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Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach Author(s): Israel M. Kirzner Source: Journal of Economic Literature, Vol. 35, No. 1 (Mar., 1997), pp. 60-85 Published by: American Economic Association Stable URL: http://www.jstor.org/stable/2729693 Accessed: 12/01/2010 14:59

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http://www.jstor.org Journal of Economic Literature Vol. XXXV (March 1997), pp. 60-85

EntrepreneurialDiscovery and the Competitive Market Process: An Austrian Approach

ISRAEL M. KIRZNER New York University

The aiithloris deeply grateful to Mario Rizzo, Peter Boettke, andc1Yat Nyarko, for exte.tsive and helpful comm7ents o an earlier draft Firther helpful coniiiiienit.swere provided by Joseph T Salernio,and by othieriaiemiibers of the AiustrianiEconomizics Colloquiumi71 at New York Univer- Oity.Several anioniymtouisreferee.s provided m1anzyadditionial valiuable suggestions. The auithlor is gr-atefiulto the Sarah Scaife Foundation for researchisupport.

I stream economics. This paper sets forth the outlines of one important approach THE AUSTRIAN TRADITION is repre- within modern Austrian economics, an sented in modern economics by a approach offering a perspective on mi- "very vocal, feisty and dedicated subset croeconomic theory which (while it has of the economics profession" (Karen generated a considerable literature of its Vaughn 1994, p. xi). Much of the work of own) is not ordinarily well-represented this group of scholars is devoted to the either at the (mainstream) textbook most fundamental problems of micro- level, or in the (mainstream) journal lit- economics.1 This Austrian work, there- erature. Although the author subscribes fore, differs in character and content to and has contributed to this from a good deal of neoclassical theory approach, the purpose of this paper is exposition, which, despite widespread and growing not advocacy. References in the paper awareness of its limitations, continues to to criticisms of mainstream microeco- serve as the analytical core of main- nomics which have been discussed in the Austrian literature should be understood 1 The emphasis here on microeconomics ex- here not as arguments in favor of the presses the focus of the present paper, not the Austrian approach, but as clues that may scope of modern Austrian economics. For impor- tant modern Austrian contributions to macro- be helpful in understanding what the economic and to monetary theory, see Roger Gar- Austrians are saying, and how what they rison (1978, 1984), Lawrence White (1984), are saying is to be distinguished from the George Selgin (1988), Selgin and White (1994), Steven Horwitz (1992). See also Brian Snowdon, approach taken by other modern econo- Howard Vane, and Peter Wynarczyk (1994, ch. 8). mists. For a link between Friedrich Hayek's macro- This paper does not offer anything like economics and the Austrian microeconomics set forth in this paper, see Dieter Schmidtchen and a survey of modern Austrian economics. Siegfried Utzig (1989). It does not deal at all with such major 60 Kirzner: Entrepreneurial Discovery 61

areas within it, such as cycle theory, economics.6 By 1950 both Mises and monetary theory, capital theory. Within Hayek had crystallized separate, defini- its chosen scope of microeconomics, it tive, statements of their disagreements does not claim to represent a universally with mainstream microeconomics, and of accepted Austrian position (or even to their own substantive approaches. These cover its entire range of topics). None- were indeed separate statements, differ- theless, the approach described here is ing from one another certainly in style arguably central to the reviving contem- and, no doubt, to some degree also in porary interest in Austrian ideas, and has substance. But it can be argued that they been treated as such in a number of re- are best understood as both overlapping cent general surveys of modern Austrian and complementary, rather than as con- economics (Stephen Littlechild 1986; trasting alternatives. It was these contri- Bruce Caldwell and Stephan Boehm butions of Mises and Hayek which, while 1992; Vaughn 1994).2 almost entirely ignored by the midcen- During the past two decades modern tury mainstream of the profession, have Austrian economics has emerged out of nourished the Austrian revival of the the classic earlier "subjectivist"tradition3 past two decades, and which have gener- (which began in the late nineteenth cen- ated the modern Austrian approach to tury with Carl Menger, Eugen von understanding the competitive market Boehm-Bawerk, and Friedrich von Wie- process set forth in this paper. ser),4 particularly as that tradition came At the basis of this approach is the to be represented in the midcentury con- conviction that standard neoclassical mi- tributions of Ludwig von Mises and croeconomics, for which the Walrasian Friedrich Hayek.5 The early work of the general equilibrium model (in its mod- Austrian School until the 1930s was cor- ern Arrow-Debreu incarnation) is the rectly perceived as simply one variant of analytical core, fails to offer a satisfying the dominant early twentieth century theoretical framework for understanding mainstream approach to economic un- what happens in market economies. This derstanding (often loosely referred to as conviction is rooted (a) in criticisms of "neoclassical"). But the work of Mises the lack of relevance in models which and Hayek from the 30s on, steered the seek to explain market phenomena as if Austrian tradition in a direction sharply they were, at each and every instant, different from that being taken at that strictly equilibrium phenomena, and (b) time by mainstream neoclassical micro- in the belief that it is a methodologically legitimate demand to be made of a the- 2 For an authoritative, encyclopedia-style set of surveys of modern Austrian economics, see Boet- ory of the market, that it not merely be- tke (1994). gin with the instrumentalist assumption 3 For discussions of Austrian subjectivism (and of already-attained equilibrium, but also also on its influence on other schools of economic thought) see Alfred Coats (1983), Jack Wiseman realistically offer a plausible explanation (1983, 1985), Gerald O'Driscoll and Rizzo (1985, of how, from any given initial set of ch. 2), James Buchanan (1982), Ludwig Lachmann nonequilibrium conditions, equilibrating (1982). 4 For general surveys of the history of the Aus- tendencies might be expected to be set trian tradition, see Hayek (1968), Vaughn (1994), into motion in the first place. As will Kirzner (1992). For collections of papers repre- senting the work of the Austrian School from 1870 6 For the thesis that these developments in the to the present see Littlechild (1990), Kirzner work of Mises and Hayek stemmed from their par- (1994). in 5 ticipation the interwar debate on the possibility Among the principal relevant works are Mises of socialist economic calculation, see Kirzner (1949), Hayek (1941, 1948, 1978). (1992, ch. 6). 62 Journal of Economic Literature, Vol. XXXV (March 1997) be noted below, such criticisms are not ery is seen as gradually but systemati- (or, at any rate, no longer) exclusively cally pushing back the boundaries of "Austrian" criticisms. In fact, a good sheer ignorance, in this way increasing deal of recent non-Austrian work in mutual awareness among market partici- microeconoinics has in some fashion pants and thus, in turn, driving prices, attempted to grapple with these difficul- output and input quantities and quali- ties. What stamps the entrepreneurial ties, toward the values consistent with discovery approach as Austrian is not equilibrium (seen as the complete ab- these criticisms themselves, but rather sence of sheer ignorance). the specific positive elements of the ap- What will emerge from this paper is proach. thus the exposition of an Austrian way of These positive elements focus on the understanding the systematic character role of knowledge and discovery in the of markets which, while sharply differing process of market equilibration. In par- from the mainstream competitive equi- ticular this approach (a) sees equilibra- librium model, does not necessarily see tion as a systematic process in which that model as totally irrelevant. (Many market participants acquire more and practical questions, such as those regard- more accurate and complete mutual ing the effects of price controls, mini- knovledge of potential demand and sup- mum wage laws, and the like, can be an- ply attitudes, and (b) sees the driving swered quite adequately without going force behind this systematic process in beyond simple competitive supply-and- what will be described below as en- demand equilibrium models.) The dy- trepreneurial discovery. Although, of namic competitive process of en- course, much contemporary mainstream trepreneurial discovery (which is the work in microeconomics takes its point driving element in this Austrian ap- of departure from the imperfection of proach) is one which is seen as tending knowledge (relaxing the older standard systematically toward, rather than away neoclassical assumption of complete, from, the path to equilibrium. There- universal information), the Austrian ap- fore, the standard, competitive equilib- proach set forth in this paper has little in rium model may be seen as more plausi- common with this work. ble as an approximate outcome, in the For the mainstream, imperfect in- Austrian theory here presented.7 This as- formation is primarily a circumstance pect of the entrepreneurial discovery ap- constraining the pattern of attained equi- proach troubles a number of the Aus- librium (and introducing a new "produc- trian economists who have not accepted tion" cost, that of producing or searching it. In order to clearly locate the for missing information). For the Aus- entrepreneurial discovery perspective trian approach imperfect information is within the range of modern Austrian seen as involving an element which can- theoretical points of view, it will be nec- not be fitted at all into neoclassical mod- essary briefly to identify more precisely els, that of "sheer" (i.e., unknown) igno- the various disagreements which other rance. As will be developed below, sheer Austrians have had with this approach. ignorance differs from imperfect infor- Section II of this paper will review the mation in that the discovery which reduces sheer ignorance is necessarily 7 For a critique of the use by Austrian econo- mists (such as Mises and Murray Rothbard) of a accompanied by the element of sur- concept (the "evenly rotating economy") which prise-one had not hitherto realized parallels that of the equilibrium state, see Tyler one's ignorance. Entrepreneurial discov- Cowen and Richard Fink (1985). Kirzner: Entrepreneurial Discovery 63

Austrian criticisms of the equilibrium the selling and buying decisions consis- emphasis of the neoclassical models. tent with maximizing under a range of Section III will develop the Austrian un- hypothesized states of affairs). It is this derstanding of the market process, based aspect of modern neoclassical economics upon the twin concepts of sheer (i.e., un- which accounts for its characteristic em- known) ignorance and entrepreneurial phasis upon: (a) the constrained maximi- discovery. Section IV will survey several zation pattern imposed by the theory areas of applied microeconomics (anti- upon individual decision making, and (b) trust economics, welfare economics, the the mathematics of simultaneous equa- theory of justice, and the possibility of tion systems. Valiant attempts have been socialist economic calculation), taking made to enrich the realism of these equi- special note of the significant differences librium microeconomic models by build- which the Austrian approach entails in ing into them assumptions acknowl- regard to policy recommendations in edging imperfections in competition. these areas. Section V will note the vari- Nonetheless, the dominant trend has ous criticisms to the entrepreneurial dis- been to concentrate upon models of covery theory developed in this paper, competitive equilibrium, that is upon offered by several contemporary Aus- models in which both prices and prod- trian economists. Section VI concludes uct/resource qualities are taken as given the paper by clearing up certain misun- to each decision maker, and as being in- derstandings concerning the Austrian ap- dependent of the decisions made. Not proach. only do these competitive models (like all equilibrium models) assume complete II mutual knowledge (in the relevant sense), they also assume, in effect, that Mainstream microeconomics inter- the crucial market variables of price and prets the real world of markets as if quality are somehow presented to each observed phenomena represent the ful- decision maker as an external fact of na- fillment of equilibrium conditions.8 Mar- ture. Neoclassical economics operates on kets consist of successfully maximizing the assumption that the world reflects agents whose decisions are held to fit in the relationships that would prevail in together perfectly, in the sense that each such equilibrium models-with the maximizing decision being made cor- model of competitive equilibrium being rectly anticipates, in effect, at least, all the favorite one. While Austrians have the other maximizing decisions being not been alone in criticizing this ap- made simultaneously. It is this latter proach to understanding markets, their condition which mathematically con- criticisms have been both pioneering and strains the attained values of the key de- trenchant. cision variables. For this condition to be Austrian dissatisfaction with this stan- fulfilled, only that set of input and out- dard approach to understanding real put prices and quantities can prevail world market phenomena emerged most which simultaneously satisfies the rele- clearly in the forties. Both Mises and vant equations of supply and demand Hayek expressed dismay at models la- (themselves constructed by aggregating beled as competitive, in which market are as it 8 It has been strongly argued by Frank participants forbidden, were, Machovec (1995) that the great neoclassical from competing (in the sense in which, economists of the period before 1930 did not pro- in everyday discourse and experience, ceed in this manner. market participants compete by bidding 64 Journal of Economic Literature, Vol. XXXV (March 1997)

higher prices or by offering to undersell (a) Criticisms of the unrealistic charac- competitors, by offering consumers bet- ter of neoclassical theory relate both to ter quality merchandise, better service, the way in which individual decisions are and the like; see Mises 1949, p. 278ftn; modeled in that theory, and the way in Hayek 1948, pp. 92-118). Their unhappi- which that theory sees real world market ness with models of so-called perfect outcomes as satisfying the conditions for competition ultimately stemmed from equilibrium. their unwillingness to surrender the (i) At the individual level Austrians economists' insights into the dynamic have taken sharp exception to the man- character of active markets to equilib- ner in which neoclassical theory has rium models, in which all decisions have portrayed the individual decision as a somehow been pre-reconciled, held as at mechanical exercise in constrained maxi- all times governing market phenomena. mization. Such a portrayal robs human It seems accurate to understand their choice of its essentially open-ended impatience with the neoclassical preoc- character, in which imagination and cupation with equilibrium models as boldness must inevitably play central arising from (a) the blatantly false nature roles. For neoclassical theory the only of the assumption that market conditions way human choice can be rendered ana- are at all times in equilibrium, and (b) lytically tractable, is for it to be modeled methodological unease with an instru- as if it were not made in open-ended mentalist mode of theorizing and empiri- fashion, as if there was no scope for cal analysis that finds it useful to pre- qualities such as imagination and bold- sume that equilibrium always prevails, ness. Even though standard neoclassical while recognizing no obligation to ac- theory certainly deals extensively with count theoretically for any equilibrative decision making under (Knightian) risk,9 process (from which equilibrium might this is entirely consistent with absence of be explained as emerging). scope for the qualities of imagination Modern presentations of the en- and boldness, because such decision trepreneurial discovery approach have making is seen as being made in the con- echoed these criticisms of equilibrium text of known probability functions. In economics, and have deployed these the neoclassical world, decision makers criticisms in seeking to demote the con- know what they are ignorant about. One cept of perfect competition from its posi- is never surprised. For Austrians, how- tion of dominance in modern neoclassi- ever, to abstract from these qualities of cal theory, in order to replace it by imagination, boldness, and surprise is to notions of dynamic competition (in denature human choice entirely.10 which market participants are, instead of Now we should emphasize that a good exclusively price takers, competitive deal of critical attention has been di- price-and quality-makers). Within the rected in recent years by non-Austrians two broad bases for Austrian (as well as at the neoclassical assumption of perfect for non-Austrian) criticism, several information. A significant literature has strands of difficulty with the neoclassical shown how imperfect information may, competitive equilibrium paradigm may be distinguished. The clear identification 9 Frank Knight developed his classic distinc- of these strands will help us understand tion between risk and uncertainty in Knight the Austrian character of the positive ap- (1921). IO(See for example, Ernest Pasour 1982 and proach, based on entrepreneurial discov- Naomi Moldofsky 1982; see also George Shackle ery, to be developed in Section III. 1972; Buchanan 1979.) Kirzner: Entrepreneurial Discovery 65

as a consequence of entailed externali- important features of reality. For Austri- ties, render the equilibrium outcomes of ans it is unacceptable to claim that, at market economies inefficient in terms of each and every instant, the configuration Paretian criteria. It is however necessary of production and consumption decisions to dispel a certain confusion which has currently made, is one which could, in arisen in this regard. Joseph Stiglitz the light of the relevant costs, not possi- (1994, pp. 24f) who has been a central bly have been improved upon. To claim contributor to this critical literature, has that, at any given instant, all conceivably taken note of what he believes to be the relevant available opportunities have parallel Austrian concern with imperfect been instantaneously grasped, is to fly in information. He has also (1994, p. 43) the face of what we know about real drawn attention to what he understands world economic systems. It is one thing as the contrary Austrian view, namely, to postulate rapid equilibrating processes that it claims informational efficiency for as imposing systematic order upon mar- the price system. We should emphasize kets; it is quite another thing (in the ab- that, on both these points, he has missed sence of any theory of equilibrative pro- the crucial element that sharply distin- cesses!) to treat the world as at all times guishes the unknown ignorance (with already in the attained state of equilib- which Austrians have been concerned) rium.11 from the imperfect information (central (b) The basic methodological founda- to the critical literature in which Stiglitz tion for Austrian unhappiness with main- himself has been a pioneer). For Stiglitz stream neoclassical preoccupation with "imperfect information"refers to known- equilibrium models, has not so much to to-be-available information which it is do with the false and misleading picture costly to produce. But for Austrians the of real markets, which standard deploy- focus is upon what has been termed ment of these models entails, as with the "previously unthought-of knowledge" instrumentalist view of theory which the (Esteban Thomsen 1992, p. 61). In Sec- neoclassical equilibrium-preoccupation tion III we shall return to see how, as a came to express. Austrians, in this ver- consequence of this distinction, Austrian sion of their criticism, need have no appreciation for the discovery potential quarrel with equilibrium models as such. of market processes does not at all imply No doubt significant features of real that "informational efficiency" for mar- world market economies can indeed be ket outcomes which Stiglitz has denied. illuminated by use of such models. But, (ii) At the market level, Austrians have the Austrian criticism runs, we are surely rebelled against a microeconomics which entitled to demand a theoretical basis for can find coherence in markets and can the claim that equilibrating processes explain market phenomena only by as- systematically mold market variables in a serting that markets are, at all times, to direction consistent with the conditions be treated as if already in the attained postulated in the equilibrium models. If relevant state of equilibrium. competitive markets are to be explained Such a picture of the world Austrians in terms of Marshallian supply and de- find simply false, not merely in the sense that an explanatory theoretical model 11 For examples of Austrian literature critical of the standard equilibrium approach see Rizzo may, obviously, not offer a photographic (1979), Sanford Ikeda (1990). For a mainstream representation of the richly complex re- reaction to this literature see Christopher Phelan ality it is being used to explain, but in (1987). See also Brian Loasby (1994), David Har- the sense that this picture falsely labels per (1994a). 66 Journal of Economic Literature, Vol. XXXV (March 1997)

mand diagrams, surely we are entitled cess. Arrow focused his attention upon to a theoretical process-"story" which the Marshallian perfectly competitive might account for the economists' confi- supply and demand model in the single dence in the special relevance of the in- commodity market, and especially, upon tersection point in that supply and de- the requirement of this model that sup- mand diagram. In our undergraduate ply equal demand. He draws attention to freshman classes we do offer such sto- the logical gap in the perfectly competi- ries: if above equilibrium prices prevail, tive model: this generates surplus of supply over de- Each individual participant in the economy is mand; these surpluses force prices down- supposed to take prices as given and deter- wards, etc., etc. But strictly speaking, mine his choices as to purchases and sales ac- these plausible stories are, within the cordingly; there is no one left over whose job neoclassical framework, quite illegiti- it is to make a decision on price. (Arrow mate. That framework requires us simply 1959, p. 43) to accept equilibrium models as the only He overcomes this difficulty by propos- explanatory tool necessary for under- ing that it be recognized "that perfect standing prices and outputs. This, for competition can really prevail only at Austrians, is methodologically unaccept- equilibrium" (Arrow 1959, p. 41). In able. What, we must ask, accounts for disequilibrium each supplier faces a the powerful equilibrating tendencies downward sloping demand curve and, which economists believe to be operat- acting "monopolistically," seeks an opti- ing in markets? If, at any time, real mal price-quantity combination. The world limitations upon the perfection of equilibrating process operates through information possessed have prevented each supplier discovering that (as a re- instantaneous attainment of equilibrium, sult of the comparable activities of his why should we have confidence in any fellow "monopolists") his demand curve possible equilibrative process?12 And is shifting "at the same time as he is ex- how, if we do observe such equilibrating ploring it" (Arrow 1959, p. 46). processes, can we understand what has Arrow recognized that the very notion generated them?13 of a perfectly competitive market in dis- Kenneth Arrow's well known paper of equilibrium is incoherent. And he recog- 1959 offers an excellent illustration of (a) nized an obligation to offer a model that how a foremost exponent of the neoclas- might account for the emergence, out of sical approach perceptively recognized initial disequilibrium, of an equilibrating one aspect of the problem upon which process. His critique of the core of neo- this latter Austrian criticism has focused, classicism, illustrates well the vulnerabil- and (b) how this led him to develop an ity of mainstream theory to the Austrian analytical dynamics from which the stan- criticisms discussed in this section. A dard competitive equilibrium model number of non-Austrian writers have emerges only as the outcome of a pro- followed Arrow's critique, and Franklin Fisher's (1983) important contribution 12 This confidence has, in recent literature, been attracted a modest amount of profes- challenged also on the grounds of possible path- sional attention. Nonetheless, the main- dependency. See for example Brian Arthur (1989), Robin Cowan (1990). stream has proceeded by virtually ignor- 13 For literature on the role of process theory in ing these criticisms, and operating as if economics, see particularly Jack High (1990), its core paradigm was, by and large, as Lachmann (1986), Ikeda (1990, 1994), Wolfgang Kerber (1994). For a pioneering contribution see relevant as ever. George B. Richardson (1960). Austrians maintain that a theoretical Kirzner: Entrepreneurial Discovery 67 framework for understanding the equili- unrealizable state of the evenly rotating brative process is available. This frame- economy if no further changes were to work offers its explanation not by deny- occur" (Mises 1949, p. 335). "In the ing the operation of competition in imaginary construction of the evenly ro- disequilibrium but per contra (and in tating economy there is no room left for sharpest contrast to Arrow's labeling sys- entrepreneurial activity . . ." (Mises tem), by reformulating the notion of 1949, p. 253). The focus here is on the competition to make it utterly inconsis- market process, as opposed to the tent with the equilibrium state. "imaginary construct" of the "evenly ro- tating economy"(corresponding roughly to III the state of general market equilibrium). Entrepreneurial activity has no place The entrepreneurial discovery ap- at all in neoclassical equilibrium micro- proach which has emerged in modern economics (because it is inconsistent Austrian economics during the past quar- with the conditions satisfied in the equi- ter of a century was developed out of librium state; William Baumol 1993, ch. elements derived from Mises and from 1). But for Austrians the entrepreneurial Hayek. From Mises the modern Austri- role provides the theoretical key with ans learned to see the market as an en- which to account for the market as a pro- trepreneurially driven process. From cess. For Mises, the economist Hayek they learned to appreciate the role of knowledge and its enhancement shows how the activities of enterprising men, through market interaction, for the the promoters and speculators, eager to profit equilibrative process. These two distinct from discrepancies in the price structure, tend toward eradicating such discrepancies elements have been welded into an inte- . . . He shows how this process would finally grated theoretical framework which, on result in the establishment of the evenly ro- the one hand, is consistent with and, on tating economy. This is the task of economic the other hand, is articulated in a man- theory. The mathematical description of vari- ner more explicit than the earlier Aus- ous states of equilibrium is mere play. The problem is the analysis of the market process. trian expositions.'4 (Mises 1949, pp. 352-53) Mises' conception of the market as an entrepreneurially driven process per- Hayek's emphasis on the role of vades his mature theoretical work. knowledge and its enhancement in the The driving force of the market process is course of the market process goes back provided neither by the consumers nor by the to his work in the thirties. It was Hayek owners of the means of productions-land, who insisted that capital goods, and labor-but by the promot- ing and speculating entrepreneurs . . . Profit- the concept of equilibrium merely means that seeking speculation is the driving force of the the foresight of the different members of the market as it is the driving force of produc- society is . . . correct . . . in the sense that tion. (Mises 1949, pp. 325-26) every person's plan is based on the expecta- tion of just those actions of other people "The activities of the entrepreneur are which those other people intend to perform the element that would bring about the and that all these plans are based on the ex- pectation of the same set of external facts . .. Correct foresight is then . . . the defining 14For excellent modern Austrian expositions characteristic of a state of equilibrium. of the approach developed in this section see Martti Vihanto (1989, 1994). For discussions (Hayek 1948, p. 42) which are at least partly critical of the Austrian approach see Loasby (1989, ch. 10) and Claudia In his pioneering discussion of the equil- Loy (1988). ibrating process Hayek pointed out that, 68 Journal of Economic Literature, Vol. XXXV (March 1997)

"if we want to make the assertion that, modities" (Mises 1949, p. 278). He cites under certain conditions, people will ap- Hayek's critique of the doctrines of im- proach (the equilibrium state), we must perfect or monopolistic competition explain by what process they will acquire (Mises 1949, p. 278 fn.), and emphasizes the necessary knowledge" (Hayek 1948, that competition (far from being de- p. 46). fined, as in the perfectly competitive For Hayek the equilibrating process is model, as the state in which all partici- thus one during which market partici- pants face identical prices) "manifests it- pants acquire better mutual information self in the facts that the sellers must concerning the plans being made by fel- outdo one another by offering better or low market participants. For Mises this cheaper goods and services and that the process is driven by the daring, imagina- buyers must outdo one another by offer- tive, speculative actions of entrepreneurs ing higher prices" (Mises 1949, p. 274). who see opportunities for pure profit in In other words, the essence of competi- the conditions of disequilibrium. What tion is precisely that dynamic rivalry permits us to recognize that these two whiclh the neoclassical equilibrium no- perspectives on the character of the mar- tion of competition is at great pains to ket process are mutually reinforcing, is exclude. Hayek's pathbreaking critique the place which each of these two writers of the dominance of the perfectly com- assigns to competition in the market pro- petitive model (and hence also of the cess. The Austrian approach includes a corollary doctrines of imperfect and mo- concept of competition which differs nopolistic competition) takes as its point drastically from that encapsulated in the of departure precisely this feature of the label "competitive" as used in modern model. That model, he points out deals neoclassical theory. with a state of what is called "competitive For neoclassical economics the maxi- equilibrium"in which it is assumedthat the mum possible degree of competition is datafor the differentindividuals are fully ad- represented by the equilibrium notion of justed to each other, while the problem perfect competition, in which all traces which requires explanationis the nature of the process by which the data are thus ad- of rivalry are absent. Anything less than justed. (Hayek1948, p. 94) perfect elasticity in the supply/demand curves faced by potential buyers/sellers For Hayek, on the other hand, "competi- corresponds, in neoclassical terminology, tion is by its nature a dynamic process to some degree of monopolistic power.'5 whose essential characteristics are as- Mises rejected this nomenclature, in that sumed away by the assumptions underly- it implies that monopoly prices are ing static analysis" (Hayek 1948, p. 94). somehow determined without that com- "Competition," he insists petitive process which constitutes for is essentially a process of the formationof Mises the essence of the market. "Catal- opinion . .. a process which involvesa con- lactic competition is no less a factor in tinuouschange in the data and whose signifi- the determination of monopoly prices cance must therefore be completely missed than it is in the determination of com- by any theorywhich treats these data as con- stant. (Hayek1948, p. 106) petitive prices . . . On the market every commodity competes with all other com- In other words the role of competition in economic theory must, for both Mises 15 See George Stigler (1957) for the emergence and Hayek, focus not on the state of af- of the view that explicitly rejects rivalrousness as fairs at the end of the market process, an ingredient in competitive analysis. but upon the character of that process Kirzner: Entrepreneurial Discovery 69

itself. More recently Hayek has empha- "maximize," but who has no opportunity sized the nature of competition as a "dis- to sell output at a price exceeding covery procedure"-i.e., as generating costs.)17 If the entrepreneur grasps the "such facts as, without resort to it, would opportunities for pure entrepreneurial not be known to anyone . . ." (Hayek profit created by temporary absence of 1978, p. 179). full adjustment between input and out- For the modern Austrian approach, put markets, the neoclassical market in this perception of competition as the dy- full equilibrium can, of course, find no namic, driving force for discovery in the room for him. In Austrian theory the en- market process has become central. The trepreneur is an agent whose character key to an explanation of the equilibrative has been carefully explored. process is to recognize the pivotal role of For Mises the term "entrepreneur" re- dynamic competition in that process. fers to "acting man in regard to the This equilibrative process of competition changes occurring in the data of the is at work even in markets in which one market" (Mises 1949, p. 255). Entrepre- firm may enjoy monopolistic privilege. neurship is human action "seen from the This is because even a monopolistic aspect of the uncertainty inherent in equilibrium can be approached, in a every action" (Mises 1949, p. 254). The world of uncertainty, only through a pro- Misesian concept of human action thus cess whereby market participants can be- implies the open-ended framework come better aware of one another's atti- within which all decisions made must tudes and plans. Only the process of necessarily partake of the speculative competition can achieve this.16 character essential to the notion of en- We have thus placed our finger on the trepreneurship. "In any real and living key interrelated analytical concepts with economy every actor is always an entre- which the modern Austrian entrepre- preneur" (Mises 1949, p. 253). By free- neurial discovery theory of the market ing microeconomic analysis from the process operates. These concepts are: (a) constrictions of the equilibrium state, the entrepreneurial role; (b) the role of Austrian theory is able to recognize the discovery; (c) rivalrous competition. speculative element in all individual de- Each of these requires some brief dis- cision making, and to incorporate the ac- cussion. tivity of the real world business man into (a) The entrepreneurial role: In stan- dard neoclassical equilibrium theory 17 The statement in the text presumes that rents earned by firms who own scarce, non-reproducible there is, by its very character, no role for resources used in their production operations, are the entrepreneur. In equilibrium there is (although included in accounting "profit") prop- no scope for pure profit: there is simply erly to be included in the firms' economic costs. These firms certainly enjoy an advantage over nothing for the entrepreneur to do. (If other firms who, not owning these resources, must textbooks do speak of the entrepreneur produce with resources of lower productivity. But in the theory of the firm this turns out to this advantage consists, for the economist (as dis- tinct from the accountant), not in entrepreneurial refer simply and imprecisely to the profit won by the fortunate firms, but rather in owner of the firm who, operating in rental income earned through asset ownership. equilibrium markets, is indeed able to The entrepreneur is considered as hiring these re- sources from himself as owner, and should then include this rental income as part of his (implicit) 16 It follows that monopolistic (or monopo- economic costs. For a full and classic discussion of listically com petitive) equilibrium states, are en- the sense in which differential rent on assets tirely compati le with the notion of dynamic com- owned are properly included in the firm's eco- petition (which might in fact bring about such nomic costs, see Fritz Machlup (1952, pp. 237f, states). 288ff). 70 Journal of Economic Literature, Vol. XXXV (March 1997) a theoretical framework that provides change price/output data. In this way, as understanding of the market process. In we shall see, the entrepreneurial role focusing upon the entrepreneurial deci- drives the ever-changing process of the sion in a Knight-uncertain world, Aus- market. Where shortages have existed, trian theory thus diverges sharply from we understand the resulting price in- the notion of the individual decision that creases as driven by entrepreneurs rec- constitutes the analytical building block ognizing, in the face of the uncertainty of neoclassical microtheory. For neoclas- of the real world, the profit opportuni- sical microtheory each decision, whether ties available through the expansion of made by consumer, firm, or resource supply through production, or through owner, is made within a definitely known arbitrage. Except in the never-attained framework made up of a given objective state of complete equilibrium, each mar- function, a given set of resource con- ket is characterized by opportunities for straints, and a given set of technologi- pure entrepreneurial profit. These op- cally or economically feasible ways of portunities are created by earlier en- transforming resources into desired ob- trepreneurial errors which have resulted jectives. (Uncertainty, while of course in shortages, surplus, misallocated re- recognized as surrounding each decision, sources. The daring, alert entrepreneur expresses itself in the form of known discovers these earlier errors, buys probability distributions relating to the where prices are "too low" and sells given elements of this known frame- where prices are "too high." In this way work.) In this neoclassical context, there low prices are nudged higher, high is no room for entrepreneurship not only prices are nudged lower; price discrep- in the sense (mentioned earlier) that no ancies are narrowed in the equilibrative opportunities for pure profit can possibly direction. Shortages are filled, surpluses exist, but also in the sense that the are whittled away; quantity gaps tend to model precludes all Knightian uncer- be eliminated in the equilibrative direc- tainty that might affect the character of tion. In a world of ceaselessly changing the individual decision. Boldness, imagi- tastes, resource availabilities, and known nation, drive are characteristics which technological possibilities, this entrepre- are simply irrelevant to individual deci- neurial process cannot guarantee rapid sion making in neoclassical microtheory. (or slow) convergence to a state of equi- This Austrian emphasis on the entre- librium. But it does at each moment preneur is fundamental.18Whereas each guarantee profit-incentives tending to neoclassical decision maker operates in nudge the market in what, from the per- a world of given price and output data, spective of that moment, must be recog- the Austrian entrepreneur operates to nized as the equilibrative direction. The critical question for an entrepre- 18 For an example of Austrian work in an ap- neurial theory of market process, is how plied field in which this emphasis on en- to understand, in the existence of such trepreneurship is central, see Charles Baird profit-incentives, the existence also of a (1987). For general discussion of this Austrian em- phasis, see also Jochen Runde (1988). A work systematic tendency for entrepreneurial which (while on the whole sharply critical of the errors to be replaced by profit-making Austrian approach) provides a very insightful expo- entrepreneurial corrections. For this as- sition of it, is Stavros loannides (1992, especially chs. 3, 4, 5). Other valuable recent critical discus- pect of the entrepreneurial discovery sions of Austrian entrepreneurial theory include theory we must postulate a tendency for Martin Ricketts ( 1993), Vaughn (1994, pp. 141ff), the profit opportunities generated by Harper (1994b). earlier entrepreneurial error, to be no- Kirzner: Entrepreneurial Discovery 71 ticed and grasped. The Austrian ap- the decision-maker's discovery of an ear- proach indeed includes such a postulate. lier error in his view of the world. To appreciate this we turn to the second Whereas earlier plans had overlooked of the above listed three key analytical available profit opportunities (as, for ex- elements in this approach. ample, where some buyers buy goods at (b) The role of discovery: We have al- high prices, that were being sold else- ready seen that Hayek pioneered in in- where in the same market for lower terpreting the equilibrative market pro- prices), subsequent plans can be ex- cess as a process of mutual discovery. In pected to reflect discovery of the profit the course of this process market partici- opportunities implicit in (and constituted pants become better informed of the by) the earlier plans. We should ac- plans being made by other participants. knowledge that, from the neoclassical Whereas some initial plans must, as a re- perspective, it is not at all obvious why sult of initial entrepreneurial error, turn we should expect such discoveries to be out to have been mistaken, these errors made. tend systematically to become elimi- After all, it may be objected from the nated as market experience reveals the mainstream economist's point of view, if infeasibility of some (hitherto sought af- an available opportunity for profit was ter) courses of action and the (hitherto universally overlooked yesterday, why unnoticed) profitability of other courses should we expect that opportunity to be of action. In the world of static equilib- noticed today? It is not as if that profit rium, a chosen course of action, because opportunity was the object of systematic it was pronounced mathematically to search (in which case it might be ex- have been the optimal course of action pected that a time consuming search within the given decision framework, process would identify it sooner or later). cannot fail to be chosen again and again, An opportunity for pure profit cannot, by so long as that given framework prevails. its nature, be the object of systematic In the market-process world of en- search. Systematic search can be under- trepreneurial discovery, on the other taken for a piece of missing information, hand, flawed plans (i.e., those made on but only because the searcher is aware of the basis of an erroneously imagined de- the nature of what he does not know, cision framework) can be expected to and is aware with greater or lesser cer- tend to be corrected through the respon- tainty of the way to find out the missing siveness of alert, imaginative entrepre- information. In the economics of search neurs to the opportunities revealed as a literature, therefore, search is correctly result of the initially flawed plans. In treated as any other deliberate process of other words, this approach postulates a production. But it is in the nature of an tendency for profit opportunities to be overlooked profit opportunity that it has discovered and grasped by routine-resist- been utterly overlooked, i.e., that one is ing entrepreneurial market participants. not aware at all that one has missed the In the neoclassical context a decision grasping of any profit. From the neoclas- can never be corrected-because no de- sical perspective, therefore, a missed op- cision can ever be truly mistaken. The portunity might seem (except as a result reason for a change in a decision, thus of sheer, fortuitous good luck) to be des- can be found only in an exogenously gen- tined for permanent obscurity. erated change in the relevant decision- It is here that the Austrian perspective framework. But in the Austrian context a offers a new insight, into the nature of decision can be corrected as a result of surprise and discovery. When one be- 72 Journal of Economic Literature, Vol. XXXV (March 1997)

comes aware of what one had previously of surprise (at one's earlier unaccount- overlooked, one has not produced knowl- able ignorance). An entrepreneurial atti- edge in any deliberate sense. What has tude is one which is always ready to be occurred is that one has discovered one's surprised, always ready to take the steps previous (utterly unknown) ignorance. needed to profit by such surprises. The What distinguishes discovery (relevant to notion of discovery, midway between hitherto unknown profit opportunities) that of the deliberately produced infor- from successful search (relevant to the mation in standard search theory, and deliberate production of information that of sheer windfall gain generated by which one knew one had lacked) is that pure chance, is central to the Austrian the former (unlike the latter) involves approach.19 The profit opportunities cre- that surprise which accompanies the re- ated by earlier entrepreneurial error do alization that one had overlooked some- tend systematically to stimulate sub- thing in fact readily available. ("It was sequent entrepreneurial discovery. The under my very nose!") This feature of entrepreneurial process so set into mo- discovery characterizes the entrepre- tion, is a process tending toward better neurial process of the equilibrating mutual awareness among market partici- market. What accounts for a systematic pants. The lure of pure profit in this way tendency toward that succession of sets up the process through which pure wholesome surprises which must consti- profit tends to be competed away. En- tute the equilibrative process, is not any hanced mutual awareness, via the en- implausible series of happy accidents, trepreneurial discovery process, is the but rather the natural alertness (Kirzner source of the market's equilibrative 1973, pp. 35f, 65f) to possible opportuni- properties. ties (or the danger of possible disaster) Austrians are careful to insist (i) that which is characteristic of human beings. continual change in tastes, resource In the world of uncertainty such natural availabilities, and known technological alertness expresses itself in the boldness possibilities always prevent this equili- and imagination which Austrian theory brative process from proceeding any- ascribes to entrepreneurs in the context where near to completion; and (ii) that of the market. Entrepreneurial alertness entrepreneurial boldness and imagina- refers to an attitude of receptiveness to tion can lead to pure entrepreneurial available (but hitherto overlooked) op- losses as well as to pure profit. Mistaken portunities. The entrepreneurial charac- actions by entrepreneurs mean that they ter of human action refers not simply to have misread the market, possibly push- the circumstance that action is taken in ing price and output constellations in di- an open-ended, uncertain world, but also rections not equilibrative. The entre- to the circumstance that the human preneurial market process may indeed agent is at all times spontaneously on the reflect a systematically equilibrative ten- lookout for hitherto unnoticed features dency, but this by no means constitutes of the environment (present or future), a guaranteed unidirectional, flawlessly which might inspire new activity on his converging trajectory. What the Austrian part. Without knowing what to look for, entrepreneurial discovery process seeks without deploying any deliberate search to explain is not any imaginary mechani- technique, the entrepreneur is at all times scanning the horizon, as it were, 19 For further discussion of the Austrian concept of discovery see Kirzner (1989, ch, 2). See also ready to make discoveries. Each such Littlechild (1982a), Michael Beesely and Lit- discovery will be accompanied by a sense tlechild (1989), Manfred Streit (1992). Kirzner: Entrepreneurial Discovery 73

cal sure-fire convergence to equilibrium, It is from this perspective that Austri- but rather the existence and nature of ans stress (i) the discovery potential in those important tendencies which mar- rivalrous competition, and (ii) the en- kets display toward continual discovery trepreneurial character of rivalrous com- and exploitation of pure profit opportu- petition. The competition that charac- nities thus tending to nudge the market terizes the market process reveals in the equilibrative direction. In this information which no one was aware of process the capacity of market partici- its having been lacking. (This, as we shall pants to discover earlier error, is cen- see in Section IV, will be of importance tral.20 in assessing the possibility of the deliber- (c) Rivalrous competition: What drives ate engineering, in a socialist economy, the market process is entrepreneurial by central planners, of the kinds of out- boldness and imagination; what consti- comes yielded in a capitalist economy by tutes that process is the series of discov- the competitive market process.) This is eries generated by that entrepreneurial what Hayek had in mind when he re- boldness and alertness. Austrians are at ferred to competition "as a discovery pains to emphasize the dynamically procedure" (Hayek 1978, p. 179). The competitive character of such a process. competitive process is an entrepre- The process is made possible by the neurial one in that it depends crucially freedom of entrepreneurs to enter mar- on the incentives provided by the possi- kets in which they see opportunities bility of pure entrepreneurial profit. for profit. In being alert to such opportu- From this perspective profit emerges nities and in grasping them, entrepre- most importantly not as evidence of en- neurs are competing with other entre- trepreneurial error (which it certainly preneurs. This competition is not the is), but as the powerful incentive to keep competitive state achieved in neoclassi- down the incidence of entrepreneurial cal equilibrium models, in which all mar- error. ket participants are buying or selling As noted in Section II, Stiglitz saw identical commodities, at uniform prices. Austrians as claiming "informational It is, instead, the rivalrous process we efficiency" (in the Paretian sense) encounter in the everyday business for this "discovery procedure" of the world, in which each entrepreneur seeks market. This is not the case. The knowl- to outdo his rivals in offering goods to edge gained through the discovery consumers (recognizing that, because process of the market refers to the those rivals have not been offering the "unthought-of knowledge" with which best possible deals to consumers, profits Austrians have been concerned. Igno- can be made by offering consumers bet- rance of this unthought-of knowledge ter deals).2' is responsible for failure to attain equi- librium. Attainment of equilibrium, 20 For clarification of possible misunderstand- imagined as the eventual outcome of an ings concerning this claim for equilibrative ten- dencies in markets, see Section VI elow. uninterrupted process of market discov- 21 For the existence of a long tradition in eco- ery, does not attribute informational nomics in which rivalrous competition was recog- efficiency to that state of equilibrium. nized, see Paul McNulty (1967), Robert Ekelund and Robert Hebert (1981). For modern Austrian The informational inefficiency which (or Austrian-influenced) discussions of dynamic Stiglitz and his colleagues have attrib- competition see Donald Boudreaux (1994), uted to equilibrium states, relate, on Dominick Armentano (1978), Mark Addleson (1994), Thomas Arthur (1994), Harald Kunz the other hand, to "known ignorance," (1989). that is, to "known-to-be-available" in- 74 Journal of Economic Literature, Vol. XXXV (March 1997) formation which it is costly to pro- dard microeconomics sees the ideal de- duce.22 gree of competition as represented by the perfectly competitive model. The IV Austrian view sees matters quite differ- ently. discovery ap- The entrepreneurial For the Austrian approach competi- offers a theoretical framework for proach tion is socially beneficial primarily in a understanding how markets work. This dynamic sense. Coordination tends to framework has important practical impli- be induced among the decisions made for economics and for cations applied in the market place under the pressure We briefly take note of economic policy. of rivalrous entrepreneurs alert to the where the Aus- four areas of application profit-opportunities created by initial trian approach implies sharply different discoordination. To harness the en- conclusions from those usually practical trepreneurial initiative intrinsic to this derived from neoclassical economics. A kind of dynamic competition, we do not number of additional areas of application require fulfillment of the classic might also have been explored here. Ex- Knightian conditions for perfect compe- of such areas, omitted here be- amples tition-in fact those conditions preclude of constraints are: law and cause space scope for (and, in fact, any need for) en- economics for example Rizzo 1979), (see trepreneurial initiative. The perfect and the economics of transition (see for knowledge requirement central to the example Boettke 1993). The four areas perfectly competitive model can in fact examined are: (a) antitrust policy; (b) the be satisfied only by assuming away the of theories of eco- applicability accepted need for any coordinative process. To in- nomic justice; (c) welfare economics; (d) duce dynamic entrepreneurial competi- workability of central planning under the tion we require the fulfillment of only socialism. one condition: guaranteeing free en- (a) Antitrust Policy: Standard econom- trepreneurial entry into any market ics, built upon neoclassical insights into where profit opportunities may be per- the Pareto-efficiency qualities of per- ceived to exist. Most of the insights of equilibrium, has for fectly competitive contestable market theory turn out not most of this century been deployed to only to be consistent with the en- support antitrust policy limiting firm size trepreneurial discovery approach, but and relative to the in- (both absolutely in fact to be implied by that approach. the healthy dose of real- dustry). Despite To limit the size of firms (for example ism introduced into antitrust economics by obstructing mergers) is, in the en- in recent decades, and despite the sub- trepreneurial discovery approach, to stantive theoretical improvements intro- block entrepreneurial entry, and is thus duced into our understanding of compe- anti-competitive in the relevant sense. tition by the theory of contestable Conversely, many aspects of real-world markets, it remains the case that stan- business activity, involving such practices as advertising, or any of innumerable 22 The paragraph in the text has the objective of forms of product differentiation, set making clear the distinction between the quite separate aspects of imperfect information treated down as imperfectly competitive or even respectively by Stiglitz and by the Austrians. It as "monopolistic" in the standard frame- does not have the objective of providing an Aus- work (because they imply less than per- trian critique of Stiglitz's position. For such a cri- tique see Thomsen (1992, ch. 3). See also Boehm fectly elastic demand curves facing (1989, pp. 208f), and Thomsen (1994). firms), are precisely the kinds of en- Kirzner: Entrepreneurial Discovery 75

trepreneurial initiative which make up In the Austrian perspective there must the dynamic competitive process.23 be afforded the possibility, at least, of (b) Economic Justice: There are many considering the justice also of discovered policy issues which hinge upon public income. A discovered income is one perceptions of economic justice or injus- gained not by earning or otherwise re- tice. In recent decades economists have ceiving a share of any given pie, but one explored the economic justice of alterna- gained by discovering the existence of tive economic policies. In this they have something valuable, the very existence of been following a venerable tradition in which was hitherto wholly unknown. Dis- economics. When John Bates Clark covery would include not only one of wrote his Distribution of Wealth almost hitherto unknown natural resources (as a century ago, his motivation, in develop- in an oil discovery) but also of new kinds ing the tools of marginal productivity of output (as through entrepreneurial theory, was to demonstrate the consis- product-innovation), or of new additional tency of capitalism with economic jus- productivity (of known outputs) available tice. One significant implication of the from known inputs (as when an entrepre- entrepreneurial discovery approach has neur innovates a new productive tech- been that it appears to cast crucial as- nique). The earmark of a genuine discov- pects of the capitalist system in a drasti- ery is that it reveals the existence of cally different ethical light than has tra- something concerning which one had not ditionally emerged from the neoclassical been merely ignorant, but in fact utterly perspective. ignorant (in the sense that one was not Neoclassical economics asks us to rule even aware of one's ignorance). All kinds on the justice of the method through of discovery essentially create something which or the pattern in which a given genuinely new, something simply not (known-to-be-knowable) pie is distrib- present (as far as human knowledge up uted among the potential claimants to it. until now could fathom) in the pie of This may be seen as a pie of given out- available inputs and outputs given just put; or, in more sophisticated versions, it prior to the moment of discovery. may be seen as the yet-to-be-determined The making of a genuine discovery is pie to be baked out of given inputs. This not an act of deliberate production (in "given-pie" framework for discussion of this it differs also from a successful de- economic justice restricts us to consider- liberate search). Neither is it simply the ing the justice of capitalist earnings or fortuitous outcome of a stroke of wholly receipts in regard only to already existing undeserved luck. Discovery is attribut- goods (including already existing inputs able, at least in significant degree, to the with the capability of generating alterna- entrepreneurial alertness of the discov- tive outputs). From the Austrian per- erer. A theory of justice built upon a per- spective, such restriction places artificial spective wlhich compels us to refrain blinders upon our ethical assessment of from considering and therefore recogniz- capitalist incomes. ing the moral character of discovered gain must, from the Austrian perspec- 23 For an excellent example of non-Austrian ap- tive, appear seriously incomplete if not preciation for these considerations, see Fisher, John McGowan, and Joen Greenwood (1983), Yale wholly misconceived. Brozen (1982). Among Austrian (or Austrian- All this has, of course, particular rele- inspired) writers on this issue see Armentano vance to judging the justice of pure en- (1986), Beesely and Littlechild (1989), Thomas DiLorenzo and High (1988), Michael DeBow trepreneurial profits. Such profits simply (1991). do not fit into the neoclassical distri- 76 Journal of Economic Literature, Vol. XXXV (March 1997) butional scheme, and, therefore, defy difficulties (especially for methodologi- any justification within standard theories cal individualists) of defining what "so- of justice otherwise sympathetic to capi- cially optimal allocation" is to mean, talist distribution patterns.24 For the within the neoclassical framework.26But Austrian viewpoint, however, pure en- the Austrian dissatisfaction of interest to trepreneurial profits emerge clearly as us in the present context has a different the wholly discovered gains, which ac- root. The entrepreneurial discovery ap- company entrepreneurial creation and proach reminds us that the degree of discovery in the sphere of production. achieved social efficiency (or even the An understanding of pure profits in this degree of efficiency that will be achieved mnannerpermits the economist to explain in the equilibrium state toward which a more accurately (to the philosopher, citi- market may be converging) is not the zen, or statesman engaged in moral judg- only dimension along which to judge the ments concerning capitalist justice) the economic success of a social system. Just true economic character of what they are as important, surely, is the speed and ac- evaluating.25 curacy with which the system is able to (c) Welfare Economics: Neoclassical identify and overcome the waste and dis- economics includes an analytical frame- coordination of disequilibrium situations. work designed to assess the social effi- Standard welfare theory provides no ciency of alternative arrangements, poli- scope for considering this dimension, be- cies, and events. The Austrian approach cause this discoordination involves that to understanding markets outlined in sheer ignorance which cannot be incor- this paper, implies a certain dissatisfac- porated into neoclassical analysis (so that tion also with the neoclassical approach intertemporal welfare analysis cannot to welfare economics. The cause for this grapple with, or even consider, the ques- dissatisfaction can be identified in tion of how rapidly-or whether-the straightforwardfashion. volume of sheer ignorance is being re- Standard welfare theory considers the duced). allocation pattern governing the uses Up to now, it must be acknowledged, made of society's resources at a given in- Austrian economics has-with one im- stant (or, by strict extension, to a given portant exception to be noted below- intertemporal allocation pattern being ir- not done much more than to identify this revocably adopted at that instant). The serious shortcoming of standard welfare theory then analyzes that pattern from a economics. But this identification (and perspective of imagined omniscience, its being related to the social function of against the socially optimal allocative the entrepreneurial discovery process) pattern implied by the data. Austrian must be considered already a significant economists along with many other step forward.27 As a result of this step, economists are of course deeply con- Austrian economnists are not satisfied to cerned by the well-understood analytical ask, in regard to issues such as tax policy

26 For Austrian critiques of standard notions of 24 See for example Clark (1899, p. 201). For a social efficiency, see Rizzo (1979), Rothbard discussion of Robert Nozick's (1974) theory of jus- (1979). tice in regard to profit, see Kirzner (1989, p. 69f). 27 Roy Cordato (1992) has done valuable work 25 These observations on an Austrian view of exploring this avenue for Austrian normative eco- economic justice have been advanced by the pres- nomics. For a critique of Cordato's work see ent writer (Kirzner 1989). They do not substan- David Prychitko (1993). See also Vihanto (1989, tially overlap with the observations concerning jus- pp. 86f), Alan Hamlin (1992), Robert Sugden tice expressed either by Mises or by Hayek. (1992) and White (1992, pp. 263f). Kirzner: Entrepreneurial Discovery 77

and the like, merely what impact will a fact, refuted the theoretical clhallenge given program have upon the allocative leveled by Mises and Hayek. The history efficiency of the system (as an exercise, of the economic calculation debate is not say, in applied comparative statics). They our concern here. What is important is also ask what impact it will have in re- that a modern Austrian understanding of gard to the stimulation of those acts of the market process is able to show the entrepreneurial discovery upon which limitations of the Lange-Lerner solution. the equilibrative process must depend. In seeking to simulate, through decen- The one area in which Austrian econom- tralized socialist production, the condi- ics has not merely raised new questions tions satisfied in a perfectly competitive but has in fact fruitfully pursued the en- equilibrium market system, that solution trepreneurial discovery approach to its in fact misses the difficulties which full welfare-economic implications, is in Mises had seen for the possibility of so- the modern version of its long-standing cialist planning. Misesian critique of central planning. To The Lange-Lerner solution requires this we now turn. the central planning authority to an- (d) Central Planning under Socialism: nounce non-market prices for resources In a famous 1920 article Mises asserted and commodities. Working with these on theoretical grounds, the "impossibil- prices as "parameters"(see Lange 1938, ity" of rational economic calculation un- p. 70)-as if they corresponded to the der socialism and hence the impossibility prices under perfectly competitive equi- of central planning. In a series of essays librium-decentralized socialist manag- during the thirties, Hayek supported ers would then plan their resource "pur- Mises' contention and responded to chases" (from state suppliers), their several attempted solutions by socialist output production and input mix, in a economists to refute that contention. manner designed to equalize marginal Out of all these attempted solutions, the cost and marginal revenue (as if maxi- "decentralized" solution of Oskar Lange mizing firm "profit" under perfectly and Abba P. Lerner became the most fa- competitive conditions). The extent to mous. For decades the mainstream lit- which the announced prices in fact di- erature on comparative systems routinely verged from the "correct" values would cited these solutions by Lange and be revealed in the surpluses and short- Lerner as having definitively laid to rest ages generated for the various resources, the critiques of the possibility of socialist thus permitting the central authority to calculation argued by Mises and Hayek. adjust prices accordingly in the direc- During the past 15 years, largely as a tions necessary to achieve resource mar- result of the resurgence of interest in the ket clearing. The entire scheme is based, Austrian tradition, a different assessment explicitly, on the view that the capitalist of the interwar calculation debate has market economy operates in this way; emerged.28 Especially as an implication that resource and output prices are given (or application) of the entrepreneurial to entrepreneurs, and that firms then use discovery approach to understanding the these prices parametrically to maximize market process, it has come to be recog- the excess of revenue over cost. The Aus- nized that Lange and Lerner had not, in trian entrepreneurial discovery approach sees the market economy quite differ- 28 Major contributions to this literature have ently, and therefore sees the problem been Don Lavoie (1985), Vaughn (1980), Boettke (1993, ch. 3), see also Willem Keizer (1989) anid J. facing the socialist central planning Huerta de Soto (1992). authority quite differently. 78 Journal of Economic Literature, Vol. XXXV (March 1997)

The economic problem facing any so- originally announced prices were in fact ciety, in this view, is primarily that of "correct") corresponds to nothing that how, in a world of incessant changes in occurs in capitalist markets (despite its tastes, resource availabilities, and tech- similarity to certain highly dubious text- nological possibilities, to generate mutu- book stories of how perfectly competi- ally sustaining expectations on the part tive market clearing prices are arrived of agents in the economy, such that (a) at). The Lange-Lerner solution offers no the series of actions taken are in fact scope whatsoever for anything in social- able to be completed as planned, and (b) ism that might correspond to the pure that that series of actions tends to reveal profit motivated entrepreneurial acts of and exhaust all the available opportuni- discovery which drive the capitalist mar- ties for social economic gain. Under the ket process.29 imagined conditions of perfectly com- petitive equilibrium this problem does V not exist, not because it has already been It remains to relate the entrepre- successfully solved, but because the neurial discovery approach outlined in equilibrium state has been constructed this paper to alternative viewpoints to avoid the problem in the first place. within the universe of modern Austrian Whether under socialism or under capi- economists. The entrepreneurial discov- talism, reference to the equilibrium state ery approach embraces elements, espe- offers no clues as to how to solve the cially elements in its criticisms of neo- problem; it offers only a picture of a classical microeconomics, with which all world in which the problem has never Austrian economists broadly agree. But existed. the specific framework of the en- From this perspective the Austrians trepreneurial discovery approach-see- understand that whatever social effi- ing the market process as consisting ciency may be achieved in the market of systematic equilibrating tendencies, economy is not achieved at all by its par- made up of episodes of mutual discovery ticipants behaving as if they were agents and learning (by market participants)- in a perfectly competitive equilibrium has been rejected by a number of mod- state-but precisely by their behaving ern Austrian economists. These econo- entrepreneurially and (dynamically) mists emphasize, more than does the competitively, under conditions of dise- entrepreneurial discovery approach, the quilibrium. The Lange-Lerner solution, radical uncertainty of the future, with in which the socialist managers are in- which mnarketparticipants must contend. structed to act as perfectly competitive We may distinguish two groups of Austri- agents, and in which resulting resource ans who have, as result of such emphasis, surpluses and shortages lead the central dissented from the entrepreneurial dis- authority to adjust resource prices, is covery approach: (a) those who object simply not a simulation of how markets radically to the asserted equilibrative actually operate under capitalism. This character of the market process, and (b) solution has not successfully incorpo- those who object to the emphasis of the rated the techniques to which any capi- entrepreneurial discovery approach upon talist successes may be attributed. Cen- tral adjustment of non-market prices in response to resource surpluses and 29 For a valuable non-Austrian paper indepen- dently recognizing much of what is here argued in shortages (generated by socialist manag- the text, see Louis Makowski and Joseph Ostroy ers having mistakenly behaved as if the (1993). Kirzner: Entrepreneurial Discover? 79 systematic mutual learning as the key as an attempt to rescue what they believe feature in the market process (as well as to be an unsalvageable way of under- to what they believe to be the implica- standing markets, viz. within the neoclas- tion of the entrepreneurial discovery ap- sical paradigm. In a world of incessant proach, that the market in fact success- change, they argue, it is precisely those fully attains approximate equilibrium). acts of entrepreneurial boldness which (a) Those who object to the asserted must frustrate any discovery efforts equilibrative character of the market made by fellow entrepreneurs. The en- process (as explained in the en- trepreneurial character of the market trepreneurial discovery approach), have process (which is not disputed) must vir- been led by one of the leading figures in tually guarantee, indeed, that that pro- the modern Austrian revival, Ludwig cess must fail to be characterized as a Lachmann. A significant number of systematic procedure of mutual discov- younger "Austrian"economists have fol- ery.30 lowed Lachmann in this regard, and Some followers of Lachmann, as well their debates with exponents of the en- as others, have questioned, not so much trepreneurial discovery approach have the meaningfulness of the equilibrium enlivened and enriched Austrian eco- concept itself (or of the notion of an nomics during the past decade. A careful equilibrating tendency), as the idea that exposition and analysis of these critics of we can, even in principle, identify an the entrepreneurial discovery theory is equilibrium position. In an open-ended beyond the scope of this paper. The fol- world there is, these critics argue, no lowing thumbnail sketch of the Lach- equilibrium position "out there" that can mann position undoubtedly fails to do serve as a reference point for discussion justice to the subtleties of that position, of the presence or absence of "equili- and is offered here only to identify, at brating tendencies" (see for example, least, a stream of Austrian dissatisfaction Buchanan and Viktor Vanberg 1991). with the entrepreneurial discovery ap- (b) Those who object to the systematic proach. Lachmann (1986, 1991) saw the learning character of the market process market process as one not only in cease- (as claimed by the entrepreneurial dis- less motion (on which the entrepre- covery approach) have been led by Mur- neurial discovery theorists would be in ray Rothbard (1994; a foremost late thorough agreement) but in a ceaseless twentieth century exponent of Austrian motion in which at no time is there any economics) and by Joseph Salerno (1993, assurance that the equilibrative forces 1994). Although their position is a rela- are stronger than the disequilibrative tively new one and has not yet generated forces (set in motion by changes in the sustained debate within the Austrian independent variables of the system)-so camp, it has already elicited a good deal that one may not presume to say that the of attention, and seems likely to stir up market process even tends to promote vigorous discussion in the immediate fu- mutual discovery among market partici- ture. Rothbard and Salerno's under- pants. Following on the later work of standing of the market process sees it George Shackle (Lachmann 1976) this 30 Among those who have been deeply influ- group of Austrians has questioned the enced by Lachmann's position, see Christopher very meaningfulness of any equilibrium Torr (1981), O'Driscoll and Rizzo (1985), Lavoie concept at all. They have deplored an ap- (1994), Wiseman (1989), Loasby (1992). See also Peter Lewin (1994). For critical reaction to Lach- proach (the entrepreneurial discovery mann's position, see O'Driscoll (1978), Garrison approach) which appears to them simply (1987). 80 Journal of Economic Literature, Vol. XXXV (March 1997) not as a continual process of knowledge quiescent calendar periods which sepa- acquisition, but as a continual process of rate successive exogenous shocks" (an entrepreneurial decision making which, invocation attributed by Salerno to at each moment, encourages the most the entrepreneurial discovery approach; perceptive entrepreneurs to make their Salerno 1993, p. 129), exogenous best judgments in a world of incessant changes are continually frustrating any change, through the use of monetary cal- tendencies toward eventual equilibra- culation of estimated profits and losses. tion. The degree to which the market achieves The brief remarks in this section con- coordination is attributed, in the Roth- cerning debates within the "Austrian bard-Salerno view, not to any systematic camp" should help dispel any illusion process of knowledge enhancement (possibly created by this paper) that the (through entrepreneurial alertness or entrepreneurial discovery approach is anything else), but to the ability of seen as a cut-and-dried, completed body shrewd entrepreneurs, using money of Austrian doctrine. Most "Austrians" prices as tools for calculation, to deploy see this approach as an important but resources at each moment, in what they still debated development in work still in believe to be their most urgently de- progress. They see it as inviting further manded uses-as judged ultimately by exploration and application to such areas the consumers. At each moment, it is as: law and economics (see, for example, then claimed, the market has generated Rizzo 1979), the interface between Aus- that "constellation of resource prices" trian and mainstream neoclassical para- which always reflects the circumstance digms, and the evaluation of mainstream that existing resources are devoted to neoclassical attempts to confront the their most valuable uses (Salerno 1993, kinds of concerns which have motivated p. 124). Rothbard and Salerno do not Austrian economics. The theory of en- deny that the entrepreneurial approach trepreneurial discovery is thus seen as accurately captures the insights pio- embodying a set of ideas able to inspire neered by Hayek in his papers on knowl- several new research programs, rather edge (Hayek 1937, 1945, 1948). Their than as constituting any kind of defini- position is simply that this approach dif- tive orthodoxy. fers sharply from a distinctly Misesian paradigm, a paradigm which they en- VI dorse. One important implication of this posi- These concluding observations take up tion is the assertion that, because of the briefly the question of whether there ex- incessant changes in the external data of ists any necessary relationship between the market, it leads to the denial of an Austrian approach (such as the en- any actual progression in historical time trepreneurial discovery perspective dis- toward long-run equilibrium (Salerno cussed here) and support for a policy of 1993, p. 122). This assertion claims, it uncompromising laissez faire. A com- appears, not merely that exogenous plete and careful discussion of this rela- changes prevent the equilibrating pro- tionship is beyond the scope of this pa- cess in any given period of time, from per (and, if it were to be successful in going very far (a claim which, it is recog- expounding the relevant nuances, would nized, the entrepreneurial discovery ap- require far more space than is here avail- proach would certainly endorse), but also able). Nonetheless it seems useful to that unless one "invokes the ideas of offer the following outline for such a Kirzner: Entrepreneurial Discovery 81

discussion. This will (a) respond to fre- the Austrian theory argues is the far quently expressed (and fully justified) more nuanced thesis that the unbridled curiosity concerning this relationship, market tends to offer the incentives and (b) perhaps provide necessary fur- likely to stimulate movement in the di- ther clarification of the Austrian position rection of complete mutual awareness. presented in this paper. To the extent that a case for laissez faire It is true that, in their policy judg- must rest on the claim that the market ments, economists in the Austrian tradi- attains complete mutual awareness, Aus- tion have tended overwhelmingly to fa- trian economics provides no basis for vor market solutions for solving society's such a case. economic problems. Certainly, this ten- In addition it should be emphasized dency is largely rooted in a shared and that, although the entrepreneurial dis- appreciative understanding of the co- covery approach throws significant light ordinative properties of the entrepre- on the incentives which stimulate move- neurial market process. There are, in- ments in the direction of full mutual deed, Austrian grounds for arguing that awareness, this does not amount to the government regulation of market activity assertion that all movements must be in is likely to obstruct and frustrate the that direction. Still less is it the case that spontaneous, corrective forces of entre- entrepreneurial discovery is claimed suc- preneurial adjustments. Yet to conclude cessfully to attain full mutual awareness. that Austrian economics by itself rigor- As was noted in Section III entrepre- ously entails adoption of unbridled lais- neurial decisions may be entirely mis- sez faire as the scientifically endorsed taken; they may in fact be more mistaken economic policy for nations, is a far too than those other entrepreneurial judg- oversimplified-and inaccurate-conclu- ments they are replacing. So that, sion. instead of correcting the earlier misallo- Let us not forget that traditionally the cations of resources, the entering entre- economic case for laissez faire de- preneurs may be making matters even pended, for whatever its worth, on the worse. And such errors may generate claim that spontaneously achieved out- still more errors. Moreover, even if one comes are, in a relevant sense, efficient imagined that, in a world of stable re- (and can therefore only be worsened, not source availabilities and consumer pref- improved, by regulatory interference). erences, entrepreneurial judgments tend Austrian economics cannot, strictly to avoid new errors, the possibility of speaking, possibly offer a case for laissez volatile changes in resource supply and faire based on this claim. After all, Aus- consumer demand conditions must inevi- trian economics makes no claim that the tably prevent the entrepreneurial discov- market outcomes at any given date are ery process from proceeding very far to- efficient and socially optimal (in any ward complete mutual awareness by sense in which traditional neoclassical market participants. welfare theory would use these terms). It If the Austrian theory claims that en- is therefore certainly a misreading of the trepreneurial discovery can account for Austrian theory to construe it as claiming a tendency toward equilibrium, that that the entrepreneurial discovery pro- vague-sounding term "tendency toward" cess ensures an unerring trajectory to- is used deliberately, advisedly, and quite ward the attainment of that complete precisely. Such a tendency does exist at mutual awareness which is necessary for each and every moment, in the sense any notion of social optimization. What that earlier entrepreneurial errors have 82 [ournal of Economic Literature, Vol. XXXV (March 1997)

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