I should start off by saying this paper is very much a work in progress.
In fact, as you can tell, there's been progress made in the last week or so
because the schedule says the title of the paper is Uncertainty, Asset, Specificity, and Business Cycles,
and I since came to the opinion that it would be better titled Uncertainty, Asset, Specificity, and Entrepreneurial Adaptation,
although I still discuss business cycles in the paper.
I started off looking at the impact, trying to look at the impact of environmental regulation
on business cycles and I began to look at the particulars of environmental regulation
and a lot of environmental regulation requires firms to install some specific kind of capital
equipment such as a scrubber on a coal-fired power plant which is a hundreds of millions
and the millions of dollars piece of equipment that might be as large as the generating facility itself
and, of course, is a piece of capital that cannot be easily transferred to some other kind of production process.
So as I began thinking about this, I thought, well, how do entrepreneurs adapt to uncertainty in the kind of capital they employ?
So the main idea here is that the Austrian emphasis on entrepreneurial judgment and heterogeneous capital helps us to understand how uncertainty reduces economic growth rates.
Entrepreneurship, most of you are familiar with the Austrian theory of entrepreneurship, but I'll briefly mention that it's the use of judgment under conditions of uncertainty.
It's not merely probabilistic risk, and so it's not a matter of just looking at the statistics and figuring out what's the best course of action.
We don't even know what the statistics are. As entrepreneurs, we have to use judgment and foresight, and it's really quite an art.
Now, I would not have been able to put this picture up here until yesterday when I heard
Mark Thornton's talk.
I'm sorry, the top margin's cut off there, but Mark Thornton has argued that this is
in fact Richard Cantillon and Cantillon's kind of our foundational figure for entrepreneurship
theory in Austrian economics.
And he said in 1755 that entrepreneurs work for uncertain wages, so to speak, and all
others for certain wages until they have them, although their functions and their rank are
very disproportionate.
The general who has a salary, the courtier who has a pension, and the domestic who has
wages are in the latter class.
All the others are entrepreneurs, whether they establish themselves with a capital to
to carry on their enterprise or are entrepreneurs of their own work without any capital, that
would be like a plumber or furniture maker or something like that, and they may be considered
as living subject to uncertainty, even beggars and robbers are entrepreneurs of this class
and perhaps we should add to that politicians, or maybe that's redundant.
Investment means the assessment of future prices of resources used in production and
the prices of those final goods and services they hope to produce.
And as we see in several places in the Austrian literature, when entrepreneurs commit to a
a particular course of action. When they make investments in capital, they are surrendering
flexibility. In fact, Robert Mulligan, who's also, I believe, appearing later in this session,
said that planners surrender flexibility whenever they commit liquid financial capital to a
particular production plan. If business conditions change, production plans cannot be completed
as originally anticipated. The removal of flexibility on the part of entrepreneurs can
be thought of as the proximate cause of the business cycle. So as I looked at the existing
mainstream literature on this, it seems that, and I've got a lot of it in the paper, I can
send you a copy if you like, but a lot of that mainstream literature which I briefly
seems to be focusing on the level of investment.
It does not put a lot of emphasis on the heterogeneity of capital,
and I think that that is a serious problem in the mainstream literature,
and one which leads them, I think, to fail to see the connection
There is some effort that I saw recently to try to measure asset specificity by looking at the saleability of assets across industries, and Kim and Kong, last year, produced a study in which they gave a kind of a numerical index of various industries in which they said
said, well, here's the degree of asset specificity for coal mining and for electric power generation
and for various services and distribution and so forth.
And as I had expected, the extractive industries, the power generation industries seem to be
near the top of that list, having the requirement of very specific capital.
But of course, one of the problems here is that Kim and Kung are looking at the physical
attributes of the capital and they're not looking at, you can't look at the judgment
of the entrepreneur, which has a great deal to say about how specific capital is.
So I think that it's under appreciative of the importance of entrepreneurial judgment,
and the foresight. Without taking into account the foresight, you can't tell exactly how
specific that asset is because you don't know all the possible uses of that asset.
So I argue that lower rates of economic growth in the face of uncertainty are related to
The defensive alterations in the capital structure that are undertaken to help entrepreneurs resist the effects of or be more resilient to changes in the political environment, the regulatory environment, and of course other sources of uncertainty.
Ben Powell in 2010 noted that capital goods derive their value from entrepreneurs who
bid on them with the aim of incorporating those capital goods into a specific plan to
produce the final consumer goods of ultimate valuation.
You can't separate the capital, the nature of capital from the entrepreneur's plan.
And then, of course, I keep running into these people, Foss and Klein in the Austrian Literature
and Entrepreneurship.
You just can't escape running into these people.
And of course, it has become Peter Klein's work and Nikolai Foss's work has become essential
to the Austrian Literature and Entrepreneurship.
And in 2005, they pointed out that assets are heterogeneous to the extent that they
They have different and different levels of valued attributes. Attributes may also vary
over time, even for a particular asset. In a world of true uncertainty, entrepreneurs
are unlikely to know all relevant attributes of all assets when production decisions are
made. Nor can the future attributes of an asset, as it is used in production, be forecast
with Certainty. Future attributes must be discovered over time as assets are used in
production. Or to formulate the problem slightly differently, future attributes are created
as entrepreneurs envision new ways of using assets to produce goods. So what I'm arguing
here is that the poor long-term performance from sources of uncertainty results from the
The difficulty of calculation, of course this has been frequently demonstrated by others
that entrepreneurs can't calculate as easily when money markets and other markets are being
distorted by changes in regulation by the Federal Reserve and other interventions of
government, but also because entrepreneurs are making a trade-off.
They're trading off, on the one hand, they want reduced exposure to economic uncertainty,
and on the other hand, they'd like to be able to have a higher output, more roundabout production
process.
But they have to weigh these two.
If they have a more roundabout production process, which might allow for some greater
are long-term efficiencies, they have to give up some of that resilience to economic uncertainty.
They have to expose themselves to a risk that a change in policy, a change in regulation
could make their production process uneconomical.
So uncertainty, I would say, reduces economic growth, not just by reducing the aggregate
investment, and that's what the mainstream seems to be focused on, but also by changing
the capital structure to increase resilience.
Now there are four ways, at least, I point out four ways in which entrepreneurs may adapt
their capital structure.
The entrepreneur may change the placement of capital assets in the firm's production process, or they could organize the firm differently.
They might merge with another firm, they might divest part of the firm, they could acquire another firm.
In fact, often you see in the tech industry where a firm will make an acquisition,
Not necessarily because they want the physical assets or maybe not even the human assets
of that firm.
They may want the knowledge or they may want some kind of IP that the smaller firm may
possess.
Secondly, entrepreneurs may move assets geographically to regulatory regimes that are more conducive
to success.
I teach at Wofford College, which is in Spartanburg, South Carolina, and Spartanburg, South Carolina,
or not just Spartanburg, but South Carolina has been the beneficiary of this kind of geographical
relocation. About 20 something years ago, we picked up a BMW assembly plant. It's one
of the first major automotive assembly plants in the South, and I believe Alabama also has
one or two. There's a Kia plant up the road near Columbus, and there's a number of others
Now, why didn't they locate in Michigan, where there's a large number, I mean there's a
clustering effect, right, there are a number of people there who know how to work on cars
and a number of engineers and suppliers and all of these things have been attractive,
but the regulatory regime in Michigan has not been conducive to success, so they moved
Third, entrepreneurs may build up precautionary assets, which some, like Bischoff, have called
putty capital.
It's an unformed capital, it's liquid, and then fourth, entrepreneurs may shift from
large time-consuming capital investments to smaller projects that have shorter lead times.
Much of this has been established already in the literature simply pointing out that these
are methods by which entrepreneurs may adapt.
We see some of the mainstreamers in this, like Pendike, says that capital asset specificity
may lead to inertia in industries that are not very well adaptable.
He says we may get greater malinvestment in energy.
We may get malinvestment.
Malinvestment, I don't think he uses the term malinvestment, but there's greater malinvestment
in energy and other industries that have a higher level of specificity.
Bernanke mentions bunching of investment projects over time.
Bloom also mentions the delays of investment and hiring.
But many of these neglect the heterogeneity of capital.
I noted that we ought to see a shift, a smoothing really of the business cycle as we've seen
a shift toward services because the service industry has typically a lower level of capital
asset specificity.
So the shift from manufacturing and extractive industries toward services ought to smooth
out the business cycle over time somewhat, other things being equal.
And so why haven't we seen that?
Also we see that moving assets geographically seems to have gotten easier as transportation
costs have dropped.
So why haven't we seen less severe, less frequent business cycles?
If you look at Seljand's work and some others well known to you, we have not seen a real
improvement in the severity of business cycles lately.
And so if we see entrepreneurs being prevented in some way from adapting, that is going to
have a similar effect to an increase in overall uncertainty.
And we probably have seen an increase in uncertainty as well, at least in the short run.
And so we've seen limits on mergers and acquisitions, we've seen restrictions on capital mobility
to some extent across political boundaries, and then if you look at some recent commentators
like John Taylor, he says we've seen both increased regulation and increased policy
uncertainty that have been holding the economy back, preventing entrepreneurs from adapting.
Taylor points out we've seen a higher number of full-time equivalent federal employees.
We've seen a less predictable tax code.
All of that may increase uncertainty and make the entrepreneur's job more difficult.
So while the mainstream approach does not see capital asset heterogeneity as a function
of entrepreneurial judgment and foresight, it misses the link between limiting entrepreneurial
freedom to adapt and worsening of business cycles and slower long-run growth rates.
So I would suggest that if you want to see improvements in growth and you want to see
Business cycles moderate instead of becoming more severe, and perhaps we ought to seek not only to reduce uncertainty, but also make it easier for entrepreneurs to adapt to the existing uncertainty.
I'll stop here. My contact information is here, and if you would like a copy of the paper, please feel free to email me.