8. Entrepreneurship and the Theory of the Cycle

The conception of entrepreneurship developed by Ludwig von Mises, Friedrich A. Hayek, and Israel M. Kirzner lies at the very root of a theory of entrepreneurship which we have presented elsewhere.²² An entrepreneur is any human actor who performs each of his actions with shrewdness, remains alert to the opportunities for subjective profit which arise in his environment and tries to act so as to take advantage of them. Human beings’ innate entrepreneurial capacity not only leads them to constantly create new information concerning their ends and means, but also spontaneously triggers a process by which this information tends to spread throughout society, accompanied by the spontaneous coordination of disparate human behaviors. The coordinating capacity of entrepreneurship sparks the emergence, evolution and coordinated development of human society and civilization, as long as entrepreneurial action is not systematically coerced (interventionism and socialism) nor are entrepreneurs obliged to act in an environment in which traditional legal norms are not respected because the government has granted privileges to certain social groups. When entrepreneurship cannot be incorporated into a framework of general legal principles or is systematically coerced, not only does it cease to create and transmit a large volume of social information, but it also generates corrupt and distorted information and provokes discoordinated and irresponsible behaviors. From this point of view our theory of the cycle could be considered an application of the more general theory of entrepreneurship to the specific case of the intertemporal discoordination (i.e., between different time periods) which follows from banking activity not subject to general legal principles and therefore based on the privilege of granting loans unbacked by a prior rise in voluntary saving (the monetary bank-deposit contract with a fractional reserve). Hence our theory explains how the violation of legal principles, which invariably causes serious social discoordination, exerts the same effect in a field as complex and abstract as that of money and bank credit. Thus economic theory has made it possible to connect legal and economic phenomena (the granting of privileges in violation of legal principles; and crises and recessions) which until now were thought to be completely unrelated.

One might wonder how entrepreneurs can possibly fail to recognize that the theory of the cycle developed by economists and presented here pertains to them, and to modify their behavior by ceasing to accept the loans they receive from the banking sector and avoiding investment projects which, in many cases, will bankrupt them. However, entrepreneurs cannot refrain from participating in the widespread process of discoordination bank credit expansion sets in motion, even if they have a perfect theoretical understanding of how the cycle will develop. This is due to the fact that individual entrepreneurs do not know whether or not a loan offered them originates from growth in society's voluntary saving. In addition though hypothetically they might suspect the loan to be created ex nihilo by the bank, they have no reason to refrain from requesting the loan and using it to expand their investment projects, if they believe they will be able to withdraw from them before the onset of the inevitable crisis. In other words the possibility of earning considerable entrepreneurial profit exists for those entrepreneurs who, though aware the entire process is based on an artificial boom, are shrewd enough to withdraw from it in time and to liquidate their projects and companies before the crisis hits. (This is, for instance, what Richard Cantillon did, as we saw in chapter 2.) Therefore the entrepreneurial spirit itself, and the profit motive on which it rests, destines entrepreneurs to participate in the cycle even when they are aware of the theory concerning it. Logically no one can predict precisely when and where the crisis will erupt, and a large number of entrepreneurs will undoubtedly be “surprised” by the event and will encounter serious difficulties. Nonetheless, in advance, from a theoretical standpoint, we can never describe as “irrational” those entrepreneurs who, though familiar with the theory of the cycle, get carried away by the new money they receive, funds which the banking system has created from nothing, and which from the start provide the entrepreneurs with a great additional ability to pay and the chance to make handsome profits.²³

Another connection links the theory of entrepreneurship to the theory of the business cycle, and it involves the stage of recession and readjustment in which the grave errors committed in earlier phases of the cycle are exposed. Indeed economic recessions are the periods in which historically the seeds of the greatest entrepreneurial fortunes have been sown. This phenomenon is due to the fact that the deepest stages of the recession are accompanied by an abundance of capital goods produced in error, goods with a market price reduced to a fraction of its original amount. Therefore the opportunity to make a large entrepreneurial profit presents itself to those entrepreneurs shrewd enough to arrive at this recession stage in the cycle with liquidity and to very selectively acquire those capital goods which have lost nearly all of their commercial value but which will again be considered very valuable once the economy recovers. Hence entrepreneurship is essential to salvaging whatever can be saved and to getting the best possible use, depending upon the circumstances, from those capital goods produced in error, by selecting and keeping them for the more or less distant future in which the economy will have recovered and they can again be useful to society.