Opportunity Discovery or Judgment? Fargo Edition
11 November 2014 at 4:53 pm Peter G. Klein 15 comments
| Peter Klein |
In the opportunity-discovery perspective, profits result from the discovery and exploitation of disequilibrium “gaps” in the market. To earn profits an entrepreneur needs superior foresight or perception, but not risk capital or other productive assets. Capital is freely available from capitalists, who supply funds as requested by entrepreneurs but otherwise play a relatively minor, passive role. Residual decision and control rights are second-order phenomena, because the essence of entrepreneurship is alertness, not investing resources under uncertainty.
By contrast, the judgment-based view places capital, ownership, and uncertainty front and center. The essence of entrepreneurship is not ideation or imagination or creativity, but the constant combining and recombining of productive assets under uncertainty, in pursuit of profits. The entrepreneur is thus also a capitalist, and the capitalist is an entrepreneur. We can even imagine the alert individual — the entrepreneur of discovery theory — as a sort of consultant, bringing ideas to the entrepreneur-capitalist, who decides whether or not to act.
A scene from Fargo nicely illustrates the distinction. Protagonist Jerry Lundegaard thinks he’s found (“discovered”) a sure-fire profit opportunity; he just needs capital, which he hopes to get from his wealthy father-in-law Wade. Jerry sees himself as running the show and earning the profits. Wade, however, has other ideas — he thinks he’s making the investment and, if it pays off, pocketing the profits, paying Jerry a finder’s fee for bringing him the idea.
So, I ask you, who is the entrepreneur, Jerry or Wade?
Entry filed under: - Klein -, Austrian Economics, Entrepreneurship, Myths and Realities, Teaching, Theory of the Firm.
Organizations and Markets 
1.
Divine Economy Consulting | 11 November 2014 at 5:47 pm
Entrepreneurs Step Forward And Bear The Uncertainties.
Why are there unnoticed opportunities? One reason – imperfect knowledge. For example, resource owners and consumers are often passive in the very dynamic economy. What ‘unnoticed opportunities’ means is that there will necessarily be more efficient ways to coordinate transactions in the resource and product market. Whoever steps forward as an entrepreneur and bears the uncertainty inherent in the market will be the one who is in the position to capture these opportunities.
Moment to moment any market participant can become an entrepreneur or not, either now or later, or over and over again. And even though economic roles are multiple – yet still they are distinct. For instance, resource ownership and entrepreneurship are completely separate functions; nevertheless the same person may be an entrepreneur, a resource owner and a capitalist and yet still perform these functions independently.
2.
Toby | 12 November 2014 at 4:13 am
I am not sure I understand, but the entrepreneur here seems to be only Jerry, whereas the division of profit is a question of bargaining power between Jerry and Wade. Had the legal system protected Jerry, and forbade Wade from acting on Jerry’s knowledge without Jerry’s consent, then Jerry could go to every other capitalist and the return to Wade would be whittled down to the risk-adjusted return. as Wade would be competing agaisnt every other capitalist.
3.
Amir Emami | 12 November 2014 at 6:56 am
In my opinion, Jerry will be called a true entrepreneur when he is not just an opportunity discoverer but also being good at using his social capitals as well his networks etc. So, being an entrepreneur or not is not just matter of opportunity feature but also a set of property he must own.
4.
Peter Klein | 12 November 2014 at 10:56 am
@Toby: I don’t mean to raise a terminological issue. If you define entrepreneur as “idea man,” then Jerry’s the guy. But if you mean the actor or economic function that moves the market, that generates economic growth — the “driving force of the market economy,” as Mises puts it — then Wade is the entrepreneur. That was my main point above.
BTW I don’t think your scenario about competing capitalists works. There is no “normal,” risk-adjusted return for Jerry’s novel idea. Each capitalist (in my terminology, capitalist-entrepreneur) will have different beliefs about the potential outcomes, and each will bid or not bid on Jerry’s idea accordingly. The one who acquires the idea and acts on it, thus bearing the unique uncertainties associated with the project, is the entrepreneur. If Jerry gets a fixed fee, he is just a factor supplier, not an entrepreneur. (If Jerry retains some equity stake in the venture, then he is acting as an entrepreneur to that extent.)
My whole point is to separate the generation of ideas, which may or not be acted upon, from entrepreneurship, which requires acting on ideas under uncertainty.
5.
Toby | 12 November 2014 at 1:33 pm
@Peter, thank you for your reply. It somewhat clarifies my confusion. To put in terms I understand, Jerry creates a new datum with his idea, and Wade acts on it. Both are necessary to move from one equilibrium to another.
Where the difficulty lies for me is that Wade can be considered an entrepreneur in the absence of Jerry. Without Jerry there is no new datum to act on, whereas in a world without Wades, Jerry’s idea cannot be acted upon. The only question in my mind is, is whether Wade’s role is a property of the institutional environment of every market economy or just a property of a particular institutional environment.
6.
Peter Klein | 12 November 2014 at 2:21 pm
Yes, one can think of it that way. But I don’t like the term “datum” for Jerry’s idea, because it implies a reality, and existence, that isn’t there. An idea is just a set of beliefs, wishes, or dreams.
Given that we never know, ex ante, whether a business idea is valuable, ideas per se aren’t really scarce. But capital is scarce. Hence the limiting factor in the pursuit of business ideas is capital, not ideas. In my conceptualization, the entrepreneurial role is that of deciding which among many potentially profitable projects to pursue. Anybody can generate ideas. But it’s just game-play until resources are committed to projects.
7.
James Hasik | 12 November 2014 at 5:41 pm
I love that scene, and had realized the implications for business. I just had never thought of it in quite the terms of the debate on what constitutes entrepreneurship.
8.
Jingjing Wang | 12 November 2014 at 6:15 pm
I love this quotation by Rothbard (1985): “Entrepreneurial ideas without money are mere parlor games until the money is obtained and committed to the projects.”
9.
Toby | 13 November 2014 at 3:25 am
@Peter, but how is that conceptualization different from say of an investor who has to choose amongst a universe of investment projects each with a specific risk-return profile? The difference I see is that the risk-return profile is in the eye of the beholder, so for investor j, we add the subscript j to risk and to return, and the difference dissappears. Furthermore, how is that conceptualization different from the decision of those selling their labor and choosing their specialization?
Entrepreneurship in this conceptualization seems to be indistinguishable from the maximizing behavior assumed on part of everyone else. Entrepreneurship seems rather mechanical in this way. The Jerry-view of entrepreneurship seems somewhat less mechanical compared to that. Though this might be a property of my education rather than a property of your conceptualization of entrepreneurship.
Do you have a book or articles that if I studied that, then I would better grasp your conceptualization? I saw the essays on mises.org, would this be a good place to start?
10.
Peter Klein | 13 November 2014 at 11:06 pm
Toby, thanks for your questions. This is all discussed in Organizing Entrepreneurial Judgment (linked in the original post). Shorter articles are
Click to access klein_sej_2008.pdf
and
Click to access fk_jope_2010.pdf
The difference between judgment as Knight, Mises, and Nicolai and I describe it, and “maximizing” behavior in the standard neoclassical economics sense, is Knightian uncertainty. There is no expected return to maximize because there are no well-defined probability distributions. Entrepreneurship is thus manifest in the possession of residual control right over heterogeneous assets in the face of Knightian uncertainty. Suppliers of labor and other inputs do not exercise judgment in this sense unless they too possess some residual rights of control (in the Grossman-Hart-Moore sense).
11.
Robert A. McKeown | 14 November 2014 at 9:04 am
Prof Klein, how does time preference relate to the two perspectives of entrepreneurship you just described in this post? That is, does one have a longer time preference than the other? Second, how important is time preferences in entrepreneurship?
12.
Robert A. McKeown | 14 November 2014 at 9:41 am
To answer your question, Wade is the entrepreneur as he is the only one with actual ownership of the resources in my opinion.
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Peter Klein | 14 November 2014 at 10:32 am
Time preference is important in the judgment-based approach. If there were no time preference, the entrepreneur would still earn a profit when realized realized revenues exceed up-front expenditures on factors. Given time preference, the entrepreneur’s accounting profit will also include an interest component, as a reward for investing resources into production rather than consuming them ex ante. (The accounting profit may also include the entrepreneur’s implicit wage for managerial services.) This was in fact one of Knight’s great contributions, showing that interest (a reward for deferring consumption) and profit (a reward for successful uncertainty bearing) are distinct sources of business income. (See also Mises’s construct of the “evenly rotating economy,” in which there is positive time preference, and hence interest returns, but no uncertainty, and hence no entrepreneurial profit.)
In the opportunity-discovery view, as elaborated by Kirzner, time preference is not relevant because the discovery and exploitation of profit opportunities is instantaneous, with no passage of time and no uncertainty.
14.
Robert A. McKeown | 14 November 2014 at 10:42 am
Thank you for your answer. I’ve always been a bit confused on the time preference question after reading Kirzner. The Austrian in me assumed he must had made an error, but you’ve made it simple to understand after breaking entrepreneurship down into these two perspectives.
15.
Divine Economy Consulting | 21 November 2014 at 10:59 pm
The entrepreneurial spirit which leads to discovery does not necessarily translate into an act of entrepreneurship. In a sense it is like savings, it can exist or it can exist as capital. Capital is the active form of savings.
To assume away the entrepreneurial quality of discovery because it has not yet combined with the bearing of risk is like assuming away savings as the origin of capital because sometimes it does not serve as capital.
This brings time preference into the discussion. Time preference is part of the human reality and it is a natural outcome of originary interest. Discovery is directly related to originary interest since it explains why people take action in the present. Humans do, indeed, place a high valuation on the present. High time preference of a degree that approaches instantaneous does not make irrelevant time preference theoretically.