WEBVTT NOTE Entrepreneurship and Austrian Business Cycle Theory 1 00:00:00.000 --> 00:00:04.000 Hello. I'd just like to start saying I'm glad to be back here at the Mises Institute. 2 00:00:04.000 --> 00:00:06.500 It's been a number of years, and I really appreciate the opportunity. 3 00:00:06.500 --> 00:00:12.500 It's great to be here. Thanks to everyone in attendance and to the supporters of the Mises Institute as well. 4 00:00:12.500 --> 00:00:18.200 Our paper is on Austrian business cycle theory, entrepreneurship and Austrian business cycle theory. 5 00:00:18.200 --> 00:00:24.800 So we're looking at the intersection of two major strands in the Austrian economics literature. 6 00:00:24.800 --> 00:00:30.640 The basic problem that we're looking to investigate, Austrian economics has extensive literatures 7 00:00:30.640 --> 00:00:37.640 developed on both the theories of entrepreneurship, Mises, Hayek, Kirzner, Schumpeter to the extent 8 00:00:37.640 --> 00:00:41.800 that he's an Austrian, and as well on business cycle theory, Tim got into a little bit in 9 00:00:41.800 --> 00:00:47.600 his paper, but I'm sure we're all familiar with the basics of both of those areas of 10 00:00:47.600 --> 00:00:50.400 research in Austrian economics. 11 00:00:50.400 --> 00:00:56.120 There's not a lot of very explicit treatment of the specific roles and actions that entrepreneurs 12 00:00:56.120 --> 00:01:00.120 necessarily take at each stage in the business cycle. 13 00:01:00.120 --> 00:01:04.760 So we do see it mentioned in some more or less detail, sometimes more just in passing 14 00:01:04.760 --> 00:01:07.600 as in Hayek. 15 00:01:07.600 --> 00:01:12.360 But to develop that more specifically, and our basic question is, can we really gain 16 00:01:12.360 --> 00:01:17.320 new insights into Austrian business cycle theory by focusing directly on the concrete 17 00:01:17.320 --> 00:01:24.520 actions that entrepreneurs take at each stage in the cycle. 18 00:01:24.520 --> 00:01:29.640 We start with Menger, one of the founding fathers of Austrian School, obviously, who 19 00:01:29.640 --> 00:01:36.280 writes entrepreneurial activity includes a, obtaining information about the economic situation, 20 00:01:36.280 --> 00:01:42.200 b, calculation, all the various computations that must be made, c, an act of will by which 21 00:01:42.200 --> 00:01:47.160 which goods of higher order are organized, are assigned to production processes, and 22 00:01:47.160 --> 00:01:49.400 finally D, the supervision. 23 00:01:49.400 --> 00:01:56.340 So I outline these, A, B, C, and D, A being perceiving, which we see most characterized 24 00:01:56.340 --> 00:01:59.480 in the opportunity discovery literature. 25 00:01:59.480 --> 00:02:02.860 We also see this mentioned in Mises as well, of course, all of these are throughout the 26 00:02:02.860 --> 00:02:07.840 different strands of Austrian entrepreneurship literature, calculations, so we have profits 27 00:02:07.840 --> 00:02:14.120 and Losses, the basic arguments all around economic calculation. C is Acting. Of course, 28 00:02:14.120 --> 00:02:17.800 entrepreneurs must control real resources in order to do this, something we see much 29 00:02:17.800 --> 00:02:23.300 more from the Misesian tradition of entrepreneurship in Austrian economics. And then, Judgment 30 00:02:23.300 --> 00:02:28.240 under Uncertainty from Knight and others. The last one, D, is one we don't see often 31 00:02:28.240 --> 00:02:33.840 emphasized explicitly, but I feel is important. It really speaks to the Austrian emphasis 32 00:02:33.840 --> 00:02:38.000 on Processes Occurring Over Time in Markets Through Entrepreneurial Action 33 00:02:38.000 --> 00:02:44.920 here, that all three A, B and C are continuously revised and updated and occur over time in 34 00:02:44.920 --> 00:02:50.040 a production process. 35 00:02:50.040 --> 00:02:55.080 We classify in the paper three basic approaches in the Austrian entrepreneurship literature. 36 00:02:55.080 --> 00:02:59.760 The first one starting from Boehm-Bawerk, Knight, Mises and Rothbard. 37 00:02:59.760 --> 00:03:06.880 This is the judgment under uncertainty paradigm where entrepreneurs must control real resources 38 00:03:06.880 --> 00:03:12.080 and take their own risks of profit and losses actually acting through the production process. 39 00:03:12.080 --> 00:03:17.040 The second coming first originally from Wieser, somewhat from Hayek and really exemplified 40 00:03:17.040 --> 00:03:24.200 in Kirzner where the entrepreneur is a pure opportunity discoverer, is alert to opportunities 41 00:03:24.200 --> 00:03:27.020 but doesn't necessarily have to control any resources 42 00:03:27.020 --> 00:03:31.640 or actually execute the investment and production plans 43 00:03:31.640 --> 00:03:34.880 that need to be undertaken to exploit that opportunity. 44 00:03:34.880 --> 00:03:37.020 And lastly, Schumpeter, again, to the degree 45 00:03:37.020 --> 00:03:39.000 that his theory is really Austrian, 46 00:03:39.000 --> 00:03:41.000 I liked what Samuel Bostaff had to say a lot 47 00:03:41.000 --> 00:03:43.400 about what Schumpeter was writing the other day, 48 00:03:44.340 --> 00:03:46.520 which is exemplified in creative destruction. 49 00:03:46.520 --> 00:03:48.700 The entrepreneur is a disequilibrator, 50 00:03:48.700 --> 00:03:50.080 taking the economy from one 51 00:03:50.080 --> 00:03:53.200 Valerian equilibrium to another. 52 00:03:53.200 --> 00:03:59.920 One connection that we do see in Schumpeter's entrepreneurship theories is the almost dependence 53 00:03:59.920 --> 00:04:03.600 on credit creation. So there's a connection here to Austrian Business Cycle Theory already 54 00:04:04.480 --> 00:04:11.680 that in order to bid real resources away from other users, entrepreneurs depend on some form 55 00:04:11.680 --> 00:04:16.720 of new credit entering the economy in order to actually execute their new innovative production 56 00:04:16.720 --> 00:04:26.000 Plans. My professor and co-author, of course, favors the first approach, so I strongly agree 57 00:04:26.000 --> 00:04:40.000 with him. Next, moving on to the basic outlines of Austrian business cycle theory, we have 58 00:04:40.000 --> 00:04:44.720 three phases, the initial being the boom, where entrepreneurs are really the active 59 00:04:44.720 --> 00:04:45.720 of Agents. 60 00:04:45.720 --> 00:04:48.560 None of these phases happen on their own. 61 00:04:48.560 --> 00:04:52.800 The central bank could print as much money as it wanted if entrepreneurs aren't actually 62 00:04:52.800 --> 00:04:58.340 investing those funds in, well, malinvesting those funds into projects of longer and longer 63 00:04:58.340 --> 00:04:59.720 time horizons. 64 00:04:59.720 --> 00:05:01.360 You don't have a business cycle. 65 00:05:01.360 --> 00:05:06.120 So the boom, you must have entrepreneurs acting as agents, adjusting the capital structure 66 00:05:06.120 --> 00:05:11.120 of the economy to the expanded level of credit, flow of credit. 67 00:05:11.120 --> 00:05:16.360 and being the point of crisis, so the bust, the revelation of entrepreneurial errors here. 68 00:05:16.360 --> 00:05:23.420 So now we see some effect of which projects that entrepreneurs began in the early stages 69 00:05:23.420 --> 00:05:27.740 of the business cycle will actually be able to obtain the resources they need to be seen 70 00:05:27.740 --> 00:05:29.640 to completion. 71 00:05:29.640 --> 00:05:34.920 And last, the recession or recovery, as Mises said, the recession is the recovery. 72 00:05:34.920 --> 00:05:39.200 Entrepreneurs as agents of liquidating the malinvestments and reallocating the resources 73 00:05:39.200 --> 00:05:46.720 to new and more profitable, well, actually profitable projects as the economy returns 74 00:05:46.720 --> 00:05:49.520 to a more efficient state. 75 00:05:49.520 --> 00:05:51.040 So how do we interact these? 76 00:05:51.040 --> 00:05:57.320 We look at the relationships between the three strands of entrepreneurial theory and three 77 00:05:57.320 --> 00:06:00.620 phases of the business cycle here. 78 00:06:00.620 --> 00:06:06.520 In the first school of entrepreneurial thought, the judgment, Misesian School, entrepreneurs 79 00:06:06.520 --> 00:06:12.820 in the initial stages of the business cycle because of falsified interest rates and in 80 00:06:12.820 --> 00:06:16.960 some cases over optimism about the course of the economy, expected future course of 81 00:06:16.960 --> 00:06:23.140 the economy, make mistakes in their economic calculation and in the actions that they take 82 00:06:23.140 --> 00:06:28.680 on the basis of those calculations because they aren't pure alert discoverers in this 83 00:06:28.680 --> 00:06:30.160 tradition. 84 00:06:30.160 --> 00:06:38.920 In the bust, we see an increase in uncertainty, a spike in 19 uncertainty as a flow of credit 85 00:06:38.920 --> 00:06:46.000 is cut off as some plans cannot be completed, businesses fail and we have a sorting effect 86 00:06:46.000 --> 00:06:51.720 between entrepreneurs whose plans can be carried through to completion and those who can't, 87 00:06:51.720 --> 00:06:56.200 those who must go bankrupt, they enter the workforce, become unemployed, retire, what 88 00:06:56.200 --> 00:06:57.860 have you. 89 00:06:57.860 --> 00:07:01.380 and then in the recovery is actual asset reallocation and reinvestment. 90 00:07:01.380 --> 00:07:06.660 So we have very active agents of the recovery here and the entrepreneurs. 91 00:07:06.660 --> 00:07:12.400 In the alertness school of thought, in the boom phase, the malinvestment is essentially 92 00:07:12.400 --> 00:07:15.340 a misperception of time preference. 93 00:07:15.340 --> 00:07:20.940 There's not necessarily being carried through to action, but this is the alertness, the 94 00:07:20.940 --> 00:07:21.940 opportunity discovery. 95 00:07:21.940 --> 00:07:26.580 Of course, some of these will later be revealed not to have been opportunities, which is a 96 00:07:26.580 --> 00:07:36.580 In the bust we see, are they discovering errors essentially? The opportunities that they discovered ex-ante in the boom phase turn out not to be profitable. 97 00:07:36.580 --> 00:07:42.580 So apparently they're not really opportunities, not sure what those would be other than pure error. 98 00:07:42.580 --> 00:07:48.580 And then the discovery of new opportunities in the recovery phase as falling prices. 99 00:07:48.580 --> 00:07:55.580 We see entrepreneurs taking advantage of liquidated assets to reallocate the structure of production. 100 00:07:55.580 --> 00:08:06.580 Lastly, the creative destruction, Schumpeterier paradigm, in the boom phase you have to have credit expansion again to allow that innovation to occur. 101 00:08:06.580 --> 00:08:10.580 So the entrepreneurs in a way are already connected to business cycles. 102 00:08:10.580 --> 00:08:17.580 At the starting point and the end point, we're in valuation equilibrium, there essentially is no role for the entrepreneur. 103 00:08:17.580 --> 00:08:21.580 During the bust, we see overinvestment in some of these new technologies. 104 00:08:21.580 --> 00:08:29.900 technologies, entrepreneurs get overextended into the new plans, irrational exuberance 105 00:08:29.900 --> 00:08:34.740 going into things like the tech bubble, and of course the obsolescence of older technologies, 106 00:08:34.740 --> 00:08:40.100 the buggy whip industry, those factories all closed down. 107 00:08:40.100 --> 00:08:43.140 And the final recovery is where we actually see the creative destruction being carried 108 00:08:43.140 --> 00:08:49.340 to completion as the economy moves into that new equilibrium. 109 00:08:49.340 --> 00:08:51.380 So the question now is so what? 110 00:08:51.380 --> 00:08:56.340 We can make laundry lists of various theories of entrepreneurship from the Austrian perspective 111 00:08:56.340 --> 00:09:01.260 and the different characteristics of phases of the business cycle, but does this really 112 00:09:01.260 --> 00:09:05.220 provide us new insights, and if not, is it really worth the effort? 113 00:09:05.220 --> 00:09:11.460 So what we've derived basically from this analysis is three claims, first being that 114 00:09:11.460 --> 00:09:16.780 the entrepreneur-discoverer, the alertness paradigm, the Kurtznerian paradigm, essentially 115 00:09:16.780 --> 00:09:21.420 Actually these entrepreneurs are passive, they could be observing the economy through 116 00:09:21.420 --> 00:09:26.540 a telescope from the moon, they're not actually necessarily acting on anything, they're just 117 00:09:26.540 --> 00:09:32.700 perceiving opportunities and they're responding to price signals, they're responding to changes 118 00:09:32.700 --> 00:09:37.220 in the market rate of interest in the boom phase, in the bust and recovery, they're responding 119 00:09:37.220 --> 00:09:40.740 to falling prices for various productive factors. 120 00:09:40.740 --> 00:09:43.300 But where do these prices actually come from in the first place? 121 00:09:43.300 --> 00:09:47.500 It must be through the action of entrepreneurs in the first place. 122 00:09:47.500 --> 00:09:56.140 And second, in Schumpeter's view, my contention is that contrary to his, the idea of the entrepreneur 123 00:09:56.140 --> 00:10:00.900 being a bold leader of men, the entrepreneur is actually somewhat weak and timid. 124 00:10:00.900 --> 00:10:06.700 The entrepreneur is paralyzed, absent the injection of new credit into the economy, 125 00:10:06.700 --> 00:10:10.860 unable to bid resources away into his new and innovative projects, which if they were 126 00:10:10.860 --> 00:10:14.100 are really worthwhile, you'd think someone would be interested in funding those, but 127 00:10:14.100 --> 00:10:19.420 apparently not in Schumpeter's framework, while simultaneously being overconfident as 128 00:10:19.420 --> 00:10:24.800 we see overinvestment in new technologies leading to the bust. 129 00:10:24.800 --> 00:10:28.860 So there's some contradiction here within Schumpeter's framework. 130 00:10:28.860 --> 00:10:35.660 Lastly, we claim that it's really the judgment-based Misesian view that best frames entrepreneurial 131 00:10:35.660 --> 00:10:37.580 action over the business cycle. 132 00:10:37.580 --> 00:10:45.380 This is where we see the entrepreneur really as an active agent of the economy and the 133 00:10:45.380 --> 00:10:47.500 business cycle. 134 00:10:47.500 --> 00:10:52.060 So this is the best way to look at how can we analyze business cycles with the emphasis 135 00:10:52.060 --> 00:10:56.700 on individual entrepreneurial action. 136 00:10:56.700 --> 00:11:00.300 So some theoretical implications of this. 137 00:11:00.300 --> 00:11:06.020 We see that the judgment-based view best describes how entrepreneurial beliefs can impact the 138 00:11:06.020 --> 00:11:10.460 Business Cycles. Entrepreneurs, as Mises said, who understand the business 139 00:11:10.460 --> 00:11:14.500 cycles better, maybe we wouldn't have business cycles if they knew that 140 00:11:14.500 --> 00:11:17.460 engaging in a given project would turn out to be malinvestment. Of course they 141 00:11:17.460 --> 00:11:21.420 don't know that ahead of time, but it's clearly the entrepreneurial beliefs 142 00:11:21.420 --> 00:11:25.380 carried into action that dictate the course of the business cycle from start 143 00:11:25.380 --> 00:11:30.780 to finish. And also an ideal I got from Tim's paper, that when you have greater 144 00:11:30.780 --> 00:11:35.660 uncertainty during boom phases, perhaps you'd see less investment in highly 145 00:11:35.660 --> 00:11:39.660 and any specific high order roundabout production processes. 146 00:11:39.660 --> 00:11:42.660 How would this affect the course of the business cycle? 147 00:11:42.660 --> 00:11:46.660 We see a much longer period until reaching the final bust 148 00:11:46.660 --> 00:11:50.660 as entrepreneurs invest in more of the putty assets, 149 00:11:50.660 --> 00:11:53.660 the less specific capital goods. 150 00:11:53.660 --> 00:11:57.660 Next we see entrepreneurial characteristics 151 00:11:57.660 --> 00:12:01.660 affect business cycles over the course of the cycle. 152 00:12:01.660 --> 00:12:04.660 Some recent research really follows this kind of paradigm. 153 00:12:04.660 --> 00:12:10.460 Evans and Vax and Dale's work on how credit expansion induces sub-marginal entrepreneurs 154 00:12:10.460 --> 00:12:16.780 to enter markets, that again, contrary to Schumpeter, it's not the bold leaders who 155 00:12:16.780 --> 00:12:21.440 are engaging in new and innovative investments during the boom phase leading up to the crisis. 156 00:12:21.440 --> 00:12:27.660 It's actually sub-marginal entrepreneurs, those whose judgment would not readily suit 157 00:12:27.660 --> 00:12:31.180 them to become entrepreneurs under normal conditions. 158 00:12:31.180 --> 00:12:48.180 Third, that the judgment-based view implies that actual entrepreneurial decisions over the cycles are not pure opportunity discovery, but must be carried through into action to actually make a business cycle happen. 159 00:12:48.180 --> 00:12:51.180 Again, a central bank could print as much money as it wanted. 160 00:12:51.180 --> 00:12:56.180 Entrepreneurs could be pure opportunity discoverers, could see that maybe there's some money to be made there. 161 00:12:56.180 --> 00:13:15.180 But unless somebody takes action, in this case, in this paradigm, entrepreneurs take action, exercise judgment to arrange assets into constellations that are going to consist of those longer plans of production at higher orders, you don't have a business cycle. 162 00:13:15.180 --> 00:13:18.180 Again, some recent research really falls into this paradigm. 163 00:13:18.180 --> 00:13:22.500 paradigm. So because we see also some of the most productive empirical and 164 00:13:22.500 --> 00:13:26.580 theoretical work is falling within this view, this judgment-based Misesian view 165 00:13:26.580 --> 00:13:33.220 is another argument in its favor. Karelian Dempster's 2001 paper where 166 00:13:33.220 --> 00:13:38.220 even if entrepreneurs know that maybe there's going to be some malinvestment 167 00:13:38.220 --> 00:13:42.540 they have faced a prisoner's dilemma of they must invest in some of these 168 00:13:42.540 --> 00:13:45.860 malinvested projects because everyone else is doing it and they'll be left 169 00:13:45.860 --> 00:13:47.740 behind, essentially miss the boat. 170 00:13:50.940 --> 00:13:55.020 Lastly, some empirical implications. 171 00:13:55.020 --> 00:13:57.580 This is something I'm particularly interested in, 172 00:13:57.580 --> 00:14:00.420 that the judgment-based view provides the best basis 173 00:14:00.420 --> 00:14:05.060 for empirical extensions of Austrian business cycle studies 174 00:14:05.060 --> 00:14:10.460 because it focuses on micro-level individual potential data 175 00:14:10.460 --> 00:14:12.700 that's out there, and phenomena anyway, 176 00:14:12.700 --> 00:14:15.460 rather than the large-scale aggregate data 177 00:14:15.460 --> 00:14:18.300 that we see in most macro studies of business cycles, 178 00:14:18.300 --> 00:14:20.300 that the actions, characteristics and beliefs 179 00:14:20.300 --> 00:14:23.820 of actual entrepreneurs, those are more readily observable. 180 00:14:23.820 --> 00:14:27.460 We have survey data on the opinions and attitudes 181 00:14:27.460 --> 00:14:30.660 and sentiments of different types of business people 182 00:14:30.660 --> 00:14:33.060 being periodically carried out. 183 00:14:33.060 --> 00:14:35.020 It's easier to assemble data, you know, 184 00:14:35.020 --> 00:14:38.580 really directly on the performance of different sectors 185 00:14:38.580 --> 00:14:40.140 of the economy and even specific businesses 186 00:14:40.140 --> 00:14:42.580 with the level of disclosure 187 00:14:42.580 --> 00:14:45.500 by publicly traded firms especially. 188 00:14:45.500 --> 00:14:48.300 So what we have is readily observable facts 189 00:14:48.300 --> 00:14:50.780 and even some counterfactuals for time periods 190 00:14:50.780 --> 00:14:53.580 or other geographic areas where the same business cycle 191 00:14:53.580 --> 00:14:55.700 maybe is not proceeding, 192 00:14:55.700 --> 00:14:59.220 which raises the bettenoir for Austrians at least 193 00:14:59.220 --> 00:15:02.860 of testable hypotheses, you know, 194 00:15:02.860 --> 00:15:05.860 actual falsifiable statements that maybe can be the basis 195 00:15:05.860 --> 00:15:09.160 of empirical or even econometric work. 196 00:15:09.160 --> 00:15:11.860 And here we actually have a literal bettenoir, so. 197 00:15:12.580 --> 00:15:17.580 And that's the conclusion basically of our paper, so thank you for your time.