The Economics of Errant Entrepreneurs

A recent stimulating Freeman article by Jane S. Shaw (April, 1987) provocatively drew attention to some of the benefits derived by society from entrepreneurial daring and imagination—even when it turns out that these are expressed in ventures that lose money and eventually fall by the wayside. Ms. Shaw cites a spiffy and charming new restaurant in Bozeman, Montana, serving gourmet seafood. She judged the venture to be “outlandishly extravagant and probably fool hardy,” and suspects that the opportunity she enjoys of contemplating blackened red snapper in a pleasurable setting may turn out to be expensive for the restaurateurs, but is grateful for the opportunity nonetheless. Ms. Shaw recognizes that no business can operate over the long run without making a profit. But, she concludes, “Bozeman’s experience suggests that an endless succession of businesses can operate without profits—as long as there are romantic optimists to take up where the disillusioned leave off.” Ms. Shaw sees this as an illustration of George Gilder’s conception of entrepreneurs as “givers,” as economic agents who “orient their lives to the service of others.”

Ms. Shaw’s piece got me thinking. Most discussions of entrepreneurial energy, dating, and vision see profitable entrepreneurial activity as largely responsible for capitalist success. Ms. Shaw is pointing out that unprofitable entrepreneurship offers social benefits, too. Should we, then, celebrate capitalism not only because it stimulates profitable entrepreneurship, but because it stimulates unprofitable entrepreneurship as well? Should we indeed view entrepreneurs who lose money as unselfish benefactors of market societies? Does the “social” perspective suggest that young people should be encouraged to become independent entrepreneurs-even where we judge them likely to lose money—on the grounds that even erroneous entrepreneurs are socially beneficial?

A little thought will convince us, and I believe that Ms. Shaw would thoroughly agree, not to arrive at affirmative answers to these questions on the basis of Ms. Shaw’s observations. There may be numerous benefits to society that derive from entrepreneurial error—but such benefits are likely to be far outweighed, in the judgment of most observers, by the harm caused by entrepreneurial errors. I shall later argue, in fact, that there is only one benefit to society arising out of unprofitable entrepreneurship that deserves to be treated as a fundamental advantage. All other benefits, while we may indeed be grateful for them, are likely to be enjoyed at the expense of more serious disadvantages both to others and to ourselves.

A profitable entrepreneurial venture benefits society in a way central to the logic of capitalist success. If an entrepreneur hires productive services for one million dollars and produces consumer goods that are bought for two million dollars, this means that services that might otherwise have produced goods judged to be worth not much more than one million have, in fact, produced goods that are much more valuable to market participants, as measured by money offered. An unprofitable venture, on the other hand, has harmed society insofar as it is likely to mean that it has used valuable, scarce social resources to produce goods worth less than other goods that could have been alternatively produced.

As Ms. Shaw has pointed out to us, however, it should not be thought that no one in society has benefited from a losing entrepreneurial venture. Clearly those who voluntarily sold to and those who voluntarily bought from losing entrepreneurs, did well for themselves—as do all participants in voluntary exchange transactions. Moreover, Ms. Shaw seems to suggest, not only does one who dines in an excellent, but money-losing, restaurant, gain from the venture, others do too. That is, we gather, because the parade of ever-changing opportunities offered by imaginative entrepreneurs undeterred by the losses of others, is itself a fascinating sight to watch, even if many of them, being unprofitable, are likely to disappear after a brief moment in the sun.

Despite all these benefits derived from unprofitable entrepreneurial ventures, we must recognize that few thoughtful observers are likely to judge that, all in all, the members of society should be grateful for this outpouring of entrepreneurial errors. The truth is that each and every entrepreneurial error represents a tragic waste of resources. For every beneficiary of such error, there are likely to be many whose lives, in consequence of this error, are poorer and less fulfilled than was in fact necessary. These victims of entrepreneurial error may never know that they are being harmed by these errors. In fact no one may ever know what alternative products these unprofitable ventures have precluded. As Henry Hazlitt taught us, the true costs of waste are always unseen—yet are nonetheless real and poignant.

The case for capitalism, for free entrepreneurial entry, does not and should not rest upon the possible residual benefits that some may derive from unprofitable entrepreneurial ventures. The great economic virtue of capitalism lies in its ability to stimulate vigorous and imaginative entrepreneurs who create profitable enterprises. In this way resources come to be deployed use fully for purposes whose urgency or feasibility had hitherto been overlooked. The virtues of capitalism rest not on any supposed altruism evinced by entrepreneurs who lose money while catering to the tastes of a too-narrow group of consumers, but on the daring and judgment of entrepreneurs who see socially valuable opportunities before others do.

In fact, the one really valuable feature of unprofitable entrepreneurial endeavor lies in its crucially important role in stimulating profitable entrepreneurship. Only in a society where entrepreneurs are free to make errors, can we expect an outpouring of entrepreneurship to lift its economy to new, hitherto unglimpsed, heights of prosperity. Only where potential entrepreneurs are free to follow the lure of profits as they see them, will there be the unleashing of entrepreneurial vision, daring, and judgment that creates profits in fact—and in so doing, creates new, more valuable ways of utilizing resources.

To be sure, errant entrepreneurs suffer losses, and it is precisely because entrepreneurs with poor judgment are likely to think twice before jumping into dangerous waters, that such erroneous leaps are likely, to some extent, to be discouraged. Moreover, as Ludwig von Mises pointed out, it is likely to be those entrepreneurs who in the past have exhibited sound market judgment, who will have accumulated the capital funds that are now able to be channeled into new entrepreneurial ventures. Hence, the central social gain from losing entrepreneurial ventures is derived not by individuals unusual enough to enjoy the output of these overoptimistic ventures, but by all members of society insofar as they stand to gain from superior entrepreneurial judgment—a quality standard enforced by the severe discipline imposed on errant entrepreneurs, and stimulated by the freedom of market participants to follow their dreams and hunches as they, and they alone, see fit.

This freedom will, to be sure, always attract a stream of entrepreneurial fools and romantic optimists. But the incredible successes of capitalism do not depend on such follies; they depend on the stimulus the system provides to farsighted, clear-visioned entrepreneurs who are, at all times, competing away resources from foolish ventures towards more judicious, more accurate, dreams and aspirations.