All Commentary
Wednesday, April 13, 2016

Who’s in Charge, Capitalists or Consumers?

Why Entrepreneurship Matters

Opponents of economic freedom have a twisted view of entrepreneurs, imagining them to be greedy exploiters of both workers and consumers. But advocates of free markets can have their own distorted ideas of entrepreneurship. Our vision is often a romantic one. We imagine the heroic businessperson who comes up with a new idea, device, or method; who persists against long odds to bring it to market; and who profits greatly when it revolutionizes an industry. The entrepreneur is heroic — a Doer of Big Things.

The vast majority of new businesses fail quickly. 

As my friend Alexei Marcoux, professor of business ethics and society at Creighton University, pointed out in a recent talk, we largely owe this vision to Joseph Schumpeter, the most well-known theorist of entrepreneurship in the 20th century. Schumpeter’s entrepreneur was a disrupter of the placid, an upsetter of economic apple carts, and the source of what Schumpeter called a “gale of creative destruction.” Alexei also noted that the Schumpeterian entrepreneur is a rare creature: only a few heroic folks have extraordinary power to disrupt the market’s routine operations.

Schumpeter vs. Kirzner

In his talk, Alexei contrasted the Schumpeterian entrepreneur with the almost opposite one we find in the work of Israel Kirzner. Kirzner’s entrepreneur, developed from ideas in Ludwig von Mises’s Human Action, is not a Doer of Big Things and a disruptor of the placid, but rather an observer who notices opportunities for profit where others have made errors, where people’s desires have shifted, or where a resource’s availability has changed.

Rather than creating new opportunities, as Schumpeter describes, Kirzner sees entrepreneurs as noticing or being alert to new opportunities. And this alertness is not something possessed by a special few, but is an ability we all have.

For example, a few weeks ago, I was about to buy a candy bar at the hotel gift shop to satisfy my desire for some dessert. Then, I had a moment of entrepreneurial alertness when I realized the hotel lounge had free cookies. What I thought was the existing set of opportunities in front of me was wrong; I actually faced a different set of options (a different “means-ends framework,” in the language of economics). That alertness — my ability to notice that the world was not what I perceived it to be — is, for Kirzner, the essence of entrepreneurship.

Entrepreneurship Can Be Incremental

One important element of Kirzner’s view of entrepreneurship is that it doesn’t just refer to pathbreaking innovations like the smartphone — the sort Schumpeter might focus on. Kirzner would also see each improvement to such phones, from better cameras to new apps to better screens to faster processors, as an equally valid example of entrepreneurship. In each case, someone noticed an opportunity to do things better. Improvements on the margin are excellent examples of Kirznerian entrepreneurship.

The entrepreneur is like a scientist testing a hypothesis, waiting for the market’s verdict to see if a perception of an opportunity was correct.

This view of the entrepreneur hinges on perception. A frustrating aspect of Kirzner’s work is that he zeros in on successful entrepreneurship, where someone’s perception of an opportunity was correct. As Alexei noted in his talk, the vast majority of new businesses fail quickly. Actual entrepreneurial activity is at least as much about having misperceived or been “wrongly alert” to a supposed opportunity.

Entrepreneurship Embraces Uncertainty

Our understanding of entrepreneurship should include what another great 20th-century theorist thought was at its core: the bearing of uncertainty. Frank Knight, the early Chicago school economist, thought that entrepreneurs were those who bore the uncertainty of making decisions today whose accuracy would not be known until later. The entrepreneur could not simply calculate the statistical risk of various options, but must forge ahead into a future whose possible outcomes and their likelihoods could not be known. In Kirzner’s language: we cannot know ex ante if our perceived profit opportunity is real.

The entrepreneur is like a scientist testing a hypothesis, waiting for the market’s verdict to see if a perception of an opportunity was correct.

Corporations vs. Consumers

Why does this difference matter, both in in how we talk about entrepreneurship and in how we talk about the way markets work?

I always find it interesting when people say things like, “Amazon put Borders out of business.” It’s interesting because, in fact, Amazon did nothing to the large chain bookstore other than offer consumers an alternative way to purchase the books they desired, often at a lower price. Amazon has no power to force other bookstores to do anything, nor can it force consumers to do anything. Amazon perceived a market opportunity and developed a process for meeting it.

What happened next is what really matters for how we talk about markets: consumers decided in droves that they preferred Amazon’s product to what they got at the brick-and-mortar Borders. This was not the first time consumers had made a decision about what they preferred in bookstores. As fictionalized in the movie You’ve Got Mail, the big chain bookstores themselves arose from the entrepreneurial perception that a profit opportunity existed, and one that turned out to be quite right. Before Amazon offered its product, Borders, Barnes and Noble, and the movie’s fictional Fox Books were offering a better product than The Shop Around the Corner and its real-life counterparts.

In the end, Borders didn’t put mom-and-pop bookstores out of business, and Amazon didn’t do the same to Borders. Consumers did. Our choices as consumers determine which bookstores survive and thrive. We put the independent bookstores out of business by choosing the big brick-and-mortar chains, and then we put the chains out of business by choosing Amazon.

Consumers Rule

This idea that we, the consumers, decide whose perceptions of profit opportunities are correct is what Mises called “consumer sovereignty.” In an unhampered market, consumers decide where resources are allocated and who earns what incomes. Firms don’t put other firms out of business; consumers do.

This view is another way of looking at Kirzner’s theory of entrepreneurship. If what entrepreneurs do is notice that consumers’ desires have changed, then they are simply responding to what they perceive consumers want. Or, perhaps more subtly, entrepreneurs perceive that consumers would want something if it were available to them. In either case, consumers’ wants ultimately cause the chain of events that includes those acts of entrepreneurship.

In the end, consumers determine how resources get used and who profits from them. Entrepreneurship consists in not just the next great innovation that disrupts a market equilibrium, but more often in the small acts of accurate cultural perception that lead to marginal changes in the production process or the product that better coordinate the market’s offerings with consumers’ wants. The best entrepreneurs are adept at figuring out what will best serve the market’s ultimate driving force: the consumer.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.