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Journal of Economic Literature
Vol. XXXV (March 1997), pp. 60-85
ISRAEL M. KIRZNER
New York University
The aiithloris deeply grateful to Mario Rizzo, Peter Boettke, andc1 Yat Nyarko, for exte.tsive
and helpful comm7ents o an earlier draft Firther helpful coniiiiienit.swere provided by Joseph
T Salernio,and by othieriaiemiibers of the AiustrianiEconomizics
Colloquiumi71 at New YorkUniver-
Oity.Several anioniymtouis referee.sprovided m1anzy additionialvaliuablesuggestions. The auithlor
is gr-atefiulto the Sarah Scaife Foundationfor researchisupport.
areas within it, such as cycle theory, economics.6 By 1950 both Mises and
monetary theory, capital theory. Within Hayek had crystallized separate, defini-
its chosen scope of microeconomics, it tive, statements of their disagreements
does not claim to represent a universally with mainstream microeconomics, and of
accepted Austrian position (or even to their own substantive approaches. These
cover its entire range of topics). None- were indeed separate statements, differ-
theless, the approach described here is ing from one another certainly in style
arguably central to the reviving contem- and, no doubt, to some degree also in
porary interest in Austrian ideas, and has substance. But it can be argued that they
been treated as such in a number of re- are best understood as both overlapping
cent general surveys of modern Austrian and complementary, rather than as con-
economics (Stephen Littlechild 1986; trasting alternatives. It was these contri-
Bruce Caldwell and Stephan Boehm butions of Mises and Hayek which, while
1992; Vaughn 1994).2 almost entirely ignored by the midcen-
During the past two decades modern tury mainstream of the profession, have
Austrian economics has emerged out of nourished the Austrian revival of the
the classic earlier "subjectivist"tradition3 past two decades, and which have gener-
(which began in the late nineteenth cen- ated the modern Austrian approach to
tury with Carl Menger, Eugen von understanding the competitive market
Boehm-Bawerk, and Friedrich von Wie- process set forth in this paper.
ser),4 particularly as that tradition came At the basis of this approach is the
to be represented in the midcentury con- conviction that standard neoclassical mi-
tributions of Ludwig von Mises and croeconomics, for which the Walrasian
Friedrich Hayek.5 The early work of the general equilibrium model (in its mod-
Austrian School until the 1930s was cor- ern Arrow-Debreu incarnation) is the
rectly perceived as simply one variant of analytical core, fails to offer a satisfying
the dominant early twentieth century theoretical framework for understanding
mainstream approach to economic un- what happens in market economies. This
derstanding (often loosely referred to as conviction is rooted (a) in criticisms of
"neoclassical"). But the work of Mises the lack of relevance in models which
and Hayek from the 30s on, steered the seek to explain market phenomena as if
Austrian tradition in a direction sharply they were, at each and every instant,
different from that being taken at that strictly equilibrium phenomena, and (b)
time by mainstream neoclassical micro- in the belief that it is a methodologically
2 For an authoritative, encyclopedia-style
legitimate demand to be made of a the-
set of
surveys of modern Austrian economics, see Boet- ory of the market, that it not merely be-
tke (1994). gin with the instrumentalist assumption
3 For discussions of Austrian subjectivism (and of already-attained equilibrium, but also
also on its influence on other schools of economic
thought) see Alfred Coats (1983), Jack Wiseman realistically offer a plausible explanation
(1983, 1985), Gerald O'Driscoll and Rizzo (1985, of how, from any given initial set of
ch. 2), James Buchanan (1982), Ludwig Lachmann nonequilibrium conditions, equilibrating
(1982).
4 For general surveys of the history of the Aus-
tendencies might be expected to be set
trian tradition, see Hayek (1968), Vaughn (1994), into motion in the first place. As will
Kirzner (1992). For collections of papers repre-
senting the work of the Austrian School from 1870 6 For the thesis that these developments in the
to the present see Littlechild (1990), Kirzner
work of Mises and Hayek stemmed from their par-
(1994). ticipation in the interwar debate on the possibility
5 Among the principal relevant works are Mises
of socialist economic calculation, see Kirzner
(1949), Hayek (1941, 1948, 1978).
(1992, ch. 6).
62 Journal of Economic Literature, Vol. XXXV (March 1997)
be noted below, such criticisms are not ery is seen as gradually but systemati-
(or, at any rate, no longer) exclusively cally pushing back the boundaries of
"Austrian" criticisms. In fact, a good sheer ignorance, in this way increasing
deal of recent non-Austrian work in mutual awareness among market partici-
microeconoinics has in some fashion pants and thus, in turn, driving prices,
attempted to grapple with these difficul- output and input quantities and quali-
ties. What stamps the entrepreneurial ties, toward the values consistent with
discovery approach as Austrian is not equilibrium (seen as the complete ab-
these criticisms themselves, but rather sence of sheer ignorance).
the specific positive elements of the ap- What will emerge from this paper is
proach. thus the exposition of an Austrian way of
These positive elements focus on the understanding the systematic character
role of knowledge and discovery in the of markets which, while sharply differing
process of market equilibration. In par- from the mainstream competitive equi-
ticular this approach (a) sees equilibra- librium model, does not necessarily see
tion as a systematic process in which that model as totally irrelevant. (Many
market participants acquire more and practical questions, such as those regard-
more accurate and complete mutual ing the effects of price controls, mini-
knovledge of potential demand and sup- mum wage laws, and the like, can be an-
ply attitudes, and (b) sees the driving swered quite adequately without going
force behind this systematic process in beyond simple competitive supply-and-
what will be described below as en- demand equilibrium models.) The dy-
trepreneurial discovery. Although, of namic competitive process of en-
course, much contemporary mainstream trepreneurial discovery (which is the
work in microeconomics takes its point driving element in this Austrian ap-
of departure from the imperfection of proach) is one which is seen as tending
knowledge (relaxing the older standard systematically toward, rather than away
neoclassical assumption of complete, from, the path to equilibrium. There-
universal information), the Austrian ap- fore, the standard, competitive equilib-
proach set forth in this paper has little in rium model may be seen as more plausi-
common with this work. ble as an approximate outcome, in the
For the mainstream, imperfect in- Austrian theory here presented.7 This as-
formation is primarily a circumstance pect of the entrepreneurial discovery ap-
constraining the pattern of attained equi- proach troubles a number of the Aus-
librium (and introducing a new "produc- trian economists who have not accepted
tion" cost, that of producing or searching it. In order to clearly locate the
for missing information). For the Aus- entrepreneurial discovery perspective
trian approach imperfect information is within the range of modern Austrian
seen as involving an element which can- theoretical points of view, it will be nec-
not be fitted at all into neoclassical mod- essary briefly to identify more precisely
els, that of "sheer" (i.e., unknown) igno- the various disagreements which other
rance. As will be developed below, sheer Austrians have had with this approach.
ignorance differs from imperfect infor- Section II of this paper will review the
mation in that the discovery which
7 For a critique of the use by Austrian econo-
reduces sheer ignorance is necessarily
mists (such as Mises and Murray Rothbard) of a
accompanied by the element of sur- concept (the "evenly rotating economy") which
prise-one had not hitherto realized parallels that of the equilibrium state, see Tyler
one's ignorance. Entrepreneurial discov- Cowen and Richard Fink (1985).
Kirzner: Entrepreneurial Discovery 63
Austrian criticisms of the equilibrium the selling and buying decisions consis-
emphasis of the neoclassical models. tent with maximizing under a range of
Section III will develop the Austrian un- hypothesized states of affairs). It is this
derstanding of the market process, based aspect of modern neoclassical economics
upon the twin concepts of sheer (i.e., un- which accounts for its characteristic em-
known) ignorance and entrepreneurial phasis upon: (a) the constrained maximi-
discovery. Section IV will survey several zation pattern imposed by the theory
areas of applied microeconomics (anti- upon individual decision making, and (b)
trust economics, welfare economics, the the mathematics of simultaneous equa-
theory of justice, and the possibility of tion systems. Valiant attempts have been
socialist economic calculation), taking made to enrich the realism of these equi-
special note of the significant differences librium microeconomic models by build-
which the Austrian approach entails in ing into them assumptions acknowl-
regard to policy recommendations in edging imperfections in competition.
these areas. Section V will note the vari- Nonetheless, the dominant trend has
ous criticisms to the entrepreneurial dis- been to concentrate upon models of
covery theory developed in this paper, competitive equilibrium, that is upon
offered by several contemporary Aus- models in which both prices and prod-
trian economists. Section VI concludes uct/resource qualities are taken as given
the paper by clearing up certain misun- to each decision maker, and as being in-
derstandings concerning the Austrian ap- dependent of the decisions made. Not
proach. only do these competitive models (like
all equilibrium models) assume complete
II mutual knowledge (in the relevant
sense), they also assume, in effect, that
Mainstream microeconomics inter-
the crucial market variables of price and
prets the real world of markets as if
quality are somehow presented to each
observed phenomena represent the ful-
decision maker as an external fact of na-
fillment of equilibrium conditions.8 Mar-
ture. Neoclassical economics operates on
kets consist of successfully maximizing
the assumption that the world reflects
agents whose decisions are held to fit in
the relationships that would prevail in
together perfectly, in the sense that each
such equilibrium models-with the
maximizing decision being made cor-
model of competitive equilibrium being
rectly anticipates, in effect, at least, all
the favorite one. While Austrians have
the other maximizing decisions being
not been alone in criticizing this ap-
made simultaneously. It is this latter
proach to understanding markets, their
condition which mathematically con-
criticisms have been both pioneering and
strains the attained values of the key de-
trenchant.
cision variables. For this condition to be
Austrian dissatisfaction with this stan-
fulfilled, only that set of input and out-
dard approach to understanding real
put prices and quantities can prevail
world market phenomena emerged most
which simultaneously satisfies the rele-
clearly in the forties. Both Mises and
vant equations of supply and demand
Hayek expressed dismay at models la-
(themselves constructed by aggregating
beled as competitive, in which market
8 It has been strongly argued by Frank
participants are forbidden, as it were,
Machovec (1995) that the great neoclassical from competing (in the sense in which,
economists of the period before 1930 did not pro- in everyday discourse and experience,
ceed in this manner.
market participants compete by bidding
64 Journal of Economic Literature, Vol. XXXV (March 1997)
mand diagrams, surely we are entitled cess. Arrow focused his attention upon
to a theoretical process-"story" which the Marshallian perfectly competitive
might account for the economists' confi- supply and demand model in the single
dence in the special relevance of the in- commodity market, and especially, upon
tersection point in that supply and de- the requirement of this model that sup-
mand diagram. In our undergraduate ply equal demand. He draws attention to
freshman classes we do offer such sto- the logical gap in the perfectly competi-
ries: if above equilibrium prices prevail, tive model:
this generates surplus of supply over de- Each individual participant in the economy is
mand; these surpluses force prices down- supposed to take prices as given and deter-
wards, etc., etc. But strictly speaking, mine his choices as to purchases and sales ac-
these plausible stories are, within the cordingly; there is no one left over whose job
it is to make a decision on price. (Arrow
neoclassical framework, quite illegiti-
1959, p. 43)
mate. That framework requires us simply
to accept equilibrium models as the only He overcomes this difficulty by propos-
explanatory tool necessary for under- ing that it be recognized "that perfect
standing prices and outputs. This, for competition can really prevail only at
Austrians, is methodologically unaccept- equilibrium" (Arrow 1959, p. 41). In
able. What, we must ask, accounts for disequilibrium each supplier faces a
the powerful equilibrating tendencies downward sloping demand curve and,
which economists believe to be operat- acting "monopolistically," seeks an opti-
ing in markets? If, at any time, real mal price-quantity combination. The
world limitations upon the perfection of equilibrating process operates through
information possessed have prevented each supplier discovering that (as a re-
instantaneous attainment of equilibrium, sult of the comparable activities of his
why should we have confidence in any fellow "monopolists") his demand curve
possible equilibrative process?12 And is shifting "at the same time as he is ex-
how, if we do observe such equilibrating ploring it" (Arrow 1959, p. 46).
processes, can we understand what has Arrow recognized that the very notion
generated them?13 of a perfectly competitive market in dis-
Kenneth Arrow's well known paper of equilibrium is incoherent. And he recog-
1959 offers an excellent illustration of (a) nized an obligation to offer a model that
how a foremost exponent of the neoclas- might account for the emergence, out of
sical approach perceptively recognized initial disequilibrium, of an equilibrating
one aspect of the problem upon which process. His critique of the core of neo-
this latter Austrian criticism has focused, classicism, illustrates well the vulnerabil-
and (b) how this led him to develop an ity of mainstream theory to the Austrian
analytical dynamics from which the stan- criticisms discussed in this section. A
dard competitive equilibrium model number of non-Austrian writers have
emerges only as the outcome of a pro- followed Arrow's critique, and Franklin
Fisher's (1983) important contribution
12 This confidence has, in recent literature, been
attracted a modest amount of profes-
challenged also on the grounds of possible path-
dependency. See for example Brian Arthur (1989),
sional attention. Nonetheless, the main-
Robin Cowan (1990). stream has proceeded by virtually ignor-
13 For literature on the role of process theory in ing these criticisms, and operating as if
economics, see particularly Jack High (1990),
Lachmann (1986), Ikeda (1990, 1994), Wolfgang
its core paradigm was, by and large, as
Kerber (1994). For a pioneering contribution see relevant as ever.
George B. Richardson (1960). Austrians maintain that a theoretical
Kirzner: Entrepreneurial Discovery 67
framework for understanding the equili- unrealizable state of the evenly rotating
brative process is available. This frame- economy if no further changes were to
work offers its explanation not by deny- occur" (Mises 1949, p. 335). "In the
ing the operation of competition in imaginary construction of the evenly ro-
disequilibrium but per contra (and in tating economy there is no room left for
sharpest contrast to Arrow's labeling sys- entrepreneurial activity . . ." (Mises
tem), by reformulating the notion of 1949, p. 253). The focus here is on the
competition to make it utterly inconsis- market process, as opposed to the
tent with the equilibrium state. "imaginaryconstruct" of the "evenly ro-
tating economy"(correspondingroughlyto
III the state of general market equilibrium).
Entrepreneurial activity has no place
The entrepreneurial discovery ap-
at all in neoclassical equilibrium micro-
proach which has emerged in modern
economics (because it is inconsistent
Austrian economics during the past quar-
with the conditions satisfied in the equi-
ter of a century was developed out of
librium state; William Baumol 1993, ch.
elements derived from Mises and from
1). But for Austrians the entrepreneurial
Hayek. From Mises the modern Austri-
role provides the theoretical key with
ans learned to see the market as an en-
which to account for the market as a pro-
trepreneurially driven process. From
cess. For Mises, the economist
Hayek they learned to appreciate the
role of knowledge and its enhancement shows how the activities of enterprising men,
through market interaction, for the the promoters and speculators, eager to profit
from discrepancies in the price structure,
equilibrative process. These two distinct
tend toward eradicating such discrepancies
elements have been welded into an inte- . . . He shows how this process would finally
grated theoretical framework which, on result in the establishment of the evenly ro-
the one hand, is consistent with and, on tating economy. This is the task of economic
the other hand, is articulated in a man- theory. The mathematical description of vari-
ous states of equilibrium is mere play. The
ner more explicit than the earlier Aus-
problem is the analysis of the market process.
trian expositions.'4 (Mises 1949, pp. 352-53)
Mises' conception of the market as an
entrepreneurially driven process per- Hayek's emphasis on the role of
vades his mature theoretical work. knowledge and its enhancement in the
The driving force of the market process is course of the market process goes back
provided neither by the consumers nor by the to his work in the thirties. It was Hayek
owners of the means of productions-land, who insisted that
capital goods, and labor-but by the promot-
ing and speculating entrepreneurs . . . Profit- the concept of equilibrium merely means that
seeking speculation is the driving force of the the foresight of the different members of the
market as it is the driving force of produc- society is . . . correct . . . in the sense that
tion. (Mises 1949, pp. 325-26) every person's plan is based on the expecta-
tion of just those actions of other people
"The activities of the entrepreneur are which those other people intend to perform
the element that would bring about the and that all these plans are based on the ex-
pectation of the same set of external facts . ..
Correct foresight is then . . . the defining
14For excellent modern Austrian expositions
characteristic of a state of equilibrium.
of the approach developed in this section see
Martti Vihanto (1989, 1994). For discussions (Hayek 1948, p. 42)
which are at least partly critical of the Austrian
approach see Loasby (1989, ch. 10) and Claudia In his pioneering discussion of the equil-
Loy (1988). ibrating process Hayek pointed out that,
68 Journal of Economic Literature, Vol. XXXV (March 1997)
"if we want to make the assertion that, modities" (Mises 1949, p. 278). He cites
under certain conditions, people will ap- Hayek's critique of the doctrines of im-
proach (the equilibrium state), we must perfect or monopolistic competition
explain by what process they will acquire (Mises 1949, p. 278 fn.), and emphasizes
the necessary knowledge" (Hayek 1948, that competition (far from being de-
p. 46). fined, as in the perfectly competitive
For Hayek the equilibrating process is model, as the state in which all partici-
thus one during which market partici- pants face identical prices) "manifests it-
pants acquire better mutual information self in the facts that the sellers must
concerning the plans being made by fel- outdo one another by offering better or
low market participants. For Mises this cheaper goods and services and that the
process is driven by the daring, imagina- buyers must outdo one another by offer-
tive, speculative actions of entrepreneurs ing higher prices" (Mises 1949, p. 274).
who see opportunities for pure profit in In other words, the essence of competi-
the conditions of disequilibrium. What tion is precisely that dynamic rivalry
permits us to recognize that these two whiclh the neoclassical equilibrium no-
perspectives on the character of the mar- tion of competition is at great pains to
ket process are mutually reinforcing, is exclude. Hayek's pathbreaking critique
the place which each of these two writers of the dominance of the perfectly com-
assigns to competition in the market pro- petitive model (and hence also of the
cess. The Austrian approach includes a corollary doctrines of imperfect and mo-
concept of competition which differs nopolistic competition) takes as its point
drastically from that encapsulated in the of departure precisely this feature of the
label "competitive" as used in modern model. That model, he points out deals
neoclassical theory. with a state of what is called "competitive
For neoclassical economics the maxi- equilibrium"in which it is assumedthat the
mum possible degree of competition is datafor the differentindividualsare fully ad-
represented by the equilibrium notion of justed to each other, while the problem
perfect competition, in which all traces which requires explanationis the nature of
the process by which the data are thus ad-
of rivalry are absent. Anything less than justed. (Hayek1948,p. 94)
perfect elasticity in the supply/demand
curves faced by potential buyers/sellers For Hayek, on the other hand, "competi-
corresponds, in neoclassical terminology, tion is by its nature a dynamic process
to some degree of monopolistic power.'5 whose essential characteristics are as-
Mises rejected this nomenclature, in that sumed away by the assumptions underly-
it implies that monopoly prices are ing static analysis" (Hayek 1948, p. 94).
somehow determined without that com- "Competition," he insists
petitive process which constitutes for is essentially a process of the formationof
Mises the essence of the market. "Catal- opinion . .. a process which involvesa con-
lactic competition is no less a factor in tinuouschangein the dataand whose signifi-
the determination of monopoly prices cance must therefore be completelymissed
than it is in the determination of com- by any theorywhich treatsthese dataas con-
stant.(Hayek1948,p. 106)
petitive prices . . . On the market every
commodity competes with all other com- In other words the role of competition in
economic theory must, for both Mises
15 See George Stigler (1957) for the emergence and Hayek, focus not on the state of af-
of the view that explicitly rejects rivalrousness as fairs at the end of the market process,
an ingredient in competitive analysis. but upon the character of that process
Kirzner: Entrepreneurial Discovery 69
itself. More recently Hayek has empha- "maximize," but who has no opportunity
sized the nature of competition as a "dis- to sell output at a price exceeding
covery procedure"-i.e., as generating costs.)17 If the entrepreneur grasps the
"such facts as, without resort to it, would opportunities for pure entrepreneurial
not be known to anyone . . ." (Hayek profit created by temporary absence of
1978, p. 179). full adjustment between input and out-
For the modern Austrian approach, put markets, the neoclassical market in
this perception of competition as the dy- full equilibrium can, of course, find no
namic, driving force for discovery in the room for him. In Austrian theory the en-
market process has become central. The trepreneur is an agent whose character
key to an explanation of the equilibrative has been carefully explored.
process is to recognize the pivotal role of For Mises the term "entrepreneur" re-
dynamic competition in that process. fers to "acting man in regard to the
This equilibrative process of competition changes occurring in the data of the
is at work even in markets in which one market" (Mises 1949, p. 255). Entrepre-
firm may enjoy monopolistic privilege. neurship is human action "seen from the
This is because even a monopolistic aspect of the uncertainty inherent in
equilibrium can be approached, in a every action" (Mises 1949, p. 254). The
world of uncertainty, only through a pro- Misesian concept of human action thus
cess whereby market participants can be- implies the open-ended framework
come better aware of one another's atti- within which all decisions made must
tudes and plans. Only the process of necessarily partake of the speculative
competition can achieve this.16 character essential to the notion of en-
We have thus placed our finger on the trepreneurship. "In any real and living
key interrelated analytical concepts with economy every actor is always an entre-
which the modern Austrian entrepre- preneur" (Mises 1949, p. 253). By free-
neurial discovery theory of the market ing microeconomic analysis from the
process operates. These concepts are: (a) constrictions of the equilibrium state,
the entrepreneurial role; (b) the role of Austrian theory is able to recognize the
discovery; (c) rivalrous competition. speculative element in all individual de-
Each of these requires some brief dis- cision making, and to incorporate the ac-
cussion. tivity of the real world business man into
(a) The entrepreneurial role: In stan-
17 The statement in the text presumes that rents
dard neoclassical equilibrium theory
earned by firms who own scarce, non-reproducible
there is, by its very character, no role for resources used in their production operations, are
the entrepreneur. In equilibrium there is (although included in accounting "profit") prop-
no scope for pure profit: there is simply erly to be included in the firms' economic costs.
These firms certainly enjoy an advantage over
nothing for the entrepreneur to do. (If other firms who, not owning these resources, must
textbooks do speak of the entrepreneur produce with resources of lower productivity. But
in the theory of the firm this turns out to this advantage consists, for the economist (as dis-
tinct from the accountant), not in entrepreneurial
refer simply and imprecisely to the profit won by the fortunate firms, but rather in
owner of the firm who, operating in rental income earned through asset ownership.
equilibrium markets, is indeed able to The entrepreneur is considered as hiring these re-
sources from himself as owner, and should then
include this rental income as part of his (implicit)
16 It follows that monopolistic (or monopo- economic costs. For a full and classic discussion of
listically com petitive) equilibrium states, are en- the sense in which differential rent on assets
tirely compati le with the notion of dynamic com- owned are properly included in the firm's eco-
petition (which might in fact bring about such nomic costs, see Fritz Machlup (1952, pp. 237f,
states). 288ff).
70 Journal of Economic Literature, Vol. XXXV (March 1997)
ticed and grasped. The Austrian ap- the decision-maker's discovery of an ear-
proach indeed includes such a postulate. lier error in his view of the world.
To appreciate this we turn to the second Whereas earlier plans had overlooked
of the above listed three key analytical available profit opportunities (as, for ex-
elements in this approach. ample, where some buyers buy goods at
(b) The role of discovery: We have al- high prices, that were being sold else-
ready seen that Hayek pioneered in in- where in the same market for lower
terpreting the equilibrative market pro- prices), subsequent plans can be ex-
cess as a process of mutual discovery. In pected to reflect discovery of the profit
the course of this process market partici- opportunities implicit in (and constituted
pants become better informed of the by) the earlier plans. We should ac-
plans being made by other participants. knowledge that, from the neoclassical
Whereas some initial plans must, as a re- perspective, it is not at all obvious why
sult of initial entrepreneurial error, turn we should expect such discoveries to be
out to have been mistaken, these errors made.
tend systematically to become elimi- After all, it may be objected from the
nated as market experience reveals the mainstream economist's point of view, if
infeasibility of some (hitherto sought af- an available opportunity for profit was
ter) courses of action and the (hitherto universally overlooked yesterday, why
unnoticed) profitability of other courses should we expect that opportunity to be
of action. In the world of static equilib- noticed today? It is not as if that profit
rium, a chosen course of action, because opportunity was the object of systematic
it was pronounced mathematically to search (in which case it might be ex-
have been the optimal course of action pected that a time consuming search
within the given decision framework, process would identify it sooner or later).
cannot fail to be chosen again and again, An opportunity for pure profit cannot, by
so long as that given framework prevails. its nature, be the object of systematic
In the market-process world of en- search. Systematic search can be under-
trepreneurial discovery, on the other taken for a piece of missing information,
hand, flawed plans (i.e., those made on but only because the searcher is aware of
the basis of an erroneously imagined de- the nature of what he does not know,
cision framework) can be expected to and is aware with greater or lesser cer-
tend to be corrected through the respon- tainty of the way to find out the missing
siveness of alert, imaginative entrepre- information. In the economics of search
neurs to the opportunities revealed as a literature, therefore, search is correctly
result of the initially flawed plans. In treated as any other deliberate process of
other words, this approach postulates a production. But it is in the nature of an
tendency for profit opportunities to be overlooked profit opportunity that it has
discovered and grasped by routine-resist- been utterly overlooked, i.e., that one is
ing entrepreneurial market participants. not aware at all that one has missed the
In the neoclassical context a decision grasping of any profit. From the neoclas-
can never be corrected-because no de- sical perspective, therefore, a missed op-
cision can ever be truly mistaken. The portunity might seem (except as a result
reason for a change in a decision, thus of sheer, fortuitous good luck) to be des-
can be found only in an exogenously gen- tined for permanent obscurity.
erated change in the relevant decision- It is here that the Austrian perspective
framework. But in the Austrian context a offers a new insight, into the nature of
decision can be corrected as a result of surprise and discovery. When one be-
72 Journal of Economic Literature, Vol. XXXV (March 1997)
comes aware of what one had previously of surprise (at one's earlier unaccount-
overlooked, one has not produced knowl- able ignorance). An entrepreneurial atti-
edge in any deliberate sense. What has tude is one which is always ready to be
occurred is that one has discovered one's surprised, always ready to take the steps
previous (utterly unknown) ignorance. needed to profit by such surprises. The
What distinguishes discovery (relevant to notion of discovery, midway between
hitherto unknown profit opportunities) that of the deliberately produced infor-
from successful search (relevant to the mation in standard search theory, and
deliberate production of information that of sheer windfall gain generated by
which one knew one had lacked) is that pure chance, is central to the Austrian
the former (unlike the latter) involves approach.19 The profit opportunities cre-
that surprise which accompanies the re- ated by earlier entrepreneurial error do
alization that one had overlooked some- tend systematically to stimulate sub-
thing in fact readily available. ("It was sequent entrepreneurial discovery. The
under my very nose!") This feature of entrepreneurial process so set into mo-
discovery characterizes the entrepre- tion, is a process tending toward better
neurial process of the equilibrating mutual awareness among market partici-
market. What accounts for a systematic pants. The lure of pure profit in this way
tendency toward that succession of sets up the process through which pure
wholesome surprises which must consti- profit tends to be competed away. En-
tute the equilibrative process, is not any hanced mutual awareness, via the en-
implausible series of happy accidents, trepreneurial discovery process, is the
but rather the natural alertness (Kirzner source of the market's equilibrative
1973, pp. 35f, 65f) to possible opportuni- properties.
ties (or the danger of possible disaster) Austrians are careful to insist (i) that
which is characteristic of human beings. continual change in tastes, resource
In the world of uncertainty such natural availabilities, and known technological
alertness expresses itself in the boldness possibilities always prevent this equili-
and imagination which Austrian theory brative process from proceeding any-
ascribes to entrepreneurs in the context where near to completion; and (ii) that
of the market. Entrepreneurial alertness entrepreneurial boldness and imagina-
refers to an attitude of receptiveness to tion can lead to pure entrepreneurial
available (but hitherto overlooked) op- losses as well as to pure profit. Mistaken
portunities. The entrepreneurial charac- actions by entrepreneurs mean that they
ter of human action refers not simply to have misread the market, possibly push-
the circumstance that action is taken in ing price and output constellations in di-
an open-ended, uncertain world, but also rections not equilibrative. The entre-
to the circumstance that the human preneurial market process may indeed
agent is at all times spontaneously on the reflect a systematically equilibrative ten-
lookout for hitherto unnoticed features dency, but this by no means constitutes
of the environment (present or future), a guaranteed unidirectional, flawlessly
which might inspire new activity on his converging trajectory. What the Austrian
part. Without knowing what to look for, entrepreneurial discovery process seeks
without deploying any deliberate search to explain is not any imaginary mechani-
technique, the entrepreneur is at all
19 For further discussion of the Austrian concept
times scanning the horizon, as it were,
of discovery see Kirzner (1989, ch, 2). See also
ready to make discoveries. Each such Littlechild (1982a), Michael Beesely and Lit-
discovery will be accompanied by a sense tlechild (1989), Manfred Streit (1992).
Kirzner: Entrepreneurial Discovery 73
formation which it is costly to pro- dard microeconomics sees the ideal de-
duce.22 gree of competition as represented by
the perfectly competitive model. The
IV Austrian view sees matters quite differ-
ently.
The entrepreneurial discovery ap- For the Austrian approach competi-
proach offers a theoretical frameworkfor tion is socially beneficial primarily in a
understanding how markets work. This
dynamic sense. Coordination tends to
framework has important practical impli-
be induced among the decisions made
cations for applied economics and for in the market place under the pressure
economic policy. We briefly take note of of rivalrous entrepreneurs alert to the
four areas of application where the Aus- profit-opportunities created by initial
trian approach implies sharply different
discoordination. To harness the en-
practical conclusions from those usually trepreneurial initiative intrinsic to this
derived from neoclassical economics. A kind of dynamic competition, we do not
number of additional areas of application
require fulfillment of the classic
might also have been explored here. Ex-
Knightian conditions for perfect compe-
amples of such areas, omitted here be- tition-in fact those conditions preclude
cause of space constraints are: law and scope for (and, in fact, any need for) en-
economics (see for example Rizzo 1979),
trepreneurial initiative. The perfect
and the economics of transition (see for
knowledge requirement central to the
example Boettke 1993). The four areas
perfectly competitive model can in fact
examined are: (a) antitrust policy; (b) the be satisfied only by assuming away the
applicability of accepted theories of eco- need for any coordinative process. To in-
nomic justice; (c) welfare economics; (d)
duce dynamic entrepreneurial competi-
the workability of central planning under tion we require the fulfillment of only
socialism.
one condition: guaranteeing free en-
(a) Antitrust Policy: Standard econom-
trepreneurial entry into any market
ics, built upon neoclassical insights into
where profit opportunities may be per-
the Pareto-efficiency qualities of per-
ceived to exist. Most of the insights of
fectly competitive equilibrium, has for contestable market theory turn out not
most of this century been deployed to
only to be consistent with the en-
support antitrust policy limiting firm size
trepreneurial discovery approach, but
(both absolutely and relative to the in- in fact to be implied by that approach.
dustry). Despite the healthy dose of real- To limit the size of firms (for example
ism introduced into antitrust economics
by obstructing mergers) is, in the en-
in recent decades, and despite the sub-
trepreneurial discovery approach, to
stantive theoretical improvements intro-
block entrepreneurial entry, and is thus
duced into our understanding of compe-
anti-competitive in the relevant sense.
tition by the theory of contestable
Conversely, many aspects of real-world
markets, it remains the case that stan-
business activity, involving such practices
as advertising, or any of innumerable
22 The paragraph in the text has the objective of
forms of product differentiation, set
making clear the distinction between the quite
separate aspects of imperfect information treated down as imperfectly competitive or even
respectively by Stiglitz and by the Austrians. It as "monopolistic"in the standard frame-
does not have the objective of providing an Aus- work (because they imply less than per-
trian critique of Stiglitz's position. For such a cri-
tique see Thomsen (1992, ch. 3). See also Boehm fectly elastic demand curves facing
(1989, pp. 208f), and Thomsen (1994). firms), are precisely the kinds of en-
Kirzner: Entrepreneurial Discovery 75
and the like, merely what impact will a fact, refuted the theoretical clhallenge
given program have upon the allocative leveled by Mises and Hayek. The history
efficiency of the system (as an exercise, of the economic calculation debate is not
say, in applied comparative statics). They our concern here. What is important is
also ask what impact it will have in re- that a modern Austrian understanding of
gard to the stimulation of those acts of the market process is able to show the
entrepreneurial discovery upon which limitations of the Lange-Lerner solution.
the equilibrative process must depend. In seeking to simulate, through decen-
The one area in which Austrian econom- tralized socialist production, the condi-
ics has not merely raised new questions tions satisfied in a perfectly competitive
but has in fact fruitfully pursued the en- equilibrium market system, that solution
trepreneurial discovery approach to its in fact misses the difficulties which
full welfare-economic implications, is in Mises had seen for the possibility of so-
the modern version of its long-standing cialist planning.
Misesian critique of central planning. To The Lange-Lerner solution requires
this we now turn. the central planning authority to an-
(d) Central Planning under Socialism: nounce non-market prices for resources
In a famous 1920 article Mises asserted and commodities. Working with these
on theoretical grounds, the "impossibil- prices as "parameters"(see Lange 1938,
ity" of rational economic calculation un- p. 70)-as if they corresponded to the
der socialism and hence the impossibility prices under perfectly competitive equi-
of central planning. In a series of essays librium-decentralized socialist manag-
during the thirties, Hayek supported ers would then plan their resource "pur-
Mises' contention and responded to chases" (from state suppliers), their
several attempted solutions by socialist output production and input mix, in a
economists to refute that contention. manner designed to equalize marginal
Out of all these attempted solutions, the cost and marginal revenue (as if maxi-
"decentralized" solution of Oskar Lange mizing firm "profit" under perfectly
and Abba P. Lerner became the most fa- competitive conditions). The extent to
mous. For decades the mainstream lit- which the announced prices in fact di-
erature on comparative systems routinely verged from the "correct"values would
cited these solutions by Lange and be revealed in the surpluses and short-
Lerner as having definitively laid to rest ages generated for the various resources,
the critiques of the possibility of socialist thus permitting the central authority to
calculation argued by Mises and Hayek. adjust prices accordingly in the direc-
During the past 15 years, largely as a tions necessary to achieve resource mar-
result of the resurgence of interest in the ket clearing. The entire scheme is based,
Austrian tradition, a different assessment explicitly, on the view that the capitalist
of the interwar calculation debate has market economy operates in this way;
emerged.28 Especially as an implication that resource and output prices are given
(or application) of the entrepreneurial to entrepreneurs, and that firms then use
discovery approach to understanding the these prices parametrically to maximize
market process, it has come to be recog- the excess of revenue over cost. The Aus-
nized that Lange and Lerner had not, in trian entrepreneurial discovery approach
sees the market economy quite differ-
28 Major contributions to this literature have
been Don Lavoie (1985), Vaughn (1980), Boettke
ently, and therefore sees the problem
(1993, ch. 3), see also Willem Keizer (1989) anid J. facing the socialist central planning
Huerta de Soto (1992). authority quite differently.
78 Journal of Economic Literature, Vol. XXXV (March 1997)
The economic problem facing any so- originally announced prices were in fact
ciety, in this view, is primarily that of "correct") corresponds to nothing that
how, in a world of incessant changes in occurs in capitalist markets (despite its
tastes, resource availabilities, and tech- similarity to certain highly dubious text-
nological possibilities, to generate mutu- book stories of how perfectly competi-
ally sustaining expectations on the part tive market clearing prices are arrived
of agents in the economy, such that (a) at). The Lange-Lerner solution offers no
the series of actions taken are in fact scope whatsoever for anything in social-
able to be completed as planned, and (b) ism that might correspond to the pure
that that series of actions tends to reveal profit motivated entrepreneurial acts of
and exhaust all the available opportuni- discovery which drive the capitalist mar-
ties for social economic gain. Under the ket process.29
imagined conditions of perfectly com-
petitive equilibrium this problem does V
not exist, not because it has already been
It remains to relate the entrepre-
successfully solved, but because the
neurial discovery approach outlined in
equilibrium state has been constructed
this paper to alternative viewpoints
to avoid the problem in the first place.
within the universe of modern Austrian
Whether under socialism or under capi-
economists. The entrepreneurial discov-
talism, reference to the equilibrium state
ery approach embraces elements, espe-
offers no clues as to how to solve the
cially elements in its criticisms of neo-
problem; it offers only a picture of a
classical microeconomics, with which all
world in which the problem has never
Austrian economists broadly agree. But
existed.
the specific framework of the en-
From this perspective the Austrians
trepreneurial discovery approach-see-
understand that whatever social effi-
ing the market process as consisting
ciency may be achieved in the market
of systematic equilibrating tendencies,
economy is not achieved at all by its par-
made up of episodes of mutual discovery
ticipants behaving as if they were agents
and learning (by market participants)-
in a perfectly competitive equilibrium
has been rejected by a number of mod-
state-but precisely by their behaving
ern Austrian economists. These econo-
entrepreneurially and (dynamically)
mists emphasize, more than does the
competitively, under conditions of dise-
entrepreneurial discovery approach, the
quilibrium. The Lange-Lerner solution,
radical uncertainty of the future, with
in which the socialist managers are in-
which mnarketparticipants must contend.
structed to act as perfectly competitive
We may distinguish two groups of Austri-
agents, and in which resulting resource
ans who have, as result of such emphasis,
surpluses and shortages lead the central
dissented from the entrepreneurial dis-
authority to adjust resource prices, is
covery approach: (a) those who object
simply not a simulation of how markets
radically to the asserted equilibrative
actually operate under capitalism. This
character of the market process, and (b)
solution has not successfully incorpo-
those who object to the emphasis of the
rated the techniques to which any capi-
entrepreneurial discovery approach upon
talist successes may be attributed. Cen-
tral adjustment of non-market prices
29 For a valuable non-Austrian paper indepen-
in response to resource surpluses and
dently recognizing much of what is here argued in
shortages (generated by socialist manag- the text, see Louis Makowski and Joseph Ostroy
ers having mistakenly behaved as if the (1993).
Kirzner: Entrepreneurial Discover? 79
systematic mutual learning as the key as an attempt to rescue what they believe
feature in the market process (as well as to be an unsalvageable way of under-
to what they believe to be the implica- standing markets, viz. within the neoclas-
tion of the entrepreneurial discovery ap- sical paradigm. In a world of incessant
proach, that the market in fact success- change, they argue, it is precisely those
fully attains approximate equilibrium). acts of entrepreneurial boldness which
(a) Those who object to the asserted must frustrate any discovery efforts
equilibrative character of the market made by fellow entrepreneurs. The en-
process (as explained in the en- trepreneurial character of the market
trepreneurial discovery approach), have process (which is not disputed) must vir-
been led by one of the leading figures in tually guarantee, indeed, that that pro-
the modern Austrian revival, Ludwig cess must fail to be characterized as a
Lachmann. A significant number of systematic procedure of mutual discov-
younger "Austrian"economists have fol- ery.30
lowed Lachmann in this regard, and Some followers of Lachmann, as well
their debates with exponents of the en- as others, have questioned, not so much
trepreneurial discovery approach have the meaningfulness of the equilibrium
enlivened and enriched Austrian eco- concept itself (or of the notion of an
nomics during the past decade. A careful equilibrating tendency), as the idea that
exposition and analysis of these critics of we can, even in principle, identify an
the entrepreneurial discovery theory is equilibrium position. In an open-ended
beyond the scope of this paper. The fol- world there is, these critics argue, no
lowing thumbnail sketch of the Lach- equilibrium position "out there" that can
mann position undoubtedly fails to do serve as a reference point for discussion
justice to the subtleties of that position, of the presence or absence of "equili-
and is offered here only to identify, at brating tendencies" (see for example,
least, a stream of Austrian dissatisfaction Buchanan and Viktor Vanberg 1991).
with the entrepreneurial discovery ap- (b) Those who object to the systematic
proach. Lachmann (1986, 1991) saw the learning character of the market process
market process as one not only in cease- (as claimed by the entrepreneurial dis-
less motion (on which the entrepre- covery approach) have been led by Mur-
neurial discovery theorists would be in ray Rothbard (1994; a foremost late
thorough agreement) but in a ceaseless twentieth century exponent of Austrian
motion in which at no time is there any economics) and by Joseph Salerno (1993,
assurance that the equilibrative forces 1994). Although their position is a rela-
are stronger than the disequilibrative tively new one and has not yet generated
forces (set in motion by changes in the sustained debate within the Austrian
independent variables of the system)-so camp, it has already elicited a good deal
that one may not presume to say that the of attention, and seems likely to stir up
market process even tends to promote vigorous discussion in the immediate fu-
mutual discovery among market partici- ture. Rothbard and Salerno's under-
pants. Following on the later work of standing of the market process sees it
George Shackle (Lachmann 1976) this 30 Among those who have been deeply influ-
group of Austrians has questioned the enced by Lachmann's position, see Christopher
very meaningfulness of any equilibrium Torr (1981), O'Driscoll and Rizzo (1985), Lavoie
concept at all. They have deplored an ap- (1994), Wiseman (1989), Loasby (1992). See also
Peter Lewin (1994). For critical reaction to Lach-
proach (the entrepreneurial discovery mann's position, see O'Driscoll (1978), Garrison
approach) which appears to them simply (1987).
80 Journal of Economic Literature, Vol. XXXV (March 1997)
discussion. This will (a) respond to fre- the Austrian theory argues is the far
quently expressed (and fully justified) more nuanced thesis that the unbridled
curiosity concerning this relationship, market tends to offer the incentives
and (b) perhaps provide necessary fur- likely to stimulate movement in the di-
ther clarification of the Austrian position rection of complete mutual awareness.
presented in this paper. To the extent that a case for laissez faire
It is true that, in their policy judg- must rest on the claim that the market
ments, economists in the Austrian tradi- attains complete mutual awareness, Aus-
tion have tended overwhelmingly to fa- trian economics provides no basis for
vor market solutions for solving society's such a case.
economic problems. Certainly, this ten- In addition it should be emphasized
dency is largely rooted in a shared and that, although the entrepreneurial dis-
appreciative understanding of the co- covery approach throws significant light
ordinative properties of the entrepre- on the incentives which stimulate move-
neurial market process. There are, in- ments in the direction of full mutual
deed, Austrian grounds for arguing that awareness, this does not amount to the
government regulation of market activity assertion that all movements must be in
is likely to obstruct and frustrate the that direction. Still less is it the case that
spontaneous, corrective forces of entre- entrepreneurial discovery is claimed suc-
preneurial adjustments. Yet to conclude cessfully to attain full mutual awareness.
that Austrian economics by itself rigor- As was noted in Section III entrepre-
ously entails adoption of unbridled lais- neurial decisions may be entirely mis-
sez faire as the scientifically endorsed taken; they may in fact be more mistaken
economic policy for nations, is a far too than those other entrepreneurial judg-
oversimplified-and inaccurate-conclu- ments they are replacing. So that,
sion. instead of correcting the earlier misallo-
Let us not forget that traditionally the cations of resources, the entering entre-
economic case for laissez faire de- preneurs may be making matters even
pended, for whatever its worth, on the worse. And such errors may generate
claim that spontaneously achieved out- still more errors. Moreover, even if one
comes are, in a relevant sense, efficient imagined that, in a world of stable re-
(and can therefore only be worsened, not source availabilities and consumer pref-
improved, by regulatory interference). erences, entrepreneurial judgments tend
Austrian economics cannot, strictly to avoid new errors, the possibility of
speaking, possibly offer a case for laissez volatile changes in resource supply and
faire based on this claim. After all, Aus- consumer demand conditions must inevi-
trian economics makes no claim that the tably prevent the entrepreneurial discov-
market outcomes at any given date are ery process from proceeding very far to-
efficient and socially optimal (in any ward complete mutual awareness by
sense in which traditional neoclassical market participants.
welfare theory would use these terms). It If the Austrian theory claims that en-
is therefore certainly a misreading of the trepreneurial discovery can account for
Austrian theory to construe it as claiming a tendency toward equilibrium, that
that the entrepreneurial discovery pro- vague-sounding term "tendency toward"
cess ensures an unerring trajectory to- is used deliberately, advisedly, and quite
ward the attainment of that complete precisely. Such a tendency does exist at
mutual awareness which is necessary for each and every moment, in the sense
any notion of social optimization. What that earlier entrepreneurial errors have
82 [ournal of Economic Literature, Vol. XXXV (March 1997)
created profit opportunities which pro- classical and Austrian Monopoly Theory," in
LouIs M. SPADARO,ed. 1978, pp. 94-110.
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changes in supply and demand condi- 1994, 69(1), pp. 1-76.
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Increasing Returns, and Lock-In by Historical
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standing of the entrepreneurial discovery 31.
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