Is Entrepreneurship a Factor of Production?

14 December 2006 at 4:17 pm 10 comments

| Peter Klein |

When explaining the returns to factors of production economists often define wages as the payment to labor, interest as the payment to capital, rent as the payment to land, and profit as the payment to entrepreneurship. Treating entrepreneurship as a factor of production, earning a return we label profit, poses some challenging problems, however. Does entrepreneurship have a marginal revenue product, corresponding to a firm’s profit? Is there an upward-sloping supply curve for entrepreneurship (more of it is offered to the market when profits rise)? Are there diminishing returns to entrepreneurship?

The answer given by the classic contributors to the economic theory of entrepreneurship such as Cantillon, Say, Schumpeter, Knight, Mises, Kirzner, and others is clearly no. They treat entrepreneurship as ubiquitous, an attribute of the market mechanism that can never be absent. This came out in John Matthews’s paper, “Rents versus Profits: What Are the Appropriate Goals of Strategizing?”, presented Wednesday at the CCSM.

John shared this quote from the French economist Jean Marchal, writing in the September 1951 American Economic Review:

[E]ntrepreneurs obtain remuneration for their activity in a very different manner than do laborers or lenders of capital. The latter provide factors of production which they sell to the entrepreneur at prices which they naturally try to make as high as possible. The entrepreneur proceeds quite otherwise; instead of selling something to the enterprise he identifies himself with the enterprise.. Some people doubtless will say that he provides the function of enterprise and receives as remuneration a sum which varies according to the results. But this is a tortured way of presenting the thing, inspired by an unhealthy desire to establish arbitrarily a symmetry with the other factors. In reality, the entrepreneur and the firm are one and the same. His function is to negotiate, or to pay people for negotiating under his responsibility and in the name of the firm, with two groups: on the one hand, with those who provide the factors of production, in which case his problem is to pay the lowest prices possible; on the other hand, with the buyers of the finished products, from which it is desirable to obtain as large a total revenue as possible. To say all this in a few words, the entrepreneur, although undeniably providing a factor of production, perhaps the most important one in a capitalist system, is not himself to be defined in those terms. (pp. 550-51)

Marchal expresses, in strong terms, the view propounded by Nicolai and myself in several papers that entrepreneurship is embodied in asset ownership (i.e., in the creation and operation of the firm). The entrepreneur is not merely an idea man, but rather an owner, who exercises judgment over the capital assets he owns and manages. (This contrasts with Kirzner’s analytical device of the “pure entrepreneur” who owns no capital.)

Here is an interesting quote from Mises (Human Action, 3rd ed., p. 293) on the ubiquity of entrepreneurship:

The entrepreneur is also jeopardized by political dangers. Government policies, revolutions, and wars can damage or annihilate his enterprise. . . . If all entrepreneurs were fully convinced that the total victory of Bolshevism was impending they would nevertheless not abandon their entrepreneurial activities. The expectation of imminent expropriation will impel the capitalists to consume their funds. The entrepreneurs will be forced to adjust their plans to the market situation created by such capital consumption and the threatened nationalization of their plants and shops. But they will not stop operating. If some entrepreneurs go out of business, others will take their place — newcomers or old entrepreneurs expanding the size of their enterprises. In the market economy there will always be entrepreneurs. Policies hostile to capitalism may deprive the consumer of the greater part of the benefits they would have reaped from unhampered entrepreneurial activities. But they cannot eliminate the entrepreneurs as such if they do not entirely destroy the market economy.

This nicely illustrates Mises view that the entrepreneurial act is, as Joe Salerno writes in an email, “a non-marginal and purely intellectual decision.” The marginal or factor-of-production approach holds that entrepreneurs enter and exit the market for entrepreneurship based on (exogenous) profit rates. For Mises, Knight, and — as illustrated by the passage above — Marchal, it is entrepreneurship that creates profit.

Part of the reason many people speak of the supply of entrepreneurship and the marginal return to entrepreneurship is that they conceive “entrepreneurship” as an occupational category, as self-employment. An entrepreneur is a person who starts his own business, as opposed to an employee who works for someone else. In this sense it makes sense to talk about entrepreneurship as a factor of production with an upward-sloping supply curve. As profit opportunities increase, relative to wages, more individuals will choose self-employment over employment.

If, on the other hand, entrepreneurship is treated as a function, process, or attribute, rather than an employment category, it cannot be treated as a factor of production and is exercised, as in the Mises quote above, even in the worst market conditions.

Entry filed under: - Klein -, Entrepreneurship, Theory of the Firm. Tags: .

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10 Comments Add your own

  • 1. Chihmao Hsieh  |  15 December 2006 at 12:31 am

    Ahh yes, the delights of debating the word ‘entrepreneurship.’

    Warning: Casual thought lies ahead!

    I can imagine that some academic could come along and try to argue that everything–ok, all ‘market processes’–relates to entrepreneurship, but then the category (or ‘concept’) of entrepreneurship isn’t very practically useful. So in the name of being practical, perhaps we say that either something (a) relates to entrepreneurship, or (b) does not relate to entrepreneurship.

    Let’s say that entrepreneurship and the state of being an entrepreneur are both objective phenomena.

    Then suppose we begin saying that entrepreneurship requires value creation. Then those who sell products or services at a loss are not engaging in entrepreneurship? I have not read any research defining entrepreneurship as such.

    OK. So entrepreneurship only requires the pursuit of value creation? Who doesn’t pursue value creation? A lazy chap who stays on the couch watching TV or staring out into space could argue that he is creating value by deriving new knowledge that he believes can be salable at a later date, in his head. Then everybody is engaging in entrepreneurship?

    Is an entrepreneur based on (i) who you are (e.g. an ‘initial state’), (ii) what you are doing (e.g. behavior) or (iii) what you’ve found (e.g. value)? If option (ii), everybody is always an entrepreneur (or alternatively, it is fundamentally impossible to know whether somebody is an entrepreneur ex ante). If option (iii), an individual can be an entrepreneur one moment and then a non-entrepreneur the next moment. Imagine how painful it would be if you asked your friend Bob whether he was an entrepreneur and he gave you a different, seemingly random answer each time based on whether he made money that day or not. Option (i) represents the possibly the most useful meaning: “I’m an entrepreneur because I’m self-employed. Next year I will not be an entrepreneur because I have plans to work for somebody else.”

    Option (iii) trumps option (i) because not everybody is self-employed. Option (iii) trumps option (ii) because very few people change jobs everyday.*

    Yes, I chuckle as I write the immediately preceding sentence.

    For the record, I think I’ve used the terms ‘entrepreneurship’ and ‘entrepreneur’ to represent all 3 of the above meanings, at some point or another, but while wearing an academic’s hat. (A paper under review–Hsieh, Nickerson, and Zenger–would agree that the entrepreneur is an idea-man/owner.) This post of mine speaks from a (arguably) more practical perspective: how we use terminology to efficiently communicate.

    *Incidentally, insofar that entrepreneurs are merely the self-employed, why not just use one term or the other? Rough speculation based solely on experience talking to the type is that an individual calls himself ‘self-employed’ if s/he is humble and/or low-ability. Individuals call themselves ‘entrepreneurs’ if they want to attract attention and/or are high-ability.

  • 2. Amnesty  |  1 February 2008 at 1:37 pm

    okay this was really confussing and gave me a headache but I get the self employment thing

  • 3. Clinton  |  30 May 2009 at 10:05 am

    The first word i said when i saw this was “i like this” because it enabled me finish up my project and the information had a lot of content. THANK YOU FOR PUBLISHING IT.

  • 4. ikumogunniyi kamoru o  |  26 June 2009 at 5:04 am

    An entrepreneur is not suppose to be one or part of the factor of production. YES or NO, if yes explain, if no why

  • 5. John Mathews  |  11 April 2010 at 10:53 am

    Could I add a late comment to this string, Peter, since I see that your posting remains one of the most popular on the site. My original framing of the question ‘Is entrepreneurship a factor of production?’ was to rebut the tendency exhibited by some of our colleagues at the Fisher College of Business at Ohio State to treat entrepreneurship as a ‘resource’ and to do so within a Ricardian setting, rather than an Austrian or neo-Austrian setting. The comments of mine that you were referring to have now appeared in a new paper just out in Organization Studies (see the posting by Dick Langlois of 7 April), where the relevant text reads that:

    ‘there is an emerging tendency in the new field of strategic entrepreneurship (associated with scholars at the Fisher College of Business at Ohio State University) to view entrepreneurship itself as a resource, and able thereby
    to earn entrepreneurial rents. Here the argument goes that entrepreneurial initiative is associated with some identifiable ‘resources’ such as entrepreneurial cognition (the recognition of opportunities) and entrepreneurial resource-combining
    (the exercise of combinative capabilities), brought to the firm by the entrepreneur, and which then earn entrepreneurial rents. According to Alvarez and Busenitz (2001: 759) if the insights and decisions reached with entrepreneurial cognition ‘are indeed rare, if they are difficult to imitate, and if the generated ideas are exploited by the entrepreneurs, then these entrepreneurial insights and decisions are a resource that can potentially lead to a competitive advantage’.
    There is an infinite regress involved in such an argument: if this kind of ‘entrepreneurial cognition’ is indeed a resource, then it can be offered by its owner to an entrepreneur building a business and as such can attract a rent. So there will
    have to be another entrepreneur B taking advantage of A’s ‘entrepreneurial cognition’—and if entrepreneur B also displays entrepreneurial cognition, then his or her cognition will be available to be used by entrepreneur C—and so on
    and on we go, in an infinite regress. This is an inescapable implication of characterizing entrepreneurial characteristics as resources which can earn rents. This is why we need a definition of resources that enables entrepreneurs to combine
    and recombine them in a way that builds on complementarities and thereby generates (original) profits. If we take such an approach, then entrepreneurship itself cannot be a resource.’

    There are several points here that demonstrate why the RBV as usually promulgated, in its Ricardian setting, and now with the tendency to view entrepreneurship itself as a resource, is leading the fields of organizations and market studies in the wrong direction. Firstly, as Peter recognizes, the notion of entrepreneurship must be given priority in any realistic framing of economic dynamics, in the sense that it is the entrepreneur who sets in motion everything else. This was fundamental to Schumpeter’s perspective, as it was for von Mises — but not, it must emphatically be said, for Ricardo, who as far as I know never uttered the word in any of his writings.

    If entrepreneurs set everything in motion, this must include resources themselves, and so we want to know what the strategic criteria might be that guide their choices. The usual formula promulgated in the Ricardian perspective is the VRIO criteria — the resources must be valuable, rare etc. But these are applied only to resources taken individually, and yet the whole point of an entrepreneurial perspective is to see how resources may be added together — to create what Penrose termed a ‘resource bundle’ — to capture complementarities, or synergies. It is entrepreneurial capture of synergies that is entirely absent from the Ricardian perspective — but it is irreplaceable in an entrepreneurial or neo-Austraian or what I am suggesting be termed a ‘Lachmannian’ perspective.

    The third point is your useful reference to the source of ‘original profits’. Here we have the core of a strategic approach to economic dynamics, one that distinguishes it from equilibrium-based economics, since it is entrepreneurial original profits that must set the machinery of the entire economy in motion. Neoclassical economics concerns itself with the distribution of rents, but it should be the strategic perspective that concerns itself with the source of original profits. This cannot be done if we regard entrepreneurship as a rent-earning resource.

    Further comments would be appreciated.

  • 6. Peter Klein  |  12 April 2010 at 9:21 am

    John, thanks for the update and further comments. I have little to add except enthusiastic agreement! But I’d like to hear from some neo-Ricardians in rebuttal….

  • 7. Dejan  |  11 October 2011 at 7:47 am

    I just read your debates and I must say that they are outstanding.But I have a question for all of you. I am a student from Macedonia and I was given a task to answer why is entrepreneurship added as a fourth factor of produciotn?

  • 8. Scott Schreiber  |  20 October 2011 at 10:39 am

    The interesting thing about the word entrepreneurship is those that practice it won’t spend the time debating it’s meaning they are far too focused on getting it done. I have found that entrepreneurs are about results not getting too lost in process.

  • 9. Mohammad Keyhani  |  29 February 2012 at 8:47 pm

    Excellent thread! I am a big fan of John Mathews’ work and my current research on proposing a new formal model of the economy that can incorporate entrepreneurship and disequilibrium dynamics is heavily influenced by his work. For me, the most important reason why entrepreneurship cannot be considered a fourth factor of production is that entrepreneurship changes the structure of the market itself. the “4th factor” perspective assumes that entrepreneurship makes no fundamental changes to the economic system and just acts as an input into the production of existing producers, producing for existing customers….This has been pointed out not only as a criticism of neoclassical economics, but Mark Casson also criticizes Kirznerian Austrians for assuming that entrepreneurship fixes errors in an a pre-existing market structure. I’m referring to his 2005 paper “Entrepreneurship and the theory of the firm” although he probably has made the argument elsewhere as well.

  • 10. Peter Klein  |  1 March 2012 at 9:37 am

    Thanks Mohammad. BTW I agree with Mark (and you) on this point!

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