WEBVTT NOTE Catallactic Functions and Real Persons in 'Man, Economy, and State' and 'Human Action'. (Further) Elements for an Austrian Theory of the Firm 1 00:00:00.000 --> 00:00:04.840 I am honored and I feel privileged to be here at the Mises Institute for the Austrian Economics 2 00:00:04.840 --> 00:00:11.480 Research Conference 2013. It's my third time already and in many ways it feels like home. 3 00:00:11.480 --> 00:00:15.880 The Mises Institute and the Austrian School are more certainly my intellectual home. I 4 00:00:15.880 --> 00:00:20.960 would like to thank Dr. Salerno, the head of this event, and Dr. Herbiner, the chair 5 00:00:20.960 --> 00:00:25.080 of this panel, for giving me the opportunity to mismanage some presentation time for a 6 00:00:25.080 --> 00:00:40.080 and of course to all those who were not at immediate interface with me but of whom I know make this event and this beautiful institute possible. 7 00:00:40.080 --> 00:00:46.080 My talk today tackles the specific problem of what Mises calls the catalytic function. 8 00:00:46.080 --> 00:00:57.080 It's a co-authorship with a colleague of mine from Romania. Some Austrians live in Romania, too, in terms of economics. 9 00:00:57.080 --> 00:01:01.080 The paper can be said to discuss issues on the theory of the firm. 10 00:01:01.080 --> 00:01:10.080 As an aside, when my wife asked me what I would talk about at the conference and I told her, she said, well, it's obvious. 11 00:01:10.080 --> 00:01:39.080 The presentation will follow the now projected outline, after a brief session of question raising concerning the place of the theory of the firm in the general body of economic theory, 12 00:01:39.080 --> 00:01:49.080 At point one, I will briefly introduce the praxeological concept of catallactic functions and explain in what sense they are not one and the same with real persons at point two. 13 00:01:49.080 --> 00:01:59.080 At point three or four, out of which I will probably just manage to tackle point three, I will try to apply the concepts to two issues or problems. 14 00:01:59.080 --> 00:02:05.080 The creditors versus the stockholder problem and, if time permits, the fully borrowed entrepreneur problem. 15 00:02:05.080 --> 00:02:14.080 After all this I will conclude suggesting some possible lines of development in the theory of the firm, the Austrian type of it of course. 16 00:02:14.080 --> 00:02:20.080 The theory of the firm can be a very frustrating field especially for an Austrian economist. 17 00:02:20.080 --> 00:02:26.080 One can very easily get to the point of considering that there is no need for a theory of the firm at all. 18 00:02:26.080 --> 00:02:29.080 Two things can contribute to such a feeling. 19 00:02:29.080 --> 00:02:43.320 On the one hand, the field of the theory of the firm includes so many somewhat overlapping and somewhat contradictory paradigms and research programs that it is not at all very clear what the field purports to explain and conceptually describe. 20 00:02:43.320 --> 00:02:52.120 Thus, there are knowledge-based and resource-based approaches, transaction cost approaches, managerial property rights based or nexus of contact ones. 21 00:02:52.120 --> 00:03:00.920 and this is to name only a few, while leaving aside the more eccentric ones such as the organic view or the Marxist exploitation theory based view. 22 00:03:00.920 --> 00:03:14.920 In the midst of this firm theory jungle, to paraphrase Harold Koontz, one cannot stop feeling that the intuitive view underlying the common usage of the word firm has not gained a great deal in conceptual and theoretical clarity. 23 00:03:14.920 --> 00:03:20.320 On the other hand, when one turns to the Austrian paradigm, the situation is somewhat the opposite. 24 00:03:20.320 --> 00:03:25.320 Considerations on the firm as such are scarce in the works of the great masters. 25 00:03:25.320 --> 00:03:30.320 Even though Mises, for instance, uses the term firm more than 80 times in Human Action, for example, 26 00:03:30.320 --> 00:03:37.320 only in a handful of these instances is he treating topics pertaining to or relevant for the theory of the firm as such. 27 00:03:37.320 --> 00:03:42.320 And the understandable reason for this is that they simply had more important problems to solve, 28 00:03:42.320 --> 00:03:47.320 money or economic calculations, business cycles, method, methodology, so on and so forth. 29 00:03:47.320 --> 00:04:17.320 In such a situation, it is legitimate to flirt with the idea that maybe, maybe, it is possible to explain whatever a theory of the firm is supposed to explain by means of the already existing body of knowledge and concepts, such as entrepreneurship, uncertainty, economic calculation, capital, capital structure, so on and so forth, and that behind a firm concept nothing hides. Now this would be a drastic solution, but one must in all honesty have it on his intellectual radar for everything that one investigates. Nevertheless, it should not be 30 00:04:17.320 --> 00:04:23.000 to swiftly and easily embraced. If a frontal attack on the issue and the clear-cut exposition 31 00:04:23.000 --> 00:04:29.960 of the theory is not feasible or possible yet, maybe some side-kicks would help. What specific 32 00:04:29.960 --> 00:04:34.280 and important questions is the theory or the concept, no matter how poor or tentative in 33 00:04:34.280 --> 00:04:39.440 question answering? Or what specific problem is it solving? Of course, questions and problems 34 00:04:39.440 --> 00:04:44.000 of importance and which could not be answered otherwise. The mainstream theory of the firm, 35 00:04:44.000 --> 00:04:52.000 speaks, since Coase's 1937 article on the nature of the firm, of three questions that any theory of the firm has to answer. 36 00:04:52.000 --> 00:05:00.000 The nature, why the firms exist, the size, how big or small firms are and why, and the internal structure, how firms are organized and why. 37 00:05:00.000 --> 00:05:10.000 But within the Austrian paradigm, there are no standard questions, specifically raised by this paradigm, the answer of which to demand or imply an Austrian theory of the firm or concept. 38 00:05:10.000 --> 00:05:19.000 and the Cossian challenge one could against as an Austrian, again as an Austrian, answer in at least two ways. 39 00:05:19.000 --> 00:05:28.000 First, that the questions are interesting and legitimate and valid and that the Austrian paradigm provides important insights and then to immediately proceed to provide those insights. 40 00:05:28.000 --> 00:05:36.000 Or alternatively, one could blame the general implicit or explicit Cossian framework as being flawed and as raising false questions, 41 00:05:36.000 --> 00:05:43.000 The answer of which is not needed, or maybe it lies somewhere else, in other fields, like law for instance. 42 00:05:43.000 --> 00:05:54.000 In this paper we try to ask some Austrian questions, the answer to which might imply, might suggest an Austrian theory of the firm. 43 00:05:54.000 --> 00:05:59.000 And for instance, what is the difference between creditors and shareholders? 44 00:05:59.000 --> 00:06:02.000 Can there be an entrepreneur with fully borrowed capital? 45 00:06:02.000 --> 00:06:08.000 And I could think of a few others. What is profit and loss? What are foreign direct investments? 46 00:06:08.000 --> 00:06:12.000 Well, I don't know if this is specifically an Austrian question. But what is a bank? 47 00:06:12.000 --> 00:06:16.000 For instance, presumably the concept of a bank implies the concept of a firm. 48 00:06:16.000 --> 00:06:21.000 And of course, I'm hoping to find probably other questions. 49 00:06:21.000 --> 00:06:30.000 And actually recently I discovered that the firm might even be needed to clearly explain the money supply. 50 00:06:30.000 --> 00:06:36.360 But that's another issue. Before tackling the first two problems, let me briefly introduce 51 00:06:36.360 --> 00:06:42.760 the catalytic function concept. And I'll try to go as quickly as possible. Mises borrowed 52 00:06:42.760 --> 00:06:49.200 the term catalactics, according to his own confession, from Richard Wetley, a 19th century 53 00:06:49.200 --> 00:06:55.120 British economist. It means something like the theory of exchange in Latin. He then coined 54 00:06:55.120 --> 00:06:59.040 the derived concept of catalytic functions to analytically describe the possible economic 55 00:06:59.040 --> 00:07:29.040 Catallactic roles that individual can play or fulfil in the exchange economy. Thus, these functions are aspects or facets of human action and they comprise, in a more or less standard enumeration, the productive catalytic functions such as entrepreneur, capitalist, labourer or landowner, and the catalytic function of the consumer. As aspects of man's effort to better his lot in this world, they might also, and probably they also, exist in the crucial model of the isolated individual, but they are way less obvious or visible. 56 00:07:29.040 --> 00:07:44.040 To consider a development of the good contributions of the classical school, Mises developed his own brand of the so-called theory of distribution, which, following insights of forerunners such as Frank Fetter or John Bates Clarke, evolved into a genuine theory of factors of production pricing. 57 00:07:44.040 --> 00:07:54.040 Thus, each function designating a productive aspect of human action and effort is paired with a specific income share, which is one and the same with the price of that production factor. 58 00:07:54.040 --> 00:08:00.040 Profit, interest, wages or rents become functional incomes under the implied principle of one 59 00:08:00.040 --> 00:08:02.160 function receives one income. 60 00:08:02.160 --> 00:08:08.920 And of course, Mises nicely integrated this theory with his own theory of economic calculation, 61 00:08:08.920 --> 00:08:13.960 which kind of adds a great deal of value to it. 62 00:08:13.960 --> 00:08:16.200 But again, that's a separate topic. 63 00:08:16.200 --> 00:08:19.960 One can immediately notice that for Mises, catalytic functions are not one and the same 64 00:08:19.960 --> 00:08:24.400 with Real Persons or with the ideal types behind the similar terms employed in business 65 00:08:24.400 --> 00:08:25.400 history. 66 00:08:25.400 --> 00:08:29.200 Every real person necessarily cumulates catalectic functions. 67 00:08:29.200 --> 00:08:34.160 One could even argue that every person accumulates all catalectic functions, some being more 68 00:08:34.160 --> 00:08:36.120 pronounced or visible than others. 69 00:08:36.120 --> 00:08:40.440 An interesting consequence of this fact is that every personal income is necessarily 70 00:08:40.440 --> 00:08:41.440 composite. 71 00:08:41.440 --> 00:08:45.160 What we would call market interest rates, for instance, or market wage rates are actually 72 00:08:45.160 --> 00:08:50.920 Composite Incomes containing elements of wage, interest rent, profit loss, again, some part 73 00:08:50.920 --> 00:08:58.200 being more exacerbated, visible than others. I would have given the floor to Mises, I have 74 00:08:58.200 --> 00:09:09.200 some quotes, he already in socialism expresses these issues, but for better time management 75 00:09:09.200 --> 00:09:16.080 And hopefully I will only read this messy slide a little bit because here I have the 76 00:09:16.080 --> 00:09:20.080 occasion to mention the content of the functions which I have not already. 77 00:09:20.080 --> 00:09:25.220 So for Mises, entrepreneur means acting man in regard to the changes occurring in the 78 00:09:25.220 --> 00:09:27.220 data of the market. 79 00:09:27.220 --> 00:09:32.080 The key point or the key concept behind this is uncertainty, uncertainty bearing. 80 00:09:32.080 --> 00:09:37.520 Capitalist and landowner, Mises sees as acting man with regard to changes brought about by 81 00:09:37.520 --> 00:09:46.520 by the mere passing of time, given time preference and worker means many regard to employment of the factors of production, human labour, again given the disutility of labour. 82 00:09:48.520 --> 00:09:53.520 And then the respective incomes. 83 00:09:55.520 --> 00:10:03.520 As the term entrepreneur, capitalist, landowner, worker can refer both to economic functions and real persons or ideal types 84 00:10:03.520 --> 00:10:15.520 and this even in hypothetical examples or mental experiments as will be seen below the possibility of inconsistent usage and of confusion arises. 85 00:10:15.520 --> 00:10:30.520 Moreover, and this is an important part of our thesis in this paper, consistent usage might require, we think it requires, the concept of the business unit or firm and therefore a theory of the firm. 86 00:10:30.520 --> 00:10:40.520 In order to illustrate this assertion, let us proceed to a discussion of creditors and stockholders that Rothbard makes at one point in Chapter 6 in his Man Economy and State. 87 00:10:40.520 --> 00:10:54.520 Thus, in subchapter 9 of the said chapter, entitled Joint Stock Companies and the Producers' Loan Market, Rothbard asserts that essentially the role of the creditor is, from an economic point of view, equivalent to that of the shareholders. 88 00:10:54.520 --> 00:10:59.560 for Shareholders. He's doing this in the context of a number of subchapters dedicated to arguing 89 00:10:59.560 --> 00:11:05.320 against the Keynesian idea that there could be a hiatus between savings and investment, 90 00:11:05.320 --> 00:11:10.960 the first too many and the other too little, due to pessimistic animal spirits. Coextensive 91 00:11:10.960 --> 00:11:16.600 with this line of argument, which stands for an essential identity between savings and 92 00:11:16.600 --> 00:11:20.840 investments, is the idea that the loan market is not an independent driving force in itself, 93 00:11:20.840 --> 00:11:25.400 but just a part and not necessarily the most important one of the broader time market. 94 00:11:25.400 --> 00:11:27.680 Let us give the floor to Rothbard. 95 00:11:27.680 --> 00:11:32.260 He says things like the following, economically and even in basic law, there is no difference 96 00:11:32.260 --> 00:11:34.560 between shareholders and productive creditors. 97 00:11:34.560 --> 00:11:39.720 The differences between the two, I'm reading the red stuff, are only technical and semantic. 98 00:11:39.720 --> 00:11:43.840 And even in the real world of uncertainty and entrepreneurship, while matters are more 99 00:11:43.840 --> 00:11:48.960 complicated, the discussion or the analysis essentially remains the same. 100 00:11:48.960 --> 00:11:57.680 And he goes on and on like this in a few instances, expressing the same idea that the difference 101 00:11:57.680 --> 00:12:02.760 between investing in stock and lending money to firms is mainly a technical one, okay, 102 00:12:02.760 --> 00:12:06.240 and I will not more dwell upon it. 103 00:12:06.240 --> 00:12:13.280 Even Mises, and Rothbard of course, tries to conscript Mises into his line of argument, 104 00:12:13.280 --> 00:12:16.440 says something similar in some places in Human Action. 105 00:12:16.440 --> 00:12:24.540 I chose two quotes, one which is a weaker thesis and the second one a stronger thesis. 106 00:12:24.540 --> 00:12:29.720 So Mises says something of the sort, the creditor is always a virtual partner of the debtor or 107 00:12:29.720 --> 00:12:33.320 a virtual owner of the pledged and mortgage property. 108 00:12:33.320 --> 00:12:38.960 But then he says something even stronger as a thesis, the creditor is less exposed to 109 00:12:38.960 --> 00:12:44.160 loss and failure than the debtor, only in so far as this legal and institutional framework 110 00:12:44.160 --> 00:12:48.320 makes it possible for him to enforce his claims against refractory debtors. 111 00:12:48.320 --> 00:12:51.600 And maybe I should have read it also the other part. 112 00:12:51.600 --> 00:12:55.840 There is, however, no need for economics to enter into a detailed scrutiny 113 00:12:55.840 --> 00:12:59.360 of the legal aspects involved in bonds and debentures, so on and so forth. 114 00:12:59.360 --> 00:13:05.720 So the stockholder creditor distinction is not one of interest for economic theory. 115 00:13:05.720 --> 00:13:11.360 The above sounds somewhat counterintuitive, 116 00:13:11.360 --> 00:13:17.760 because then I would look at the stockholder and the creditor represented there by the bondholder 117 00:13:17.760 --> 00:13:22.560 from the point of view of various strands of theory and I just can make no difference, no 118 00:13:23.840 --> 00:13:29.120 essential difference between them and it's puzzling in a sense, it's counter-intuitive, 119 00:13:29.120 --> 00:13:35.760 so they both wait, they both bear uncertainty, they both employ monetary calculation, so on and so 120 00:13:35.760 --> 00:13:42.840 and so forth. So I can find no theoretical difference. Is there any relevant theoretical 121 00:13:42.840 --> 00:13:49.680 difference between the two in the end? Because I think at the intuitive answer of my wife. 122 00:13:49.680 --> 00:13:57.360 Of course there is a difference. So maybe there is some substance there or maybe not. 123 00:13:57.360 --> 00:14:07.320 So, if creditors, if I take the assertion at face value, problems might appear. 124 00:14:07.320 --> 00:14:12.280 If creditors are the equivalent of capitalists and shareholders of the entrepreneurs, then 125 00:14:12.280 --> 00:14:16.560 it follows that capitalists are equivalent in all respects to entrepreneurs. 126 00:14:16.560 --> 00:14:21.920 If this is contemplated and analyzed in terms of catalytic functions, it is problematic, 127 00:14:21.920 --> 00:14:24.240 as it equates two distinct functions. 128 00:14:24.240 --> 00:14:29.540 If it is contemplated in terms of real persons, it is not necessarily wrong, but it's somewhat 129 00:14:29.540 --> 00:14:31.680 fuzzy and can be misleading. 130 00:14:31.680 --> 00:14:37.920 We argue that the thesis is correct from an aggregate or, if I may say so, macro perspective. 131 00:14:37.920 --> 00:14:42.720 Yes, there is no capital surplus over possible entrepreneurial project. 132 00:14:42.720 --> 00:14:47.920 Yes, there are no savings that cannot be channeled into profitable investment on the free market. 133 00:14:47.920 --> 00:14:52.520 And yes, in an important sense, all capitalists are entrepreneurs and all entrepreneurs are 134 00:14:52.520 --> 00:14:53.740 also capitalists. 135 00:14:53.740 --> 00:15:05.460 But if we zoom into the microsphere, the creditor-sharehold-equivalence thesis is problematic. 136 00:15:05.460 --> 00:15:10.460 We suggest that to make sense of this relation, one needs a concept of the business unit, 137 00:15:10.460 --> 00:15:14.700 or firm, such that the stockholders are considered to be inside the firm, while the creditors 138 00:15:14.700 --> 00:15:17.760 as such are considered to be outside the firm. 139 00:15:17.760 --> 00:15:21.260 Of course, while the latter could very well be considered to be inside their own business 140 00:15:21.260 --> 00:15:22.860 unit, the bank, let's say. 141 00:15:22.860 --> 00:15:28.940 One very important, in our opinion, difference, and it's an economic difference between creditors 142 00:15:28.940 --> 00:15:35.420 and stockholders, is that the latter are the ones to incur first any losses. Or, to put 143 00:15:35.420 --> 00:15:42.500 it otherwise, there is a non-zero level of losses by which the shareholders are hit, 144 00:15:42.500 --> 00:15:47.140 but creditors are not, as they can be repaid more or less swiftly from the capital of the 145 00:15:47.140 --> 00:15:52.140 first. And this proves, in an important sense, that they are in different businesses. Thus, 146 00:15:52.140 --> 00:16:04.140 A person can accumulate catalytic functions in more ways than one. First, in his own firm, or simply as a private person, one is entrepreneur, capitalist, and maybe other things, self-employed and landowner. 147 00:16:04.140 --> 00:16:14.140 In addition to that, one can be only a capitalist, functionally, with respect to a particular firm business unit that, of course, is not, therefore, his own. 148 00:16:14.140 --> 00:16:29.900 To conclude, all capitalists are entrepreneurs and all entrepreneurs are capitalists, but 149 00:16:29.900 --> 00:16:34.900 not necessarily with respect to the same business unit. Entrepreneurs, who are also necessarily 150 00:16:34.900 --> 00:16:39.700 capitalists with respect to their own firm, bear specific uncertainty, associated to a 151 00:16:39.700 --> 00:16:48.700 The specific particular business project. Thus, taking again the example of a credit relationship between a bank and a widget producing firm, we can describe the situation as follows. 152 00:16:48.700 --> 00:16:56.700 The bank bears the uncertainty of that particular operation of money lending and as a bank of money lending in general. Let's call it uncertainty one. 153 00:16:56.700 --> 00:17:05.700 The firm bears the uncertainty of widget production. Let's call it uncertainty two. Uncertainty one and uncertainty two are connected, but they are not identical. 154 00:17:05.700 --> 00:17:18.700 Again, the widget firm might have a loss, while the bank at the same time might have a profit, maybe even from the very loan to that particular firm, if the creditor has wisely assessed the collateral pledged by the debtor or his equity in general. 155 00:17:19.700 --> 00:17:34.700 Thus, on the one hand, the bank's shareholders are entrepreneurs and capitalists, at least with respect to the banking business unit, but only capitalists with respect to the widget producing firm. 156 00:17:34.700 --> 00:17:42.700 On the other hand, the widget-producing firm's shareholders are entrepreneurs and capitalists with respect to the widget-producing business unit. 157 00:17:42.700 --> 00:17:45.700 They are just debtors with respect to the bank. 158 00:17:45.700 --> 00:17:48.700 Just might be a grave thing. 159 00:17:48.700 --> 00:17:58.700 Thus, in our judgment, the creditor-shelholder distinction implies both equity-debt distinction and the idea of a business unit. 160 00:17:58.700 --> 00:18:03.060 The task of the theory of the firm in explaining the nature of the firm becomes one of describing 161 00:18:03.060 --> 00:18:08.460 the role of the persons who fulfill the entrepreneurial function, those who incur the first losses, 162 00:18:08.460 --> 00:18:13.540 with regard to a stock of capital goods brought together by those very same persons in what 163 00:18:13.540 --> 00:18:15.780 thereby becomes a business unit. 164 00:18:15.780 --> 00:18:21.840 At the end of it all, and with this I conclude, we find in the middle of a framework suggested 165 00:18:21.840 --> 00:18:29.160 and developed in recent past works by Professor Salerno, Professor Klein and Professor Foss. 166 00:18:29.160 --> 00:18:34.720 As for possible practical implications of an Austrian entrepreneurial theory of the firm, 167 00:18:34.720 --> 00:18:39.120 which is at the same time truly praxeological, let me briefly suggest but two. 168 00:18:39.120 --> 00:18:43.560 First, for business practice or corporate governance consultancy, it becomes relevant 169 00:18:43.560 --> 00:18:44.560 to check the following. 170 00:18:44.560 --> 00:18:49.840 To what extent decision-making in the business unit resides or is directly and strongly connected 171 00:18:49.840 --> 00:18:53.040 with the persons who fulfill the entrepreneurial function. 172 00:18:53.040 --> 00:18:58.160 Along this line, one could speak of badly structured versus well-structured firms. 173 00:18:58.160 --> 00:19:04.080 Of course, this would be a judgment or an interpretation of an actual situation based on theory, with all its perils. 174 00:19:04.080 --> 00:19:12.880 Second, for policy purposes, the theoretical framework suggested could be used to engage in a critic of positive legislation, for instance, 175 00:19:12.880 --> 00:19:19.520 namely to see whether corporate and business law in general unleashes or hampers the expression through action. 176 00:19:19.520 --> 00:19:24.160 Of course, of those who fulfill the entrepreneurial function in a business unit, and one could 177 00:19:24.160 --> 00:19:27.760 distinguish between good and bad business law. 178 00:19:27.760 --> 00:19:31.320 In the hope that the above made some sense, I thank you.