Entrepreneurs identify opportunities to use scarce resources more efficiently, or in new ways. In doing so, their role in extending knowledge mitigates scarcity through the discovery of fresh ways of using more, or different, resources.

The account of entrepreneurship in Israel Kirzner’s scholarly work is crucial, having affirmed an unpredictable but central variable into economic sciences: the entrepreneur. The academic study of economics usually assumes perfect knowledge, and the ability of buyers and sellers to buy or sell as much as they wish at the prevailing market price. However, the success of a market through time lies in a process of discovery driven by change produced by competition and the ability of some players to discover superior ways of producing goods and/or taking advantage of hitherto unrecognized resources.

Many of these processes can be discovered by seeing temporary ‘distortions’ in the market and using that same entrepreneurial acumen to bring about rectification and thus economic growth.

Very often, standard economics texts explain that in a free economy markets work through voluntary exchange, and without central direction or control. However, they do not explain exactly why and how those markets work through time.

Israel Kirzner describes the importance of “entrepreneurial discovery” through which decentralized decision makers recognize opportunities that have not previously been recognized by others.

 

The Dangers of Scientism

I argue a chief factor driving ignorance of Kirzner’s observations is the scientization of economics methodology. It is pervasive, even among those making the case for free markets, as George Gilder frequently points out. As Sam Gregg explains, for much of the twentieth century, most economists underplayed the entrepreneur’s role in transforming economies. An economist himself, Israel Kirzner observed that “as economic theory became more sophisticated, as marginal analysis and market equilibrium theory came to be more carefully and more fully articulated, the entrepreneur receded more and more from theoretical view”.

The focus on entrepreneurship in economics has come into the forefront in recent years in another quarter: philosophy. Profound unquantifiable and subjective qualities are at the heart of entrepreneurship. These subjective qualities are virtues as captured by theologian and philosopher Michael Novak: other-centredness, persistence and industriousness, among others. Kirzner’s account of entrepreneurship is a vital counterpoint to the scientization of economics, placing the roles of values and ethics into full view. The entrepreneur is a sentient being with economic and moral decision-making power. Those traits matter.

To create a new enterprise and sustain it requires hard work, drive, perseverance and patience in the face of what are usually enormous challenges. Profit in so many instances cannot result unless the act tied to its creation is accompanied by the virtues above.

In seeking a profit, the entrepreneur often undertakes ventures others ordinarily would not. By  placing his or her material well-being at risk, the entrepreneur forsakes ordinary economic security in pursuit of a goal with no guarantee of success. Ultimately, this willingness to risk one’s time and capital drives economic growth in the long-term and improves the general welfare of entire societies.

 

Distortions in the Driving of Economic Growth

The entrepreneur as change agent begins with a profound insight into reality; through the price mechanisms of the market, he or she makes actual decisions seeking to take advantage of specific opportunities. This process can take place only when the entrepreneur is uniquely in tune with the wants and needs of the people he or she will serve, assuming he or she is able to read truthful non-distorted market signals and respond to them. This makes the importance of distortion in economics an ethical one, and not merely one of efficiency.

Owing to the alertness of entrepreneurs, a virtue Novak identified, the “other-centredness” places the entrepreneur in a unique position as a change agent. Unlike philanthropy, where giving is the locus of the act, creation is at the core of the entrepreneurial venture. The very act of entrepreneurship, if it is to be successful, requires harmony with the needs of the market, expressed as the free decisions of millions of buyers and sellers.

Schumpeter identifies this creative impulse as the driving force in the process of economic development. “Creative Destruction”, as he describes it, translates to fresh innovations in the market place, leading to the constant changes that are responsible for ongoing increases in productivity, economic growth and overall human material advancement.

By ignoring entrepreneurship, scientized models are subject to the black swan effect, referring to any factor causing change yet not incorporated into the model. Fundamentally the very existence of entrepreneurs to disrupt economies in the wealth-generating process of create destruction, nullify a “scientized” approach to economics because the entrepreneur plays the role of the “black swan”. Nassim Talib, who coined the phrase, warns against the pitfalls of scientization to which modern economics has fallen.

 

Bad Ideas, the Private Sector and Cronyism

Scientization’s follies are not limited to government. At a micro-level, companies like Long Term Capital Management, using Modern Portfolio Theory based on mathematical modelling of market  behaviour, fell prey to the black swan and saw massive losses.

Alfred Nobel’s family wished to abolish the prize in economics on the belief that it had become an arrangement for reciprocal celebration amongst establishment economists who share a common scientized outlook premised on mathematical modelling. Axel Kaiser offers a full appraisal of the situation in his book Interventionism and Misery: 1929-2008.

The great Austrian economist Friedrich Hayek in his lecture The Pretense of Knowledge diagnosed mathematical modelling as folly. However, the reasons for its persistence may be explained in economic terms by James Buchanan. Ordinarily mistakes by the private sector are borne by those who make them, and form part of the process of entrepreneurial discovery (in this case discovering what does not work). However, deviations in the form of bailouts have been a persistent reality where government intervenes to protect through regulation or subsidy.

Buchanan points out in works like The Calculus of Consent that there is no reason to assume when politician and bureaucrats make decisions, they act for the common good any more than anyone in business. Buchanan’s public choice theory accounts for why undermining accurate market signals continues to occur.

Buchanan further argues economists are trapped in Keynesian ideology preserving an “engineering mentality” assuming and/or claiming they can control economic variables, an impossible feat since it assumes the ability to control the “unpredictable variable”.

Despite ill-intent when it occurs on the part of the public sector actors – to be remedied in democratic processes – it is the faulty basis for scientized economics  that should preoccupy free market economists in order to lay rest bad policy.

Fully exploring and celebrating the role of entrepreneurial action confirms the institutions needed for economic growth, it also demonstrates the limits of intervention. All while bringing to the fore discussions of commercial ethics and virtue so vital to the free society.

 

 

 

Garreth Bloor is a vice president of the IRR, the oldest classical liberal think tank in South Africa. He served as a former executive politician in the country and is the founder of a venture capital firm. Bloor currently resides in Toronto.