Entrepreneurship and Knowledge

18 February 2013 at 1:32 pm 3 comments

| Peter Klein |

Hayek famously argued that prices embody information and that economic actors, responding to price changes, act as if they knew the underlying circumstances generating these changes. “[I]n a system in which the knowledge of the relevant facts is dispersed among many people, prices can act to coordinate the separate actions of different people in the same way as subjective values help the individual to coordinate the parts of his plan.” To economize, people don’t need “knowledge of the particular circumstances of time and place,” they only need access to prices. “The mere fact that there is one price for any commodity . . . brings about the solution which (it is just conceptually possible) might have been arrived at by one single mind possessing all the information which is in fact dispersed among all the people involved in the process.” Hayek illustrates with his famous example of the tin market: “All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply.”

Hayek offers a powerful argument against interference with the price mechanism. But we should remember that prices embody information about the past, and the entrepreneur’s job is to anticipate, or “appraise,” the future. Entrepreneurs, far from discovering and exploiting “gaps” in the existing structure of prices, deploy resources in anticipation of expected — but uncertain — profits generated by future prices. For this, they rely on what Mises called a “specific anticipative understanding of the conditions of the uncertain future,” an understanding that requires a lot of knowledge of particular circumstances of time and place!

The knowledge requirements of the successful entrepreneur or arbitrageur are vividly illustrated in this passage from Carsten Jensen’s magnificent novel, We the Drowned, in a passage about 19th-century ship brokers, entrepreneurs who own, lease, and manage ships and shipping contracts:

A ship broker needs to know how the Russo-Japanese War will hit the freight market. He doesn’t need to be interested in politics, but he has to pay attention to his skippers’ finances, so a knowledge of international conflict is essential. Opening up a newspaper — he’ll see a photograph of a head of state and if he’s bright enough, he’ll read his own future profits in the man’s face. He might not he interested in socialism, in fact he’ll swear he isn’t: he’s never heard such a load of starry-eyed nonsense. Until one day his crew lines up and demands higher wages, and he has to immerse himself in union issues and other newfangled notions about the future organization of society. A broker must keep up to date with the names of foreign heads of state, the political currents of the time, the various enmities between nations, and earthquakes in distant parts of the world. He makes money out of wars and disasters, but first and foremost he makes it because the world has become one big building site. Technology rearranges everything, and he needs to know its secrets, its latest inventions and discoveries. Saltpeter, divi-divi, soy cakes, pit props, soda, dyer’s broom — these aren’t just names to him. He’s neither touched saltpeter nor seen a swatch of dyer’s broom. He’s never tasted soy cake (for which he can count himself lucky), but he knows what it’s used for and where there’s a demand for it. He doesn’t want the world to stop changing. If it did, his office would have to close. He knows what a sailor is: an indispensable helper in the great workshop that technology has made of the world.

There was a time when all we ever carried was grain. We bought it in one place and sold it in another. Now we were circumnavigating the globe with a hold full of commodities whose names we had to learn to pronounce and whose use had to be explained to us. Our ships had become our schools. They were still powered by the wind in their sails, as they had been for thousands of years. But stacked in their holds lay the future.

Entry filed under: Ephemera. Tags: .

New Review Paper on Multinational Firms Armen Alchian (1914-2013)

3 Comments Add your own

  • 1. Jim Chappelow  |  18 February 2013 at 4:29 pm

    Isn’t Hayek really missing the entrepreneur though?

    “prices can act”

    No, they most certainly cannot. It is entrepreneurs who act based on their knowledge of past prices and subjective estimates of likely future conditions.

  • 2. stevepostrel  |  21 February 2013 at 8:12 pm

    It’s interesting to look at the many gradations of knowledge implied in the quoted passage. A user of tin doesn’t need to know that much about the causes of rising tin prices to economize on tin (although you might think about temporary versus permanent price increases and the varying response to each). At the next level, a ship broker needs to know about what soy cake is used for but not how to make it or what it tastes like. A manufacturer of soy cakes probably needs to know quite a lot about the technological and circumstantial factors affecting production costs and quality.

    And there are further gradations, e.g. Intel’s goal of “shallow knowledge” of semiconductor manufacturing wherein detailed underlying causality is often ignored in favor of pragmatic “recipe” type knowledge. A maker of semiconductor manufacturing equipment, however, might require exactly this deeper causal knowledge in some cases.

    Participants’ knowledge is like a bunch of partly nested, partly overlapping black boxes with varying degrees of uncertainty about the input-output relationships for each box.

  • 3. Peter Klein  |  21 February 2013 at 9:29 pm

    Indeed, that is a good way to put it!

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