All Commentary
Wednesday, August 1, 1990

Book Review: Discovery, Capitalism, And Distributive Justice by Israel M. Kirzner

Basil Blackwell, P.O. Box 1655, Hagerstown, MD 21741 • 1989 • 179 pages • $29.95 cloth

In three earlier books (1973, 1979, and 1985), Israel Kirzner developed his positive theory of market process which, he convincingly argued, is superior to neoclassical comparative statics as a framework for understanding how markets work in the real world. In the present book he employs the insights of his positive analysis to build a brilliant new theory of distributive justice, which he calls the “discovery theory of justice.”

Just about everyone these days agrees that capitalism (meaning an economic system based on private property and voluntary exchange) does a better job of creating wealth than any other known economic system. But far too many still allege that capitalism fails to distribute that wealth equitably. Even the best known, and most respected, efforts to defend capitalist distribution—e.g., J. B. Clark’s marginal productivity theory and Robert Nozick’s entitlement theory—fail to convince the doubters. While Kirzner’s arguments won’t persuade all doubters, they are likely to reduce their ranks greatly.

The book is organized into seven easy-to-read chapters. In the first, Kirzner introduces his theme and outlines his argument. In chapters 2 and 4, he develops the key concept of discovery and explains its role in ongoing market processes. More about this later.

In chapter 3, Kirzner demonstrates that the discovery principle was overlooked by economists J. B. Clark, F. B. Hawley, Frank Knight, and Joseph Schumpeter. Surprisingly, according to Kirzner, even Ludwig von Mises failed to grasp the normative implications of discovery. Although Mises’ economic analysis incorporated the discovery principle, he defended capitalist distribution merely on utilitarian grounds. Philosopher John Rawls’ view of economics is in the neoclassical tradition of welfare economics. Market processes and discovery are completely foreign to him. Although Robert Nozick’s entitlement theory is consistent with a market process view of economics, he fails to incorporate any discovery concepts.

In chapter 5, Kirzner makes the case that once the role of discovery is. fully understood, the well-known finders-keepers rule is seen to be applicable to the normative evaluation of capitalist distribution. In chapter 6, he defends the finders-keepers rule as a “widely shared ethical intuition” and shows how it overcomes the weaknesses of Nozick’s entitlement theory. Finally, in chapter 7 he points out some of the questions—e.g., the problem of rectification of past injustice—which the discovery principle is incapable of answering.

My only substantive criticism of the book is that chapter 3 seems out of place. Chapters 2 and 4 naturally go together. So far as I can see, chapter 3 could easily follow chapter 4 without any disadvantage. It makes better sense to search for discovery in the work of others after discovery and its place in the market process have been fully explicated.

That said, the argument of the book is compelling. Briefly, and incompletely, it goes like this. There are two kinds of ignorance that every individual must cope with in the real world—ignorance of which one is aware and ignorance of which one is unaware. The first involves things which we know we don’t know. We remain igno rant of some things by design simply because we don’t think it is worth the trouble to find out about them. This sort of ignorance can be dispelled by deliberate search for the missing knowledge. It is the kind of ignorance that neoclassical economists address in the literature on information costs and search.

The second kind of ignorance, what Kirzner calls “sheer ignorance,” refers to things that we don’t know that we don’t know. We simply have no inkling that any knowledge is missing. In many cases of sheer ignorance we would place a high value on the missing knowledge if it ever came to our attention. We just fail to notice it or fail to see that it would be worthwhile to obtain. Sheer ignorance is dispelled by discovery. Discovery involves no deliberate deployment of resources in search; it comes spontaneously to those who are alert to new possibilities. A discoverer envisions a possible alternative state of affairs that he considers superior to the status quo. In other words, a discoverer is an entrepreneur who notices a hitherto unnoticed profit opportunity.

The next important distinction is between pure production and discovered production. In the former, a fully specified set of inputs is transformed into a fully specified output. This is the concept of production in neoclassical theory. Here it can be said that possession of the inputs guarantees possession of the output. The set of all inputs that are necessary (in the engineering input-output sense) for the physical production of the output can be considered inchoate output. The output can be attributed solely to the contributions made by each of the necessary inputs to the final product. This, indeed, is the basis of J. B. Clark’s marginal productivity theory of factor incomes.

But in the real world things are not so simple. Given inputs aren’t mechanically transformed into given outputs. Before any such physical transformation takes place someone has to envision the possibility that such production would be worthwhile. Someone has to discover the production possibility, assemble the necessary resources, and deploy the inputs. Desirable output goals and necessary means to those goals are not “given” to anyone. Discovery is the originative act upon which everything else depends.

Entrepreneurial alertness is fueled by the prospect of pure profit. Pure profit is defined as the difference between the price at which the output is sold and the sum of the prices paid for all of the inputs necessary, in the engineering input-output sense, for production. Entrepreneurship, therefore, is not a resource in the sense of neoclassical production theory. The pure profit gained by a successful entrepreneur cannot be defended as a Clarkian marginal productivity resource income.

But entrepreneurship/s necessary for production in the sense that entrepreneurial discovery is the originative act upon which all production depends. In this sense it can be said that entrepreneurship is responsible for the whole of the final A successful entrepreneur discovers a profit opportunity. Before the opportunity was discovered it did not exist in any economically significant sense. The discoverer can be said to have created the possibility, and it is a widely shared ethical intuition that a person who brings something into existence has a just entitlement to it.

Moreover, entrepreneurial discovery amounts to creation ex nihilo. The entrepreneur does not deliberately deploy any resources in discovery. The entrepreneur simply notices that which hitherto has been overlooked by everyone. The entrepreneur finds the profit opportunity, and, if we subscribe to the widely shared ethical intuition called the “finders-keepers” rule, we must conclude that the entrepreneur has a just entitlement to the pure profit that results.

Here I have a quibble. In chapter 2, Kirzner explains the difference between discovery and search. He writes, “One may, as a result of searching, ‘find’ something valuable that one sought. But the verb ‘to find’ in this context, is not at all the same as the verb ‘to discover.’” In chapter 5 he adopts “finders-keepers” as the name of the ethical principle upon which to base his discovery theory of justice. This seems contradictory. Presumably he uses “finders-keepers” because that is the common name attached to the idea. But precisely because the name is so common, some may dismiss the principle as trite. Perhaps a better name for the principle would be something like “creators-keep-ers” or “originators-keepers.”

Lest one think that the discovery principle applies only to a relatively few people called entrepreneurs and only to one sort of income called pure profit, Kirzner goes on to explain that every income received by every transactor in a capitalist economy includes a discovery component. As Mises pointed out, and as Kirzner has often reminded us, although it is analytically useful to separate the role of the entrepreneur from the role of resource owners and the role of consumers, everybody is an entrepreneur. A seller of labor is never in the position of merely having to choose from a well-defined and ranked set of alternatives. Neither is a capitalist, a landowner, or a consumer. Markets are never in neoclassical equilibrium. No one is ever sure what the available means and ends are. All decision making is done in the presence of at least some sheer ignorance. Better employment alternatives, better investment alternatives, better purchase opportunities, and better prices all must be discovered. Doing the best you can for yourself, no matter what that means to you, requires alertness and entrepreneurial discovery. Discovery and the finders-keepers rule are applicable to all incomes.

One of the highlights of the book is Kirzner’s discussion of supply and demand in chapter 4. Neoclassical analysis is centered on market-clearing prices and quantities—where supply and demand intersect. But most markets are out of equilibrium most of the time. Kirzner’s description of the role of discovery in the actions of all transactors in any market in disequilibrium is the most complete and most convincing I have ever seen. It should accompany every lecturer’s discussion of the famous scissors diagram.

Although Kirzner’s discovery theory of justice is much more than a mere supplement to Nozick’s entitlement theory, Kirzner deploys his theory to overcome two major objections that have been leveled against Nozick’s arguments. Nozick’s theory includes justice in original acquisition of titles to things and justice in transfer of such titles. Nozick uses Locke’s labor theory of property to define his principle of justice in acquisition, and he bases his principle of justice in transfer on voluntary exchange. The former has been challenged on the grounds of the Lockean Proviso, and the latter has been challenged on the basis that an exchange is not truly voluntary unless all transactors give their informed consent.

According to Locke, one gets a just entitlement to an unowned gift of nature by being the first to mix his labor with the gift of nature providing that “there is enough, and as good left in common for others.” In a world of scarcity, dissenters say, the proviso can never be met. Thus private property titles to what are originally gifts of nature cannot be justified. Ironically, it is only in a world of scarcity that the institution of private property is significant.

Nozick tries to escape this problem by redefining the proviso to require only that the acquisition of title not worsen the condition of others. Nozick claims that the wealth-creating characteristics of capitalism make it possible to avoid worsening the condition of others. Thus Nozick, like Mises, relies on a utilitarian defense of capitalist distribution.

Kirzner thinks, and I agree, that Nozick’s modification of the Lockean Proviso isn’t likely to persuade dissenters. More important, Kirzner explains that the principle of discovery makes the Lockean Proviso irrelevant. The act of mixing labor with a hitherto unowned gift of nature has to be preceded by the originative act of the discovery that such an acquisition would be worthwhile. It cannot be said that such an act of acquisition diminishes what is available to others. Before the discovery, the acquisition wasn’t available to anyone.

Those who challenge Nozick’s principle of justice in transfer do so on the grounds that in many ostensibly voluntary exchanges at least one party doesn’t divulge all he knows to his exchange part-nets. Thus such exchange partners don’t give their informed consent to the exchange.

For example, consider simple arbitrage. An entrepreneur notices that someone is willing to sell something at a price that is significantly lower than the price that someone else is willing to pay for it. The entrepreneur grasps the opportunity by buying low from the first person and selling high to the second person. The entrepreneur, however, could not do so if the over-eager seller knew the price that the over-eager buyer was willing to pay. Nor could the entrepreneur do so if the over-eager buyer knew the price at which the over-eager seller was willing to sell. By withholding such information, the entrepreneur makes it impossible for the others to give their informed consent. Hence, the dissenters say, the entrepreneur’s gain cannot be justified.

Here again, the principle of discovery overcomes the objection. The opportunity for the low-price seller to sell directly to the high-price buyer did not exist in any practical sense prior to the entrepreneur’s discovery of the price discrepancy. The buyer and the seller did not know of each other, and, moreover, they did not know that they did not know of each other. The possibility simply never Occurred to them. The discovery of the possibility actually created it, and, in accordance with finders-keepers, the entrepreneur is entitled to the pure profit he created.

With the collapse of Communism, the only serious obstacle to the eventual universal adoption of the private property, voluntary exchange economic system is the continued perception by many that capitalist distribution is unavoidably unjust. Kirzner’s book is a major contribution toward the correction of that perception.

Dr. Baird is Professor of Economics at California State University at Hayward.

  • Charles Baird is a professor of economics emeritus at California State University at East Bay.

    He specializes in the law and economics of labor relations, a subject on which he has published several articles in refereed journals and numerous shorter pieces with FEE.