The longstanding debate on the exact theoretical role and nature of the entrepreneur has traditionally featured the works of three great economists, Joseph Schumpeter, Frank Knight and Israel Kirzner. Each had a somewhat different take on this question, but each of them shared the common assumption that the entrepreneurial function exists as an independent and objective input into the productive order. However, this assumption was vigorously called into question in a little noticed but very important piece by Harold Demsetz in 1983. Demsetz may be said to have “unbundled” the other writers entrepreneurial packages and could find substantially nothing therein that was not already accounted for in the standard neoclassical market model, with investors being rewarded for taking risk under conditions of uncertainty. He comes very close to denying that there even exists a separate entrepreneurial function in the production process. This paper then proceeds to argue that Demsetz has overstated his case and that there is a distinctive aspect to entrepreneurship that has not heretofore been noted in the literature. That is the idea of “the idea”, the original cognitive formulation of a plan, a new business, an invention, a reorganization or any other new concept. The problem in understanding the role of the entrepreneur is one of intellectual property, since, at the moment of idea formulation, there is no practical way to give property right protection to an abstract idea. A comparison to the patent and the copyright system elucidates this point. The only practicable method of protecting the inherent value of a new non patentable or non-copyrightable idea is by joining it with another input which can receive property right protection, such as any of the traditional production inputs. This explains the common confounding between entrepreneurship and starting a new firm. Because of the team production nature of the venture, it is impossible to measure the marginal contribution of each of the constituent elements, thus explaining why a lot of entrepreneurial ventures are “one-man” firms. The matter of compensating for entrepreneurial services in publicly held corporations is also considered.
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Knight did have a concept of entrepreneurial “judgment,” which might be seen as a parallel concept to Kirzner’s alertness. However, he did not make this central to his theoretical development.
It was perhaps intended to be something like Dante’s Inferno, a frightful warning to evil doers, or, in Schumpeter’s case, to those who would seek to interfere with innovation and progress. But in this connection it is well to keep in mind Demsetz’ warning that the classical economists were only trying to explain how a decentralized system would work to allocate resources to their most efficient use. They were not trying to explain more than that, and a great deal of criticism of their work simply misses this point. See Demsetz and Ronen (2011) for a more recent use of this distinction, this time addressing market criticism based on trransaction-costs arguments..
Not all the issues, since he did not address the compensation issue mentioned in the text nor did he discuss the nature of “profits”.
“Entrepreneurship was neglected because the problems of economic change would simply have made it more difficult to focus on the coordination problem.” (Demsetz 1983: 274). This bifurcation of concerns might also help us understand the organization of Knight’s classic Risk, Uncertainty and Profit, the first part of which is a description of the perfect competition model. Still, as a justification for the classical writers’ not paying more attention to change, this is fairly weak gruel. Baumol similarly blames modern theory of the firm for the absence of entrepreneurial studies, since the classic formulation of this theory implied a static model with no room for change. (Baumol 2000: 14–15)
This powerful criticism applies as well to many other theories of the entrepreneur. See, Klein (2008).
One is reminded of the profound lesson of the great golfer, Gary Player, who pointed out that “the more I practice, the luckier I get.” Tyler Cowen (2003) also belittles Kirzner’s “costless” alertness while offering a “poetic” version of the entrepreneur as being similar to Kant’s aesthetic genius, less different from Kirzner’s entrepreneur than might first appear.
“But even if this pure component is the more important source of economic progress, it is, in a sense, beyond the scope of scientific analysis.” Demsetz (1983:278)
Though he would probably say that he was only critiquing Kirzner here and not adducing a new theory. Be that as it may, he does not notice the obvious property-rights relevance of what he says.
We could add trade secret to this mix, but just considering patent and copyright simplifies the analysis, especially since the trade secret mode of protection is not generally considered to exist by virtue of the political system.
Consider, as an example, the normal practice of business firms to send back unopened or at least unconsidered any suggestion for a new product or other innovation. This is done regularly to protect against subsequent law suits claiming prior property rights in something the company was already considering in any event. Or the recipient might require the submitter to agree to whatever compensation, if any, the recipient decided upon.
The analogy here to the common law of property rights in wild animals is instructive. There, the animals are considered common property until one is physically possessed by the hunter. At that point he owns it. (Pierson v. Post, 3 Cai. 175 N.Y. Sup Ct. 1805)
Klimis and Wallis (2009), among others, examine whether existing patent or copyright institutions in fact encourage the production of ideas that fall under their protection.
Most current literature is, however, concerned with the “growth” issue, normally in the context of discussions of underdeveloped economies, such as Baumol et al. (2007)
Baumol, Litan and Schramm (2007:3)
Alchian and Demsetz, Production, Information Costs, and Economic Organization, American Economic Review 62, p. 777 (1972)
Coase, The Nature of the Firm, Economica 4, p.386 (1937).
Though one could easily find circumstances in which the idea of a coming up with a new idea itself is contracted for, for example by a contract to invent or do research. That in turn would take the invention or research finding idea out of the realm of the entrepreneurial and into the realm of a particular kind of labor service with an ascertainable market price. That feature alone distinguishes the entrepreneurial from the merely inventive and distinguishes between the notion of an idea as a separate input and knowledge which can be purchased in the marketplace.
That implicates a role for psychology, education and culture in a full blown theory, but the present effort is merely to resurrect the economic concept of the entrepreneur as a useful and practical one.
See Schumpeter (1943) pt. 2 ch 12,14.
But whether we focus on Knight’s “optimism” or Kirzner’s “alertness,” or even Demsetz’ “luck”, the question of how to compensate for this function will remain
For a greater elaboration of this point, see Manne (2011). Note the logical fit with the point implied above in the text that the entrepreneur is “selling” his idea, exactly what needs to be accomplished in the large corporation setting but which current laws on insider trading prohibit.
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Manne, H.G. Resurrecting the ghostly entrepreneur. Rev Austrian Econ 27, 249–258 (2014). https://doi.org/10.1007/s11138-014-0254-z
- Intellectual property
- Team production
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