Judgment versus Alertness

1 September 2006 at 10:45 am 4 comments

| Peter Klein |

Nicolai and I have written several papers on the Knightian concept of entrepreneurship as judgment (e.g., here, here, and here). We contrast the judgment view of entrepreneurship with several other approaches, including Israel Kirzner’s idea of entrepreneurship as “discovery” or alertness to profit opportunities.

Readers and seminar participants are often confused by the distinction between judgment and alertness. We describe the judgment approach as “Austrian,” associating it not only with Knight but also with Austrian and proto-Austrian economists Richard Cantillon, Frank Fetter, Ludwig von Mises, and Murray Rothbard. But, we are asked, isn’t Kirzner an Austrian? Isn’t Kirzner’s entrepreneurial-discovery approach “the” Austrian view?

Not necessarily. Here’s why.

Of course, Kirzner is certainly an Austrian economist, an outstanding scholar and leading member of the modern Austrian school. Kirzner received his Ph.D. under Mises at New York University and has described his work as the working out of various parts of Mises’s system. However, we place Mises in the Cantillon-Knight tradition of entrepreneurship as judgment over the deployment of resources, not alertness per se.

Here are some of the key differences between the judgment and alertness perspectives. First, alertness is the ability to react to existing opportunities while judgment refers to the creation of new opportunities. “I view the entrepreneur not as a source of innovative ideas ex nihilo, but as being alert to the opportunities that exist already and are waiting to be noticed” (Kirzner, 1973, p. 74). Judgment is an active, creative agency, while alertness, in Kirzner’s concept is a “responding” agency. In the words of one critic: “Alertness is the mental quality of being on the lookout for something new; judgment is the mental process of assigning relevance to those things we already know” (High 1982, p. 167). As a result, entrepreneurs “are not content to passively adjust their . . . activities to readily foreseeable changes or changes that have already occurred in their circumstances; rather, they regard change itself as an opportunity to meliorate their own conditions and aggressively attempt to anticipate and exploit it” (Salerno 1993, p. 123). As Mises (1949, p. 585) puts it: “What distinguishes the successful entrepreneur and promoter from other people is precisely the fact that he does not let himself be guided by what was and is, but arranges his affairs on the ground of his opinion about the future. He sees the past and the present as other people do; but he judges the future in a different way.”

Second, Kirzner’s entrepreneurs do not own capital, so they cannot suffer losses. They discover opportunities, but do not bear uncertainty. In the language of the efficient sidewalk theory, the Chicago economist says there cannot be a $20 bills on the sidewalk, because if there were someone would have picked it up. The Kirznerian says there are a few $20 bills scattered around, and they have a tendency to be picked up, but not instantly. The Knightian says a given sidewalk may or may not have a $20 bill on it, but no one knows for sure because the bill is partially covered by debris. To find out, an entrepreneur must buy a shovel and start digging; hopefully he’ll find one, but maybe he won’t.

Kirzner (1973: 39-40) agrees that in a world of uncertainty, resource owners exercise entrepreneurial judgment in allocating their resources to particular uses. But he goes on (1973: 40-43) to introduce the analytical device of “pure entrepreneurship,” the act of discovery or alertness to profit opportunities by those with no resources under their control, and claims that this function, rather than uncertainty-bearing, is the “driving force” behind the market economy.

This leads to what, in my judgment (pun intended), is the key to understanding Knightian and Kirznerian entrepreneurship. The main differences are instrumental, not ontological. Knight’s purpose in developing the theory of the entrepreneur is to decompose business income into its two main components, interest and profit. Interest is the reward for forgoing present consumption; profit is the reward for bearing uncertainty. Kirzner has a different purpose in mind, namely to explain the tendency toward equilibrium in a market setting. Entrepreneurship is the force that leads resources to be allocated toward their highest valued uses in a world in which change is not instantaneous.

In this sense, the criticisms of Kirzner above are beside the point. He is not trying to describe entrepreneurship, philosophically, or to characterize the psychological process of discovery. (Hence I find it ironic that the “opportunity identification” strand of the entrepreneurship literature takes Kirzner as a Founding Father, even though he would not regard his work as particularly relevant to the study of opportunity identification.) As Kirzner notes, in a 1997 interview, “I do not mean to convey the idea that the future is a rolled-up tapestry, and we need only to be patient as the picture progressively unrolls itself before our eyes. In fact, the future may be a void. There may be nothing around the corner or in the tapestry. The future has to be created. Philosophically, all this may be so. But it doesn’t matter for the sake of the metaphor I have chosen.” The purpose of the metaphor, in other words, is simply to explain the convergence toward equilibrium, not to describe entrepreneurship itself.

As I read Mises, however, he is not particularly interested in the question of the question of whether there exists a systematic tendency toward general equilibrium. This question was hotly debated by followers of Kirzner and Ludwig Lachmann in the 1980s, but is only a minor issue for Mises. For Mises, efficient resource allocation requires only private property and free trade, such that each individual trade is “market-clearing,” from the perspective of the traders who momentarily exhaust the gains from trade with every exchange. Entrepreneurship is a critical element in Mises’s system, but for different reasons, namely to explain factor pricing (and, by extension, why rational economic planning is impossible under socialism).

Look for an article along these lines in the coming months.

Entry filed under: - Klein -, Austrian Economics, Entrepreneurship.

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4 Comments Add your own

  • 1. AJE  |  1 September 2006 at 12:18 pm

    Very interesting points, and reminded me of this anecdote.

    Would the bottom line be that judgement is action, whereas alertness explains/defines action?

    Which brings us back to whether alertness is “merely” a theory of luck, and whether Kirzner’s exogenous, explanatory variable is genetics…

  • 2. Peter Klein  |  1 September 2006 at 5:02 pm

    I think the key for Kirzner is not whether entrepreneurs are smart or just lucky, but whether opportunities for entrepreneurial gain — however arrived at — are seized. As long as these opportunities tend to be exploited, then, in Kirzner’s model, the market can be said to have equilibrating tendencies. In other words, Kirzner is mainly concerned with the effect of entrepreneurial alertness (so conceived), not its nature and causes.

  • 3. Jüri Saar  |  4 September 2006 at 12:33 pm

    Good post. I’ll be looking forward to the article/paper.

  • 4. Siyaah  |  29 September 2006 at 4:52 pm

    “The future has to be created.”
    I think that’s a very powerful statement. It leaves behind ‘equilibrium’ approaches as fundamentally inadequate for understanding entrepreneurship / strategy in the real world.
    Relatedly, rational economic planning under socialist systems is not possible because equilbrium never exists in the real world.

    Great post. Hope to see the article.

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