned, there lies an essential unity; the differences are unimportant, merely epiphenomenal to that underlying unity. Or one can take the position that it is the differences that are essential, that whatever superficia similarities may appear among theories are in fact merely a cover for fundamentally divergent views. Schumpeter adopted the former attitude, at least so far as the marginalist revolution – and indeed the economics of his own day – was concerned. “Nobody denies that, numerous differences in detail notwithstanding, Jevons, Menger, and Walras taught essentially the same doctrine”5 (Schumpeter, 1954, p. 952). However true such an assertion might have been in 1950, it is clear that, in the last few decades at least, quite a number of historians of thought have begun to deny just that. The marginalist revolutionaries have been “dehomogenized” (to use Jaff´e’s (1976) expression), a development that may say as much about the status of present-day economics as it does about that of the 1870s. And most of the dehomogenizers wish to enlist the syncretist and Walras-admiring – but also Austrian – Schumpeter into the dissident Mengerian camp. “It is just because he admired Walras so much,” writes Erich Streissler, “that Schumpeter is such a bad guide to the real Austrian achievement, which has always been in complete contrast to Walras” (Streissler, 1972, p. 430n). One might also say that Schumpeter’s admiration for Walras also served to mask the distinctly non-Walrasian character of his own achievement. There are a number of ways in which Schumpeter’s work displays affinitie to that of Menger. In one important sense, both were more in the classical than the neoclassical tradition.6 Like Adam Smith, they were concerned with the problem of economic development – of the creation of wealth – rather than with questions of the simple allocation of resources. “It is in the true tradition of Menger that Schumpeter’s treatment of technical progress is so much more inclusive than

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the Marxian or modern neoclassical treatment” (Streissler, 1972, p. 431). Other similarities between Schumpeter and Menger would include an emphasis on disequilibrium processes; a concept of competition very unlike the Walrasian “perfect competition” construct; and a concern with social institutions.7 For present purposes, though, the most important way in which Schumpeter’s theory is Mengerian (or at least non-Walrasian) is in its attitude toward economic knowledge and learning. Having appropriated Shackle’s term “epistemic,” let me now turn it to my own uses. There are, it seems to me, two fundamental categories of epistemic theories – that is, two categories of theories about the way economic agents know and learn.8 One category is that of rationalist theories. Broadly speaking, such theories portray the rationality of economic agents as consisting entirely in logical deduction from explicit premises. In ordinary neoclassical models – which clearly fall into this category – the agent faces a problem of maximization (or minimization). The agent is rational when he or she solves that problem correctly. The data of the problem – what the agent “knows” – is always given, and any learning that takes place is also a matter of logical processing (e. g. Bayesian updating) of given data. The other category is that of empiricist theories. In an empiricist theory, the criterion of rationality is less demanding, typically requiring only reasonable behavior in light of the situation the agent faces, not behavior reflectin the substantively correct solution to an explicit (and sometimes quite complicated) problem. More importantly, the nature and source of the agent’s knowledge is empirical in character; it is gained from experience rather than deduced. As a result, the agent’s knowledge is frequently tacit (Polanyi, 1958) or contained inexplicitly in various habits, conventions, and institutions. In his discussion of the role and importance of entrepreneurship, Schumpeter places himself squarely in the empiricist camp. “The assumption that conduct is prompt and rational,” he says, “is in all cases a fiction But it proves to be sufficientl near to reality, if things have time to hammer logic into men . . . . But this holds good only where precedents without number have formed conduct through decades and, in fundamentals, through hundreds of thousands of years, and have eliminated unadapted behavior” (Schumpeter, 1934, p. 80). This is a conception of behavior as fundamentally rule-governed.9 For Schumpeter, rationality as conscious calculation exists only within a small sphere carved out from and define by the larger mass of the agent’s inexplicit knowledge. Within this sphere, “we can depend upon it that the peasant sells his calf just as cunningly and egotistically as the stock exchange member his portfolio of shares” (Schumpeter, 1934, p. 80).

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The other important aspect of an empiricist epistemic theory of the sort Schumpeter adheres to in these passages is the inherently open-ended or evolutionary character of economic knowledge it implies. Since economic knowledge is not a matter of logical deduction from givens, that knowledge is potentially unbounded. There is always new knowledge that is not yet not within the agent’s “calculative sphere” or means/ends framework. Indeed, the job of the entrepreneur is precisely to introduce new knowledge.10 The “Circular Flow of Economic Life” is a state in which knowledge is not changing. Economic growth occurs at the hands of entrepreneurs, who bring into the system knowledge that is qualitatively new – knowledge not contained in the existing economic configuration This novelty is what distinguishes the entrepreneurial function from that of manager or the capitalist. This is why one is an entrepreneur only while carrying out new combinations, not once the business is well established. To Schumpeter, “the distinctive element is readily recognized so soon as we make clear to ourselves what it means to act outside the pale of routine. The distinction between adaptive and creative response to given conditions may or may not be felicitous, but it conveys an essential point; it conveys an essential difference” (Schumpeter, 1951, p. 253). The crucial point for my argument is that a conception of entrepreneurship (or something very much like it) is essential for any theory that proposes to deal with innovation and economic growth.11 Conventional neoclassical models tell stories about the adjustment of known means to given ends, but they say very little about how those means and ends change or come into being in the firs place. Schumpeter would seem to agree strongly that a concept of entrepreneurship is a theoretical necessity. In a vibrant passage, he describes the epistemic role of the entrepreneur (if I may put it that way) in a manner that emphasizes the empirical nature of his conception. What has been done already has the sharp-edged reality of all things which we have seen and experienced; the new is only the figmen of our imagination. Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it. How different a thing this is becomes clearer if one bears in mind the impossibility of surveying exhaustively all the effects and counter-effects of the projected enterprise. Even as many of them as could in theory be ascertained if one had unlimited time and means must practically remain in the dark. As military action must be taken in a given strategic position even if all the data potentially procurable are not available, so also in economic life action must be taken without working out all the details of what must be done. Here the success of everything depends on intuition, the capacity of seeing things in a way which afterwards proves to be true, even though it cannot be established at the moment, and of grasping the essential fact, discarding the unessential, even though one can give no account of the principles by which this is done. Thorough preparatory work, and special knowledge, breadth of intellectual understanding, talent for logical analysis, may under certain circumstances be sources of failure (Schumpeter, 1934, p. 85).

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Entrepreneurship – introducing the qualitatively new – is an activity inherently different, it would seem, from the kind of rational calculation portrayed in the imagery of neoclassical modeling. It is interesting that Schumpeter regards the entrepreneurial act as requiring in fact greater conscious rationality than routine activity (Schumpeter, 1934, p. 85). This re-emphasizes the empirical nature of his conception of economic knowledge. Routine behavior requires less conscious rationality because it is essentially “preprogrammed” through trial-and-error learning. Notice, of course, that the conscious rationality of the entrepreneur is not adequate – in “early” capitalism, at any rate – to the task of innovation. This is why entrepreneurship requires intuition, the leap of logic. But – and here we get to the heart of the matter – conscious rationality, for Schumpeter, is in fact becoming increasingly adequate to the job of dealing with the radically new. The more accurately, however, we learn to know the natural and social world, the more perfect our control of facts becomes; and the greater the extent, with time and progressive rationalisation, within which things can be simply calculated, and indeed quickly and reliably calculated, the more the significanc of this [entrepreneurial] function decreases. Therefore the importance of the entrepreneurial type must diminish just as the importance of the military commander has already diminished (Schumpeter, 1934, p. 85, emphasis added).

Notice the syllogism. Because the unknown can be increasingly calculated rationally, the “extra-logical” function of the entrepreneur becomes increasingly unnecessary, and so the importance of the entrepreneurial type must diminish. What this amounts to is a strange commingling of an empiricist and a rationalist theory of economic knowledge. In “early” capitalism (not the “early Schumpeter”) economic rationality derived largely from evolved habit and convention; attempts to step outside this configuratio of knowledge could not be accomplished by conscious rationality and explicit calculation. Rationality was “bounded,” in effect. In “later” capitalism (not the “later Schumpeter”) the bounds of rationality are being broken. Conscious rationality is beginning to conquer not merely the entrenched conventions of the past but also the previously unknowable future. Perhaps the analogy with a more recent writer will make this clearer. Schumpeter’s epistemic theory (if I may use that high-blown phrase again) is ultimately very close to that of Herbert Simon (Langlois, 1990, 2003a). Simon is, of course, the author of the expression “bounded rationality.” The basic idea is that human information-processing capacity is limited, making conscious rationality of the neoclassical variety quite impossible. The agent must therefore “satisfice and rely on heuristic approximations. What is typically overlooked in Simon’s conception, however, is that it is at base a strongly rationalist theory of knowledge. For Simon, one is rational only when one has reached the substantively correct solution of the

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explicit choice problem one faces. His preferred imagery includes chess games and complex differential equations, problems that do in fact have substantively correct solutions, even if they are solutions to which we can at present only aspire. His innovation, in short, is to suggest that one may only approximate true rationality; he does not ultimately call the notion itself into question. Moreover, Simon like Schumpeter is convinced that improvements in computational and management technique will provide closer and closer approximations to true rationality and may even unbound rationality in some spheres.

IV. THE SCHUMPETERIAN IRONY What, then, are we to make of the “Schumpeterian tension”? I contend that it has strong implications for Schumpeter’s assessment of the workability of socialism and the eventual demise of capitalism. Schumpeter’s argument, we saw, goes something like this. Entrepreneurship – bringing the radically new into the economic system – has been the province of bold individuals because, in a world of limited knowledge, it is necessarily an unpredictable and extra-rational activity. Notice that this is in effect an argument in favor of a capitalist (or, more correctly, a liberal) social order. For Schumpeter, the relative efficien y of an economic system depends not on how it “administers existing structures” (Schumpeter, 1942, p. 84) but on how well it generates innovation. Because of limited knowledge, “planning” is incompatible with innovation; progress depends on the ability of individuals to command resources and direct them in unconventional and surprising directions. But the limits to knowledge are disappearing, Schumpeter believes, and socialism will thus eventually come to be roughly as effective as capitalism in generating economic growth. But does the argument hold water? Does the growth of economic and technical knowledge in fact imply that innovation is becoming predictable and routine? This is a matter of some dispute. It is certainly true that innovation – or R&D, at any rate – is more organized today than it was in the nineteenth century. This is a manifestation of the growing division of labor, one that would not have surprised Adam Smith and the classicals (Langlois, 2003b). But for Smith, the increasing division of labor did not generate innovation because it made the future predictable; rather, the division of labor heightened innovation because it increased the diversity of ideas in society. Innovation remained a matter of empirical trial and error. We can put the issue somewhat differently. I have argued that Schumpeter’s story of a transition from bounded to unbounded rationality actually implies a transition from an empiricist to a rationalist theory of economic knowledge. Is

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such a transition possible? Or does Schumpeter’s account ultimately rest on a confusion of two logically distinct kinds of knowledge? Although I cannot mount the arguments here,12 there is good reason to think that such a confusion is indeed in operation in Schumpeter. If so, the mechanization-of-progress thesis loses much of its force. In order to see what this would mean, we need to understand the routinization of progress, and thus the passing of the entrepreneur, in the complete context of Schumpeter’s sociological argument. “We have seen,” he says, “that, normally, the modern businessman, whether entrepreneur or mere managing administrator, is of the executive type. From the logic of his position he acquires something of the psychology of the salaried employee working in a bureaucratic organization” (Schumpeter, 1942, p. 156). This is not an unfamiliar observation. The conclusion usually drawn from it, especially by writers in the now well-developed tradition of Berle and Means (1932), is that it is therefore a matter of indifference, from a functional standpoint, whether the productive organization is privately or state owned; indeed, state ownership would seem preferable since its motives are “public” and hence purifie of the taint of private desire. Schumpeter draws a much different conclusion from this observation. To Schumpeter, the crucial fact about the modern corporation is that its managers cannot fil the strong social role played by the entrepreneur. Entrepreneurs are pillars of strength, symbols of legitimacy, role models. They provide the new ideas and new blood that refresh the “bourgeois stratum.” “Economically and sociologically, directly and indirectly, the bourgeoisie therefore depends on the entrepreneur and, as a class, lives and dies with him, through a more or less prolonged transitional stage – eventually a stage in which it may feel equally unable to die and to live – is quite likely to occur, as in fact did occur in the case of the feudal civilization” (Schumpeter, 1942, p. 134). Socialism will succeed because, without the entrepreneur to guard it, “the bourgeois fortress . . . becomes politically defenseless.” It is not the managerial class who are the plunderers; it is a New Class of socialist intellectuals and government officials “Defenseless fortresses invite aggression, especially if there is rich booty in them. Aggressors will work themselves up into a state of rationalizing hostility – aggressors always do. No doubt it is possible, for a time, to buy them off. But this last resource fails as soon as they discover that they can have it all” (Schumpeter, 1942, p. 143). Schumpeter is thus after bigger game than Berle and Means: nothing less than Marx himself. Schumpeter has no great love for a socialist system (or, in particular, a socialist culture); but he does see the similarities between private and state bureaucracy as smoothing the way for socialism. “Thus the modern corporation, although the product of the capitalist process, socializes the bourgeois

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mind; it relentlessly narrows the scope of capitalist motivations; not only that, it will eventually kill its roots” (Schumpeter, 1942, p. 156). Like Marx, then, he sees capitalism as leading to its own destruction. But unlike Marx, Schumpeter sees capitalism as the victim of its own economic success not its economic failure. This tale stands Marx on his head, its plot laced with a heavy and self-satisfie irony. The tone is disinterested and the attitude fatalistic; but the message is largely cautionary. At base, Schumpeter is nothing so much as a neoconservative, perhaps the firs neoconservative. How would this story have to change if Schumpeter is wrong about the mechanization of progress? On one level, the effect is significant An economic system that continues to rely on tacit, empirical knowledge – what Hayek (1945) called “the knowledge of the particular circumstances of time and place” – would sacrific much of its innovativeness, and thus much of its engine of progress, by consigning its industry and commerce to a bureaucratic socialism. This would certainly make the transition to socialism much more painful to the voting population, and thus would likely slow or modify (if not necessarily prevent) its advent. Needless to say, this interpretation seems far more compelling now after 1989 than it did perhaps when Schumpeter was writing. The role of the mechanization-of-progress thesis in the larger sociological theory is to underscore the power of bourgeois capitalism on an economic level: it is so efficien that it has conquered even our ignorance of the unknown; it can stamp out innovation with all the efficien y that it brings to bear on stamping out mass-produced goods. To deny capitalism this power over the future mars the aesthetic of Schumpeter’s panorama somewhat, for it makes the inversion of Marx less perfect than otherwise, and it diminishes the fatalism that gives the story much of its color. In the end, however, taking all this too seriously puts us in danger of reading Schumpeter literal-mindedly. The force of the argument is in the texture of the landscape – not in its details. Indeed, there is a sense in which the “Schumpeterian tension” – the tension between the Schumpeter who comes to praise entrepreneurship and the Schumpeter who comes to bury it – actually enriches the majestic irony of Capitalism, Socialism, and Democracy.

NOTES 1. One might also mention the more dubious recent association of Schumpeter with so-called endogenous growth theory, on which see Langlois (2001). 2. In fact, Schumpeter’s concept of innovation goes far beyond technological change in the narrow sense. He is concerned with what he calls “the carrying out of new combinations”

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interpreted broadly. “The concept,” he writes, “covers the following fi e cases: (1) The introduction of a new good – that is one with which consumers are not yet familiar – or of a new quality of a good. (2) The introduction of a new method of production, that is one not yet tested by experience in the branch of manufacture concerned, which need by no means be founded upon a discovery scientificall new, and can also exist in a new way of handling a commodity commercially. (3) The opening of a new market, that is a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before. (4) The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has firs to be created. (5) The carrying out of the new organisation of any industry, like the creation of a monopoly position (for example through trustification or the breaking up of a monopoly position” (Schumpeter, 1934, p. 66). 3. But even in the 1911 original, Schumpeter toyed with the idea that the state could take over the entrepreneurial role. (See especially Schumpeter, 1911, pp. 173ff. Thanks to Wolfgang Gick for help with the German.) A more detailed study might well discover that the continuity really goes back to 1911 or earlier, not merely to 1926. 4. Becker and Knudsen attempt to explain Schumpeter’s new stance on entrepreneurship in terms of events and tragedies in his personal life. I fin far more compelling the possibility, which Becker and Knudsen discount, that, always ambitious and sensitive to intellectual fashion, Schumpeter was simply reflectin the widespread popularity of Max Weber’s approach in the German-speaking world of the 1920s, an approach that had pushed into the background the older traditions of Austrian economics and the German Historical School that had influence the 1911 edition. 5. Regarding Schumpeter’s attitude toward the unity of economic thought in his own day, see Schumpeter (1982). In an article written not long after Schumpeter’s death, Fritz Machlup defended this syncretism – “a conciliatoriness which could be misjudged as weak eclecticism” – as a form of methodological tolerance or methodological pluralism (Machlup, 1951, p. 146). 6. “Schumpeter is much closer intellectually to Marshall and Smith than he is to Samuelson and Arrow” (Nelson, 1977, p. 136). “Schumpeter was well within the classical tradition” (Nelson & Winter, 1977, p. 64). 7. Streissler (1972, passim); Jaff´e (1976, passim); and Kirzner (1979, esp. p. 3). But see also Kirzner (1979, pp. 53–75). 8. I have developed these ideas at some length elsewhere, especially in Langlois (1985) and Langlois (1986). See also Boland (1982) and Littlechild (1986). 9. See especially Schumpeter (1934, p. 83). 10. As Schumpeter repeatedly stressed, the knowledge with which he was concerned is new from the economic point of view – not necessarily from the scientifi or technical point of view. For him, an idea becomes an innovation when it is tried out in practice for the firs time – again emphasizing the empirical character of the conception. 11. Indeed, from the point of view of internal logical consistency, the issues Schumpeter raises are fundamentally troubling ones for neoclassical theory. If rationality is defined as optimally adjusting means to ends, then the act of choosing the framework of means and ends in the first place can never ultimately be a rational one (Elster, 1983, pp. 74–75; Kirzner, 1982, pp. 143–145; Langlois, 1986, p. 227; Winter, 1964, pp. 262–264 and passim). 12. But see Lavoie (1985) for a discussion of the “socialist calculation debate” along these lines.

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ACKNOWLEDGMENTS The ideas in this paper occurred to me when I was working on my Ph.D. thesis at Stanford University in the late 1970s, and a version of this argument appears there (Langlois, 1981). I presented a draft of this paper at the History of Economics Society annual meeting, June 21, 1987, Boston. I revised it slightly after conversations with the late L´aszl´o Csontos, and it circulated as Working Paper 91-1503, Department of Economics, University of Connecticut, November 1991. It has been available on the web since the late 1990s. The Becker-Knudsen translation of Entrepreneur and the accompanying translator’s introduction finall galvanized this revision and publication. I am grateful to Thorbjørn Knudsen and Roger Koppl for encouraging me to publish the paper now, and to many people who have given me comments along the way.

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