The last decade saw an explosion of popular literature on entrepreneurship in the form of biographies, company histories, newsletters, and journals such as Entrepreneur and Inc. The noise made in the business world, however, contrasts sharply with the silence of economists on the subject, with the exception for the noise that Austrian economists such as Don Lavoie made. The entrepreneur is a rare character in economic theory. An important reason is the conception of individual behavior in terms of constrained maximizations and the difficulty of incorporating the problem of knowledge in such a setup.
Many have already recognized that the constrained optimization strategy requires abstraction from the problem of knowledge. “Fully rational action,” Shackle asserts, “can only occur in a momentary or timeless system…” (Shackle 1966, p. 20). He argues that in historical time, economic agents do not necessarily know their constraints, the actions of others, and the possible outcomes of their actions. Hayek concurs. In his well-known 1945 article, “The Use of Knowledge in Society,” he writes: “The problem is thus in no way solved if we can show that all the facts, if they were born to a single mind (as we hypothetically assume them to be given to the observing economist), would uniquely determine the solution; instead we must show how a solution is produced by the interactions of people each of whom possesses only partial knowledge (Hayek 1945, p. 530).” The thinking about the process is crucial to him. The optimization approach, he argues, “disregards an essential part of the phenomena with which we have to deal: the unavoidable imperfection of man’s knowledge and the consequent need for a process by which knowledge is constantly communicated and acquired.”Footnote 1
Knight, Schumpeter, as well as Kirzner deserve credit for recognizing that the Walrasian/constrained optimization setup ignores the problem of knowledge. To them, that lack is a good reason to introduce the entrepreneur into their analysis and, as I would like to advance as a hypothesis, their narratives. Schumpeter argues that where knowledge is imperfect there is operating space for entrepreneurs. His entrepreneurs are innovators; they upset the economic equilibrium and set the economy in motion. In Kirzner’s interpretation, which Lavoie (1991) would elaborate later, the entrepreneurs are equilibrators; they perceive opportunities others do not perceive and by acting upon what they perceive they are instrumental in the adjustments of markets to an equilibrium position. Thus, Kirzner gives flesh and blood to Walras’s lifeless auctioneer.
In both scenarios, the entrepreneurial process, including the formation and communication of knowledge, remains in a black box. Both Schumpeter and Kirzner simply postulate the problem of knowledge, allude to idiosyncratic qualities of the entrepreneurs, and leave the process to the reader’s imagination.
Sam Wu (1989) explains the presence of entrepreneurs with the absence of contingency markets. Moral hazard and adverse selection account for the absence of markets for entrepreneurial services. Entrepreneurs, therefore, are dependent on ex post rewards in the form of profits. To reduce risk, they cooperate with each other, that is, they organize firms. Thus, Wu adds further insight into the entrepreneurial process. Among economists who have considered the process of decision making are Nelson and Winter (1982). The evolutionary approach that they propagate motivates them to think of the search for and selection of decision rules. Their research needs to be taken seriously, but it does not go far enough. We propose that economists step down from their analytical throne and find out what entrepreneurs actually do.
I start with the knowledge process. In a conventional neo-classical/neo-Walrasian account decisions follow algorithmic rules with the given of (subjective) preferences. The decision is the outcome of interplay between the circle and the square in the picture below (see Klamer 1988). The circle is the domain of the personal, the subjective. Feelings, morals, (religious) beliefs, and preferences (taste) belong here, at least in this conventional approach. These are the factors left out of the analysis of the decision process. The (scientific) interest is directed at the square, the domain of the logical, of all that can be analyzed in systematic (or scientific) manners. It is where analysis takes place—the deduction of propositions from well-specifies assumptions and axioms—as well as the (econometric) testing of the propositions with data.
But most of actual deliberations take place outside the box and the circle. Because of the uncertainties they face, people stick to rules and principles and, as McCloskey and I have argued, persuade themselves and others of actions to be undertaken. One quarter of GDP is persuasion, so we have calculated (Klamer and McCloskey 1994; see also Shleifer on the role of persuasion in the stock market, Mullainathan and Shleifer 2005). It may be even more than that. Persuasion involves appeals not only to logic and facts but also to emotions (pathos) and relies on the credibility and authority of the speaker (ethos). In the fuzzy area outside the box of logic and subjectivity, people use analogies and metaphors, tell stories and anecdotes, and do so in an endless interactions (or conversations as I prefer to say). “How much do you really want this?” “Even though you think you will not be able to afford this diamond ring, imagine what happiness it will bring you for the rest of your life? How meaningless this amount of money is if you consider your enjoyment.” The point is that decision making involves communication and persuasion and usually does not respect algorithmic rules as the conventional analysis stipulates. Acknowledgement of the rhetorical dimension of human activity gets us closer to the distinctive features of the character that we call the entrepreneur.
How to be in the fuzzy domain outside the box? That is the question. Pursue that question and you most likely have to relinquish the safe haven of the logic of choice toward thinking in terms of human actions and activities. What do people do? That is the opening question.
Much of what people do is a matter of routine. Going to the refrigerator, the store, or the office we do what we usually do, without giving it much, if any, thought. Ignorance prevails, but we have learned to cope with it. Habitually we respond to the signals that invade our organs, habitually ignoring most of them. When do activities cease to be habitual? Schumpeter sidesteps the question, even though he stresses the fact that entrepreneurs break routines. We do not have a good response either. One could say that action that can be described in “square” terms is routine. That makes any action based on calculation according to well-specified strategies (such as cost-benefit calculations) routine. But very few activities are likely to meet that standard. Much of what people do is a matter of mimesis: We follow examples—do what others do, or act by analogy—do what we did in an analogous situation. All this is part of a routine but cannot be captured in square terms only. In other words, routines follow rules, which can be conscious and tacit, individual and social.
The distinction between social and individual routine appears to be important when it comes to entrepreneurial behavior. Steve Jobs may habitually violate commonly held standards; the important point is that he does not do what others would do in a similar situation. He starts up a new firm when other “knowledgeable” persons advise him against it (in other words, he acts upon divergence in interpretation of the situation in the computer industry).
Why people break routines is an intriguing question. The promise of abnormal profit is elusive, as Sam Wu points out, a reward ex post. Schumpeter alludes to non-rational motives, among which the desire to acquire power, the excitement of conquering, and the joy to create. Personal motivations, however, become a less pressing issue once we recognize the discursive content as the dominant factor.