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I am sympathetic to Professor Horwitz's shrewd observation that:

"The desire for stability and predictability has been the calling card of dirigisme regimes since the dawn of capitalism"

but would object to his characterization of the market as

"enabl[ing] us to peer through the fog of uncertainty that surrounds human action. Prices provide signals for capitalists to interpret to try to provide the goods and services people will want in the future. Profits tell them they've done well at it, losses tell them they haven't."

It is my contention that a market with free prices would simply be unbearable. And you don't need to consult the heterodox literature to see this point. What is Coase's basic message: The price system operates between firms and not between market exchanges. But these prices are carefully controlled so as to avoid opportumism and permit scope for the possibility of vertical integration if the circumstances permit. But these prices are not really free in the sense that they are subject to wild fluctuation (which is what profit and loss requires, does it not?). These prices are fixed in contracts both in inter and intra-firm relations.

To give an example (which is going to be taken from Hugh Townshend's 1937 paper): Free market prices do not react to supply and demand conditions in the standard sense but instead reflect individuals' daily "psychological revaluations of existing assets" (Townshend 1937, p. 162). Market forces will, of course, have some impact on the processes of investment and production, and the utilization of resources in these areas will influence in some respect the vector of relative prices; but it is obvious that the physical effects of production and investment will never be able to keep up with the movement of prices generated by the "purely mental" impact of economic expectations on investment activity. The actual course of money-prices become in this scheme entirely indeterminate, and can, in principle, move up or down without limit in the absence of certain self-imposed constraints. Hence the need for the Firm a la Coase and Williamson (in my own PK interpretation).

Now Austrians do not see the price system in this way, and this has resulted in several errors on their part. Take economic calculation. I would argue that economic calculation cannot exist in a *perfectly* free market economy because in the absence of fixed price contracts, entrepreneurs would lose all ability to control costs by limiting their liabilities. To quote Paul Davidson, it would become almost impossible to calculate the "future marginal costs associated with varying production flows" (Davidson, 1987, p. 151), and entrepreneurs, as a result, would be prevented from discovering Kirzner's theory of "unexploited opportunities."

Now none of this is new. If Austrians read seriously the work of NIE, Transaction cost economics, and Post Keynesian economics, they would be able to synthesize all of these different elements and update the Hayekian research program. Are we really going to be quoting from Hayek's 1945 essay forever???

What do people think of the ARISE scheme "Automatic Reorganization of Insolvent Systemically-important Enterprises" proposed by one of our local egg heads who is a consultant to our Federal government on deregulation.
http://clubtroppo.com.au/2008/09/22/arise/

He gave a good talk to the Centre for Independent Studies on the travails of deregulation, and he described sculling as the ideal sport for deregulators because it involve looking in the opposite direction to the way you are heading.

I counted Dr Gruen as a friend until last night when he described my contribution to the debate (taking my cue off this blog) as one of the silliest and emptiest blog posts he has seen.

See comment no 9.

http://clubtroppo.com.au/2008/09/22/the-death-of-the-free-market/

Matt wrote:

"Take economic calculation. I would argue that economic calculation cannot exist in a *perfectly* free market economy because in the absence of fixed price contracts, entrepreneurs would lose all ability to control costs by limiting their liabilities."

Who says fixed price contracts are antithetical to a free market economy? Once again Matt, you are confusing the world of neoclassical theory with the vision of the market adopted by the Austrians. Fixed price contracts are exactly one way that competitors deal with uncertainty, which is exactly what Austrians would expect in a free market.

If you want to criticize Austrians, please don't confuse their vision with that of neoclassical theory.

I am probably the least fit intellectually or academically to comment on this blog, but Matt Mueller's comments drew me away from my People Magazine. As I read S. Horwtiz's general comments about the importance of price signals, I never once assumed he imagined a market without firms. I don't think every blog comment requires these types of qualifications among readers who share similar assumptions.

When an entrepreneur becomes a rich capitalist having made a success, he tends to change from a hungry and customer-caring innovator to a protective and defensive stability seeker. The free market should be a fair playing ground for everyone. But if I have to take a side, I would make the market better for entrepreneurs.

Dr. Horwitz,

A fine point, and one that you have raised before (my apologies for raising old criticisms). You are right. Prices, for the Austrians, send signals, but imperfect signals. The market does not require perfection for it to be considered truly free. I like all this very much. For those reading, please see Esteban Thomsen "Prices and Knowledge" (and my review of it on amazon) for the best account of the Austrian take on price theory.

But once this point is acknowledged and accepted, I see another problem with the Austrian theory of entrepreneurship. Remember that imperfect price signals are only serviceable to the extent that entrepreneurs can compete in a sufficiently competitive environment. The theory of the entrepreneur is what holds together the entire corpus of Austrian economics. Without the entrepeneur, the Austrians would be in bad shape.

But what have the Austrians done with this theory. Well, as Karen Vaughn notes in her Review of Political Economy article, the Austrian theory of entrepreneurship has not changed one bit since 1973 (it's true!). Basically, the theory states that entrepreneurs will discover profit opportunities through alertness. *Alertness*. That is all we have, and that is even more vague than Coase's theory of the firm. It is a tautology. We need to do what Williamson did with Transaction Cost economics and operationalize it. I have given some thought to this and think that it can be done. But as it now stands, the Austrian theory of entrepreneurship is terribly vague. But Kirzner was onto something just like Coase was. We just need to put it into action!

Matt,

You say that "Without the entrepeneur, the Austrians would be in bad shape." But without the entrepreneur, economics would be in bad shape. Even given this, the Austrians have a lot more to say than simpler focusing on the entrepreneur. What about business cycle theory, And economic calculation doesn't just focus on entrepreneurs as being alert.

Also, the theory isn't vague. It is well developed. Perhaps you should go back and read Competition and Entrepreneurship.

Nick

Matthew,
"Remember that imperfect price signals are only serviceable to the extent that entrepreneurs can compete in a sufficiently competitive environment."

I'm not sure if I'm interpreting you correctly, but I disagree with this statement. Even monopolistic prices convey something. Would-be competitors to the monopolist glean extremely valuable information from prices (and quantities of the good or service sold, of course). ANY price is valuable. In this sense, newly-emerging markets can be more risky than established ones, because the knowledge revealed by prices isn't there. I'd count this knowledge as a not-insignificant public good.

However, even in new markets with no existing firms (a hard thing to define; are snowboards in the same market as snow skis, for example?), prices are invaluable. The reason for this is of course because all firms are still competing for scarce resources that could be used in other, perhaps totally unrelated, markets. To be honest, I can't imagine a market so far-removed from some form of competition that existing prices aren't invaluable.

Obviously the entrepreneur can have it easy if his product offering is a direct replacement for an existing product. He has all the knowledge conveyed by prices, and his job is a purely technical one: make product X for less than the competitors. More commonly however, he cannot simply replicate an existing product more cheaply than the competition (as this is often more difficult than guessing demand). He must instead search for an unfilled niche and guesstimate the market's demand by looking at other (hopefully similar) prices and volumes.

I apologize if I'm misinterpreting anything you've written - sometimes its hard to remember how the semantics of economics differ from business.

I'm also not a professional economist, but I never saw the Austrian theory of the entrepreneur as being vague (certainly not as vague as Coase's theory of the firm). Could you elaborate?

Perhaps the system that has come closest to fixed price contracts was "real existing socialism" (i.e., empirical market socialism by any other name, incl. central planning).

Lange's pure theory of market socialism, too.

I would add, Matt, that the theory of the entrepreneur HAS been expanded upon since 1973. Specifically, David Harper's work and his *Foundations of Entrepreneurship and Economic Development*. Randy Holcombe's *Entrepreneurship and Economic Progress* is also worth a look. And let us not forget our own Fred Sautet's *Entrepreneurial Theory of the Firm*. All of these have been published in the last decade, in addition to a smattering of journal articles.

How about providing a specific and clear -- even if very brief -- application of Horwitz's First Law?

Exactly whom are the "capitalists" in your theory? How do you define them, where do you find them? If you really mean "entrepreneurs," then I have all the same questions, up and down, as I do for the "capitalists" in the First Law.

I mean, take a look at AIG. Precisely whom are the capitalists in this extremely important case? Whom are the capitalists that have actually sought the Treasury's bailout?

The Board of Directors are to be ousted by the Treasury. Are you speaking of them? What was the percent of their shareholdings?

The shareholders did not have a vote -- a right that was suddenly thrown away -- in this bailout. Are you speaking of them as the capitalists?

Institutional shareholders -- such as CV Starr Co. (does that sound familiar, anybody?) -- are you speaking of them as the capitalists?

While I do believe that capitalists hate competition, and they will often try to use state power to influence their place in the market, and while that disturbs me a great, great deal, I'd like to know whom, in this grand AIG case, you can identify as the most relevant and clear application of your First Law.

I'm being sincere, and I'd like to know, inasmuch as you can provide any specifics (or at least definitions and expectations) as to whom you would apply your First Law in the grand AIG case.

Steve, after responding to my previous questions, can you also consider the following questions?

Are you making the totalistic claim that the typical "capitalist hates" capitalism? It seems that way. I say it's most generally only a marginal "hate" (whatever), not a rejection.

And is it really a hate (whatever) at all? Maybe I myself spoke too soon at the end of my last reply. Maybe it only appears as "hate" (whatever) when we confuse marginal with all-or-nothing analysis. Your First Law, it seems to me, might be interpreted in a way that sees any given "capitalist's" likely potential for an all or nothing "hate."

So others might get a taste of my point, consider Boettke & Prychitko's preface to a textbook:

"We like economics, but we *love* our families, although it might not always appear that way at the margin."

I'm not sure "capitalists" generally "hate" capitalism when they compete -- compete even fiercely -- in markets, although it might not always appear that way at the margin.

Horwitz's First Law is not meant to be a totalistic one. It's also deliberately overstated in order to provoke conversation, especially among students. And of course you're right Dave that all decisions, including "hate", are on the margin. That's certainly true of what capitalists think of capitalism. As I once wrote ("The Costs of Inflation Revisited" - RAE 2003):

"In his well-known article on the theory of the firm, Coase (1937) argued that the choice between markets and firms as coordination processes will depend on the relative costs of each. If market costs (such as negotiating and monitoring contracts) are less than firm costs (administration and bureaucracy), then the market will be chosen, and vice versa. We can extend that framework to the choice between markets and politics as means for individuals to enhance their wealth. From the individual’s perspective either process holds the promise of enhancing his wealth. Which process any given individual will make use of will depend on the costs of using each. Because inflation disrupts the reliability of market prices in the ways discussed above, it raises the relative cost of using the market to acquire wealth, and will induce wealth-seekers on the margin to switch to the political process."

In essence that's all Horwitz's First Law says, minus the provocative formulation. The owners of the means of production will create every opportunity they can, or take advantage of existing ones, to use the political process to transfer resources.

And now I must get back to work, as Aunty Deirdre is coming to visit today and I have a nice long to-do list to tackle.

Matt Mueller writes: "Basically, the theory states that entrepreneurs will discover profit opportunities through alertness. *Alertness*. That is all we have, and that is even more vague than Coase's theory of the firm. It is a tautology. We need to do what Williamson did with Transaction Cost economics and operationalize it. I have given some thought to this and think that it can be done. But as it now stands, the Austrian theory of entrepreneurship is terribly vague. But Kirzner was onto something just like Coase was. We just need to put it into action!"

Steve has already mentioned recent Austrian work by David Harper, Randy Holcombe, and Fred Sautet that attempts to develop the Kirznerian metaphor of entrepreneurial discovery. I would add that there is a healthy and robust literature in entrepreneurship that is self-consciously Kirznerian, seeing its mission as the operationalization of Kirznerian alertness (for instance, by analyzing the characteristics of particularly "alert" individuals or by describing, in more general terms, the cognitive aspects of discovery). Examples include Scott Shane's "individual-opportunity nexus" (see his 2003 book), Saras Sarasvathy's "effectuation" model, Jeff McMullen's work on venturing, and many others.

For a flavor of this literature, note this passage in a 2001 review article by Gaglio and Katz:

"Almost all of the initial empirical investigations of alertness have focused on the means by which an individual might literally “notice without search.” For example, Kaish and Gilad (1991) interpret this as having an aptitude to position oneself in the flow of information so that the probability of encountering opportunities without a deliberate search for a specific opportunity is maximized. Therefore, in their operational measures of alertness, they asked founders to recall: (a) the amount of time and effort exerted in generating an information flow; (b) the selection of information sources for generating an information flow; and (c) the cues inherent in information that signal the presence of an opportunity. From this data the authors deduced: (d) the quantity of information in the flow and (e) the breadth and diversity of information in the flow.

"Their results conform to expectations in some ways but also reveal some unexpected patterns. Compared to the sample of corporate executives, the sample of new venture founders do appear to spend more time generating an information flow and do seem more likely to use unconventional sources of information. Interestingly, the founders do seem more attentive to risk cues rather than to market potential cues. However, the data also reveal that only inexperienced or unsuccessful founders engage in such intense information collection efforts. Successful founders actually behave more like the sample of corporate executives. Cooper et al. (1995) found a similar pattern of results in their survey of 1100 firms although Busenitz (1996), in an altered replication of Kaish and Gilad's survey, did not. Indeed Busenitz found few significant differences between corporate managers and new venture founders. In addition, validity checks of the survey measures yielded low reliability scores, which led the author to conclude that future research in alertness required improved theoretical and operational precision."

I argue in the paper below that this applied literature rests on a fundamental misunderstanding of Kirzner's analytical device of the entrepreneur. Still, one can hardly argue that no one has attempted to add substance to or elaborate upon the concept.

http://ssrn.com/abstract=1141549

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