CHAPTER 22 The Entrepreneur

Since the early seventeenth century, mention has been made of the “projector”— the ingenious idea-smith, who was “at the same time inventor, … alchemist, reformer, but also fantasist and carpetbagger”—as well as the entrepreneur. The entrepreneur was described for the first time by Richard Cantillon (1680–1734), an Irish–French banker, in his Essay sur la Nature du Commerce en général (1732), as follows: an “entrepreneur” is a person who assumes the economic risk by buying and combining factors of production in order to offer goods on the market with the intention of making a profit (Matis 2002, pp. 31–32). The achieved profit is to be understood as a kind of risk premium. Members of the Austrian School delved more deeply into this basic description. Beginning with Carl Menger and Victor Mataja, and on through Ludwig von Mises and Friedrich A. von Hayek, entrepreneurial action was assigned more significant, even central, relevance. Schumpeter’s Theorie der wirtschaftlichen Entwicklung (1912) (The Theory of Economic Development) erected more of a heroic-literary monument to the personality of the entrepreneur. According to Schumpeter, risk was borne not by the entrepreneur, but by the banker.

In his main work, Grundsätze der Volkswirthschaftslehre (1871) (Principles of Economics, 1950/2004), Carl Menger described the work of the entrepreneur as preparing and directing processes which serve the transformation “of goods of higher order into goods of lower and first order.” Specifically this involves “(a) obtaining information about the economic situation; (b) economic calculation—all the various computations that must be made if a production process is to be efficient (provided that it is economic in other respects); (c) the act of will by which goods of higher order … are assigned to a particular production process; and finally (d) supervision of the execution of the production plan” (Menger 1950/2007, p. 160, emphasis in the original).

In the early days of entrepreneurship, said Menger, the entrepreneur himself would still step into the production process with his “technical labor services.” His specific function became more clearly apparent only “with progressive division of labor and an increase in the size of enterprises”; and finally, it assumed the nature of an economic good. Even today, “the value of entrepreneurial activity” has to be included in the value of all goods necessary for a production process (ibid., p. 161). The distinctive features of this category of activities are twofold: first, “they are by nature not commodities (not intended for exchange) and for this reason have no prices” and second, “they have command of the services of capital as a necessary prerequisite since they cannot otherwise be performed” (ibid., p. 172).

Unlike other forms of income, for example labor wages or capital interest, the income of the entrepreneur is, according to Viktor Mataja in Der Unternehmergewinn (1884) (“The Entrepreneurial Profit”), “much more difficult to identify.” There is a need to develop a precise conceptual definition of this income. Firstly, it is incorrect to view the use of capital as a general feature of business ventures. For, “if this were the case, what would all those producers be who, solely through their own labor, place their products on the market?” (Mataja 1884/1966, p. 134). Another “improper narrowing of the term” is

when one describes the intention of the entrepreneur to acquire income as part of the nature of the business venture….Purely benevolent institutions like savings banks, societies with business-like natures that do not work toward their own ends—cooperatives, for example—and certain state institutions, etc., definitely bear the characteristics of business ventures, and may even produce an entrepreneurial profit, but are nevertheless not set up with the intention of achieving this or any other such income (ibid., p. 136).

But what all business ventures do have in common is the “production of market values (goods destined to be sold),” which is guided by the entrepreneur, and “that this production takes place on his behalf” (ibid., pp. 142–143).

According to Mataja, entrepreneurial profit is the income which “results entirely from economic exchange and which furthermore accrues to the owner of the business venture absolutely and exclusively.” Entrepreneurial income and entrepreneurial profit, therefore, need to be clearly distinguished. While the entrepreneurial income includes those incomes which befit “the individual entrepreneur as capitalist and laborer according to the capital in his ownership and his amount of work,” the entrepreneurial profit is created only “when the earnings of the business venture (difference between costs and revenue) result in a surplus over and above these two quantities” (ibid., p. 142). Capital profit, according to Mataja, is simply “the reward for the productive involvement of capital in the creation of goods,” whereas entrepreneurial profit is a “premium for the most productive exploitation possible of already existing goods of a higher order,” effectively the “proceeds for the administration of a kind of ‘social office’ (Schäffle)” (ibid., p. 196).

Just as every human action is directed toward the future and is, as Ludwig von Mises wrote in Nationalökonomie (1940) (Human Action, 1949), “always speculation,” (entrepreneurial) action always involves the future use of the means of production (Mises 1949/1998, p. 253). Economics calls those entrepreneurs “who are especially eager to profit from adjusting production to the expected changes in conditions, those who have more initiative, more venturesomeness, and a quicker eye than the crowd, the pushing and promoting pioneers of economic improvement” (ibid., p. 255), and

[w]hat distinguishes the successful entrepreneur … 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 (ibid., p. 582).

Ultimately however, anyone can become a promoter (entrepreneur)

if he relies upon his own ability to anticipate future market conditions better than his fellow citizens and if his attempts to act at his own peril and on his own responsibility are approved by the consumers. One enters the ranks of the promoters by aggressively pushing forward, thus submitting to the trial to which the market subjects, without respect for persons, everybody who wants to become a promoter or to remain in this eminent position. Everybody has the opportunity to take his chance. A newcomer does not need to wait for an invitation or encouragement from anyone. He must leap forward on his own account and must know for himself how to provide the means needed (ibid., p. 309).

“The capitalists, the enterprisers, and the farmers,” wrote Mises in Bureaucracy (1944), are ultimately nothing other than those means which serve to manage economic affairs:

They are at the helm and steer the ship. But they are not free to shape its course. They are not supreme, they are steersmen only, bound to obey unconditionally the captain’s orders. The captain is the consumer. Neither the capitalists nor the entrepreneurs nor the farmers determine what has to be produced. The consumers do that…. If the consumers do not buy the goods offered to them, the businessman cannot recover the outlays made…. If he fails to adjust his procedure to the wishes of the consumers he will very soon be removed from his eminent position at the helm. Other men who did better in satisfying the demand of the consumers replace him.

In a capitalist system the consumers are

[t]he real bosses…. They, by their buying and by their abstention from buying, decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality. Their attitudes result either in profit or in loss for the enterpriser. They make poor men rich and rich men poor…. Thus the capitalist system of production is an economic democracy in which every penny gives a right to vote. The consumers are the sovereign people. The capitalists, the entrepreneurs, and the farmers are the people’s mandatories. If they do not obey, if they fail to produce, at the lowest possible cost, what the consumers are asking for, they lose their office. Their task is service to the consumer. Profit and loss are the instruments by means of which the consumers keep a tight rein on all business activities (Mises 1944/1983, pp. 23–25).

Friedrich A. von Hayek described the role of the entrepreneur with an eye on competition in particular. By uncovering hitherto hidden knowledge in a systematic process of discovery, he is able to supply entrepreneurs with information relevant to them. Wherever we employ competition, we do not know the relevant circumstances: “In sport or in exams, when awarding government contracts or awarding prizes for poems and, not least, in science,” Hayek wrote in his Freiburger Studien (1969a), “it would obviously be absurd to hold a competition if we knew in advance who the winner was going to be. Therefore, I would like … to consider competition systematically as a process for discovering facts, without which they would either remain unknown or at the very least not be utilized” (Hayek 1969a, p. 249). In addition, competition is “a method for breeding certain types of mind.” It is always a process “in which a small number makes it necessary for larger numbers to do what they do not like, be it to work harder, to change habits, or to devote a degree of attention, continuous application, or regularity to their work which without competition would not be needed” (Hayek 1973/1976/1979, vol. 3, pp. 76–77). Competition generally fosters discipline and helps motivate existing talent to achieve outstanding results.

“One revealing mark of how poorly the ordering principle of the market is understood,” Hayek wrote in The Fatal Conceit: The Errors of Socialism (1988), “is the common notion that ‘cooperation is better than competition.’ ” Of course cooperation is also useful, but particularly in small, homogeneous groups, in which there is a great amount of consensus. But when it comes to adjusting to unknown conditions, there is not much merit in cooperation. Ultimately it was competition “that led man unwittingly to respond to novel situations; and through further competition, not through agreement, we gradually increase our efficiency” (Hayek 1988, p. 19).