WEBVTT NOTE Frank H. Knight: The Forgotten Austrian 1 00:00:00.000 --> 00:00:09.000 My title is, of course, somewhat tongue-in-cheek, because Frank Knight is not, of course, a member of the Austrian School. 2 00:00:09.000 --> 00:00:17.000 Knight is one of the most important American economists and most important 20th century economists in the world. 3 00:00:17.000 --> 00:00:24.000 Knight was the intellectual father or one of the intellectual fathers of the Chicago School 4 00:00:24.000 --> 00:00:38.640 and is known primarily among Austrians for a very sort of bitter attack against Hayek and Boehm-Bawerk in the 1930s and 1940s over their theory of capital. 5 00:00:38.640 --> 00:00:45.760 Knight is also widely considered one of the founders of the modern theory of perfect competition, 6 00:00:45.760 --> 00:00:52.720 which of course has been sort of a bet noir for Austrian economists and other heterodox types for many decades. 7 00:00:52.720 --> 00:00:59.120 So my claim is not that Frank Knight belongs, that Knight's name should go up here. 8 00:00:59.120 --> 00:01:07.920 Maybe we could replace Gary Robin's name with Knight's name with some footnotes to explain exactly what is meant. 9 00:01:07.920 --> 00:01:15.720 The point that I wish to make is that in many ways, Knight's thought is much closer to that of the Austrians, 10 00:01:15.720 --> 00:01:20.120 Mises in particular, than has been generally recognized. 11 00:01:20.120 --> 00:01:31.620 Knight's epistemology, while somewhat eclectic, does have some similarities to the praxeological method espoused by Mises. 12 00:01:31.620 --> 00:01:40.620 Knight's development of perfect competition theory was really intended more as a kind of analytical foil 13 00:01:40.620 --> 00:01:46.620 to explain certain features of real markets in the absence of perfectly competitive conditions, 14 00:01:46.620 --> 00:01:56.620 is sort of analogous to the way that Mises and Rothbard have used the concept of the evenly rotating economy and other so-called imaginary constructs. 15 00:01:56.620 --> 00:02:12.620 In particular, Knight's theory of the entrepreneur, Knight's theory of profit, and his explanation of the differences between profit and other forms of business income are central to Austrian notions of entrepreneurship and the firm. 16 00:02:12.620 --> 00:02:19.900 And I'll try to convince you that Mises in particular takes a view very similar to Knight's 17 00:02:19.900 --> 00:02:27.100 view on the theory of the entrepreneur and the place of profit in a competitive market 18 00:02:27.100 --> 00:02:28.100 economy. 19 00:02:28.100 --> 00:02:32.660 One of the reasons I was tinkering with my slides a little bit during the previous presentations 20 00:02:32.660 --> 00:02:38.700 because I realized that in this room you can't see the bottom of the slides, correct? 21 00:02:38.700 --> 00:02:42.220 So except for a few of you in the front, you can only see what's at the top. 22 00:02:42.220 --> 00:02:58.220 Now, I tried to bump some stuff up and I have a few slides where it kind of scrolls up in the middle so those of you who can't see, you'll be able to see a little bit better as we go and anything that you can't see, I can assure you, is brilliant and highly insightful. 23 00:02:58.220 --> 00:03:24.220 Interesting person with a diverse background and of course Knight wrote in a number of different fields, not only economics but was an important social thinker in other disciplines, he studied at the University of Tennessee and received his PhD at Cornell in 1915. 24 00:03:24.220 --> 00:03:33.820 His major professor was Alvin Johnson. He also worked very closely with Alan Young and with Herbert J. Davenport at Cornell. 25 00:03:33.820 --> 00:03:42.220 I'll mention Davenport again later, but Davenport was one of the leading members of the so-called American Austrian School, 26 00:03:42.220 --> 00:03:49.220 including John Bates Clark and Frank A. Fetter, who were adherents of Menger, 27 00:03:49.220 --> 00:03:55.820 Devotees of the Menger's Price Theory and the Austrian Method, more or less. 28 00:03:55.820 --> 00:04:07.120 In fact, they affected somewhat of a synthesis or they tried to affect a synthesis between Menger and some aspects of British classical and neoclassical economics. 29 00:04:07.120 --> 00:04:16.920 They took some of Marshall and some of other leading British economists, incorporated those with much of Menger's Price Theory and that of the other Austrians. 30 00:04:16.920 --> 00:04:46.920 Come back to that point later. There's a strong influence on Knight of Davenport's thinking. Knight taught for eight years at the University of Iowa and he left and went to the University of Chicago in 1927 where he remained until his retirement in 1952 and he stayed on as an emeritus professor at Chicago and Knight was one of the huge, almost godlike figures at Chicago. 31 00:04:46.920 --> 00:05:16.920 in Chicago, along with Jacob Viner, extremely important economic theorist, particularly in international issues, who was also at Chicago. Knight and Viner have often been compared to Wieser and Boehm-Bawerk, where Viner, like Boehm-Bawerk, was a very careful and systematic thinker and a clear writer. Knight, like Wieser, was more of an iconoclast and was less clear and not as easy to understand. 32 00:05:16.920 --> 00:05:21.560 but in many ways a more original and sort of creative thinker. 33 00:05:21.560 --> 00:05:29.560 At Chicago, of course, Knight was the dissertation chair and sort of intellectual guru for the 34 00:05:29.560 --> 00:05:35.480 important figures of the later Chicago School that we would all recognize, people like Friedman 35 00:05:35.480 --> 00:05:39.080 and Stigler, of course, James Buchanan and so on. 36 00:05:39.080 --> 00:05:46.480 So in many ways, the sort of late 20th century neoclassical Chicagoites, against whom the 37 00:05:46.480 --> 00:05:52.560 and the Austrians engaged in many disputes were the intellectual proteges of Frank Knight. 38 00:05:52.560 --> 00:05:59.120 Knight's most important book was his first book, Risk, Uncertainty and Profit, published in 1921, 39 00:05:59.120 --> 00:06:04.720 a revised version of his doctoral dissertation at Cornell, and one of the most important 40 00:06:04.720 --> 00:06:11.240 and one of the most highly cited books in the history of economic thought, known obviously 41 00:06:11.240 --> 00:06:17.400 in particular for making the distinction, which I'll discuss a bit later, between risk and uncertainty. 42 00:06:17.400 --> 00:06:26.040 Knight wrote a number of other important works on different aspects of economics and its social, moral, and political implications. 43 00:06:26.040 --> 00:06:32.760 A collection of essays on ethics, called The Ethics of Competition, published in the 1920s. 44 00:06:32.760 --> 00:06:38.200 A less well-known but also very important book called The Economic Organization, 45 00:06:38.200 --> 00:07:08.200 not about firms as organizations but about sort of development of a kind of circular flow model of the U.S. economy and then Knight published several essays and letters on capital theory critiquing the Austrians, many of which were collected in a book called The Quantity of Capital in the Rate of Interest and Knight also wrote a very interesting methodological article that I think has been underappreciated by Austrians called Fact and Value in Social Science 46 00:07:08.200 --> 00:07:14.420 published in 1942. What were some of Knight's major contributions? The 47 00:07:14.420 --> 00:07:19.780 distinction, the idea for which Knight is best known among contemporary 48 00:07:19.780 --> 00:07:25.780 economists is the distinction between risk and uncertainty. Risk being described 49 00:07:25.780 --> 00:07:31.580 by Knight as situations in which actors do not know exactly what will obtain in 50 00:07:31.580 --> 00:08:01.580 in Future Periods. But they can describe the set of possible outcomes in a fairly precise manner. In other words, one can enumerate a list of things that could possibly happen tomorrow and assign probabilities to each of those events occurring, such that one can, in the familiar contemporary jargon, use expected value theory to come up with the optimal outcome in the face of these unknown future events. But Knight argues 51 00:08:01.580 --> 00:08:11.980 that in many aspects of life, different ways that human beings act, we're not faced with that kind of situation. 52 00:08:11.980 --> 00:08:20.580 We have to act under conditions in which we do not even know the set of possible outcomes that could occur tomorrow, 53 00:08:20.580 --> 00:08:27.580 much less have the ability to assign probability weights to them so that we can make expected value calculations. 54 00:08:27.580 --> 00:08:34.740 Rather, we have to act with a different kind of understanding and exercise what Knight called judgment, 55 00:08:34.740 --> 00:08:46.060 meaning a way of evaluating future conditions, of making conjectures about future outcomes in the absence of known, fixed and stable probability distributions. 56 00:08:46.060 --> 00:08:53.260 Actually, the first half of, or almost two-thirds of Knight's book, Risk, Uncertainty and Profit, 57 00:08:53.260 --> 00:09:00.620 is not devoted primarily to this issue, but rather to the development of a model, if you like, of perfect competition. 58 00:09:02.620 --> 00:09:09.700 Knight's, the second half of the book focuses on resource allocation under conditions of uncertainty, 59 00:09:10.100 --> 00:09:14.860 a condition that of course is absent when perfect competition is present. 60 00:09:14.980 --> 00:09:20.700 And Knight explains the role of the entrepreneur exercising judgment under uncertainty 61 00:09:20.700 --> 00:09:25.500 in directing the allocation of resources in a market economy. 62 00:09:25.500 --> 00:09:31.700 In particular, Knight develops the notion that an entrepreneur's judgment is non-contractable, 63 00:09:31.700 --> 00:09:35.700 meaning that one cannot buy and sell judgment on the market, 64 00:09:35.700 --> 00:09:39.700 but rather judgment can only be exercised through action, 65 00:09:39.700 --> 00:09:45.700 specifically by ownership and control of material resources, 66 00:09:45.700 --> 00:09:48.700 which are then combined and recombined in various ways 67 00:09:48.700 --> 00:09:52.900 in anticipation of earning profits in the future. 68 00:09:52.900 --> 00:09:58.300 Knight also did some work on investment theory, 69 00:09:58.300 --> 00:10:03.420 the sort of standard notion that investments will tend to be made 70 00:10:03.420 --> 00:10:07.780 across opportunities, across investment opportunities until the 71 00:10:07.780 --> 00:10:11.100 rate of return is, 72 00:10:11.100 --> 00:10:15.580 rates of return are equalized at the margin. This notion was elaborated by 73 00:10:15.580 --> 00:10:16.100 Knight 74 00:10:16.100 --> 00:10:18.940 in his book called The Economic Organization. 75 00:10:18.940 --> 00:10:22.420 He also wrote an interesting piece on congestion pricing, 76 00:10:22.420 --> 00:10:26.420 long before Ronald Coase and the modern Chicago 77 00:10:26.420 --> 00:10:29.620 law and economics approach to dealing with external benefits 78 00:10:29.620 --> 00:10:33.780 and external costs. He wrote a critique of Pigou 79 00:10:33.780 --> 00:10:38.820 who had argued that there needed to be regulation 80 00:10:38.820 --> 00:10:41.460 over publicly used resources like roads 81 00:10:41.460 --> 00:10:43.660 to make sure that they weren't overused 82 00:10:43.660 --> 00:11:01.660 and Knight pointed out, where's Walter Block? Walter's not here but much to Walter Block's delight that privatizing the roads and allowing the road owners to charge appropriate prices would be an alternative to Pigou's solution for a way of mitigating the congestion problem. 83 00:11:01.660 --> 00:11:09.660 Now, you know, Austrians, many Austrians are familiar with Knight's critique of Hayek and Boehm-Bawerk on capital. 84 00:11:09.660 --> 00:11:14.460 Capital. That's not going to be my main focus today. Obviously these differences were important 85 00:11:14.460 --> 00:11:21.140 and were very deep. Some of them rested, perhaps it's not quite right to say they rested on 86 00:11:21.140 --> 00:11:27.540 misunderstandings, but the key to understanding the differences between the Austrians and 87 00:11:27.540 --> 00:11:33.620 Knight and to some degree John Bates Clark, who also took Knight's side in this debate, 88 00:11:33.620 --> 00:11:39.060 is to realize that they conceived of capital in very different ways. That for Knight, capital 89 00:11:39.060 --> 00:11:44.900 Capital in the economically meaningful sense was not, as the Austrians conceived it, a 90 00:11:44.900 --> 00:11:51.700 stock of heterogeneous resources, specific capital goods, rather Knight and Clark conceived 91 00:11:51.700 --> 00:12:01.200 of capital as money, as a fund of value that would maintain its value, even in the absence 92 00:12:01.200 --> 00:12:05.980 of particular productive activities on the part of agents, and that interest in Knight's 93 00:12:05.980 --> 00:12:15.980 The Knight's formulation was not determined at all by time preference, by sort of technical considerations of the marginal productivity of capital. 94 00:12:15.980 --> 00:12:22.980 You know, going back and reading through the literature and this long set of debates between Knight and the Austrians, 95 00:12:22.980 --> 00:12:31.980 just to give you an example, this was a recent paper in the history of political economy called The Knight, The Hayek-Knight Capital Controversy, 96 00:12:31.980 --> 00:12:38.380 University, has a little bibliography of the relevant articles and personal letters between 97 00:12:38.380 --> 00:12:42.580 Hayek and Knight where they hashed this out, and as you can see there was quite a lot. 98 00:12:42.580 --> 00:12:44.660 It's a lot to go through. 99 00:12:44.660 --> 00:12:50.180 And it's not easy reading because you find that in many cases the authors are using similar 100 00:12:50.180 --> 00:12:53.620 terms to mean entirely different things. 101 00:12:53.620 --> 00:12:59.780 So clearly, you know, Knight's Austrianism does not extend to certain critical aspects 102 00:12:59.780 --> 00:13:02.140 of Capital Theory, of Production Theory, 103 00:13:02.140 --> 00:13:04.460 the Marginal Theory of Distribution and so on. 104 00:13:04.460 --> 00:13:07.420 However, there are important similarities 105 00:13:07.420 --> 00:13:10.060 between Knight and the Austrians that deserve, 106 00:13:10.060 --> 00:13:12.940 I think, a second look. 107 00:13:12.940 --> 00:13:15.700 Knight's views on uncertainty have been characterized 108 00:13:15.700 --> 00:13:16.780 in different ways. 109 00:13:16.780 --> 00:13:21.620 There's almost a cottage industry of scholars producing 110 00:13:21.620 --> 00:13:23.700 huge amounts of secondary literature 111 00:13:23.700 --> 00:13:27.460 on what Knight really meant, what was Knight's epistemology 112 00:13:27.460 --> 00:13:39.060 really all about, and that's one indication that Knight was a very provocative writer, but not an especially clear writer, particularly on these kinds of topics. 113 00:13:39.060 --> 00:13:54.660 Some of Knight's critics, much to my amusement, have dismissed Knight's writings on methodology and on epistemology as being extended Austrian-style disquisitions on the foundations of human knowledge and conduct and the like. 114 00:13:54.660 --> 00:14:04.660 and the like is supposed to be dismissive, like, oh gosh, there they go again, the Austrians with their blah blah blah about human, you know, the foundations of knowledge and so on. 115 00:14:04.660 --> 00:14:08.660 So this is meant by the writer to be a dismissal of Knight. 116 00:14:08.660 --> 00:14:15.660 In other words, you don't bother to read Knight's methodological writings. He's as crazy as an Austrian. 117 00:14:15.660 --> 00:14:22.660 Actually, Knight's views on probability are extremely interesting. 118 00:14:22.660 --> 00:14:26.980 and it turns out that the way many people think of the risk uncertainty 119 00:14:26.980 --> 00:14:32.740 distinction is not exactly the way I think Knight meant it. He actually 120 00:14:32.740 --> 00:14:37.140 distinguishes among three different types of probability what he calls a 121 00:14:37.140 --> 00:14:43.500 priori probability where we can know on purely deductive grounds what is 122 00:14:43.500 --> 00:14:46.900 the likelihood of a particular event taking place by which he meant for 123 00:14:46.900 --> 00:14:51.620 example a coin flip right so simply knowing the properties of the coin that 124 00:14:51.620 --> 00:14:59.620 If we can assume that it's a fairly weighted coin that has two sides and so on, the probability of heads or tails coming up is 0.5. 125 00:14:59.620 --> 00:15:06.620 We don't need to perform experiments to come up with those numbers. We can deduce them in an a priori fashion. 126 00:15:06.620 --> 00:15:14.620 But there are other cases where the things we don't know cannot be parameterized this way using a priori criteria. 127 00:15:14.620 --> 00:15:19.240 and he distinguished two different cases what he called statistical probability 128 00:15:19.240 --> 00:15:25.420 and what he called estimated probability so statistical probability describes 129 00:15:25.420 --> 00:15:29.860 cases where we have a fairly well-defined situation in which we can 130 00:15:29.860 --> 00:15:34.700 repeat a certain experiment over and over and over we can count how many 131 00:15:34.700 --> 00:15:39.700 times a particular outcome arises and we can infer from that what is the 132 00:15:39.700 --> 00:15:45.340 The Statistical Probability that any particular outcome will obtain in a series of sort of 133 00:15:45.340 --> 00:15:51.900 repeated trials, as opposed to other cases where we do not have enough occurrences of 134 00:15:51.900 --> 00:15:57.940 similar events to put them in a category where we can perform this kind of repeated experiment 135 00:15:57.940 --> 00:16:03.380 across, we cannot perform repeated trials because we have unique heterogeneous events 136 00:16:03.380 --> 00:16:06.140 that cannot be pooled in this fashion. 137 00:16:06.140 --> 00:16:12.260 Now, both a priori probability and what he called statistical probability, according 138 00:16:12.260 --> 00:16:18.100 to Knight, are categories of risk. So risk describes both of these two situations in 139 00:16:18.100 --> 00:16:24.780 which it is possible for different reasons to come up with a well-specified sort of characterization 140 00:16:24.780 --> 00:16:30.220 of the problem. There are X number of outcomes, each of which obtains with probability P 141 00:16:30.220 --> 00:16:37.380 and so on, as opposed to the situation of estimated probability, which Knight called 142 00:16:37.380 --> 00:16:38.380 uncertainty. 143 00:16:38.380 --> 00:16:43.260 Okay, so the risk uncertainty distinction is really a distinction among these three 144 00:16:43.260 --> 00:16:47.060 different types of what Knight called probabilities. 145 00:16:47.060 --> 00:16:51.400 Now many of you will recognize, particularly in the way I described Knight's approach 146 00:16:51.400 --> 00:16:57.660 to statistical probability, that this sounds very much like the so-called frequentist approach 147 00:16:57.660 --> 00:17:02.260 of Ludwig von Mises' brother, Richard von Mises. 148 00:17:02.260 --> 00:17:09.980 So Richard von Mises, a very famous natural scientist, 149 00:17:09.980 --> 00:17:12.740 very important figure in the history of statistics, 150 00:17:12.740 --> 00:17:15.940 professor at Harvard University. 151 00:17:15.940 --> 00:17:18.860 Richard von Mises is famous for distinguishing 152 00:17:18.860 --> 00:17:22.420 between what he calls class probability and case 153 00:17:22.420 --> 00:17:23.860 probability. 154 00:17:23.860 --> 00:17:53.860 So, probability for Richard von Mises and the so-called frequentist school is sort of the mathematical limit of what we observe in a series of repeated trials, as I described, whereas what Richard von Mises calls case probability refers to situations where each event is a unique case and therefore we cannot perform these repeated trials and come up with statistical estimates of the likelihood of particular things happening. 155 00:17:53.860 --> 00:17:59.660 happening. In fact, the term case probability is a little bit of a misnomer. What Richard 156 00:17:59.660 --> 00:18:06.260 von Mises means is that probability only applies to situations where we have members of a homogeneous 157 00:18:06.260 --> 00:18:13.060 class. So case probability is really case non-probability or case something else, okay? 158 00:18:13.060 --> 00:18:18.660 The terms case, class and case probability are well known to Austrians because the same 159 00:18:18.660 --> 00:18:23.740 Human Terminology was adopted by Ludwig von Mises in his own treatment of these issues 160 00:18:23.740 --> 00:18:25.700 in Human Action. 161 00:18:25.700 --> 00:18:34.740 And actually, my chapter in the Hoppe Festschrift, which came out in 2009, I think, 2008, 2009, 162 00:18:34.740 --> 00:18:42.580 deals specifically with the positions of Richard von Mises, Ludwig von Mises, and Knight, and 163 00:18:42.580 --> 00:18:46.840 also Hans Hoppe, who has written an article on this, on the distinction among different 164 00:18:46.840 --> 00:19:16.840 So, while Knight did not exactly reject the so-called subjective probability of Keynes in which all probabilities are simply subjective value judgments formed by individuals, he did believe that there were qualitative differences between these kinds of estimates that are formed in the minds of judgmental entrepreneurs and the kinds of probabilities that we can deduce either a priori or through a series of repeated trials. 165 00:19:16.840 --> 00:19:46.840 Trials. But sort of the key to what Knight had in mind here, when Knight distinguishes between risk and uncertainty in the way that we're all familiar with, really what he means by uncertainty is cases in which the actor, the entrepreneur, cannot articulate his or her beliefs about the future in a way that those beliefs can be communicated to other actors. When the categories of knowledge themselves are unknown, they cannot form the basis of interpersonal 166 00:19:46.840 --> 00:19:51.840 Agreement, and Market Exchange, according to an interesting article by Dick Langlois. 167 00:19:51.840 --> 00:19:56.840 That's not 1930, no, that's obviously a time, but I think that's 1993. 168 00:19:56.840 --> 00:20:01.840 They're not that old. Langlois is not that old. 169 00:20:01.840 --> 00:20:06.840 In other words, the reason that entrepreneurial judgment is non-contractable 170 00:20:06.840 --> 00:20:11.840 is because the entrepreneur cannot articulate 171 00:20:11.840 --> 00:20:19.840 and, effectively, his assessment of future conditions in a way to sort of sell that judgment to someone else. 172 00:20:19.840 --> 00:20:26.840 The only way the entrepreneur can put his judgments into practice is by owning and controlling resources, 173 00:20:26.840 --> 00:20:32.840 combining them with other resources, and so on, by being a business owner, a business operator, etc. 174 00:20:32.840 --> 00:20:42.840 So, 90 and uncertainty is really about our ability to communicate information that is highly difficult to articulate. 175 00:20:42.840 --> 00:20:48.840 This, of course, will strike many of you as familiar to Hayek's distinction between explicit and tacit knowledge, 176 00:20:48.840 --> 00:20:54.840 which is often interpreted by modern scholars in terms of precisely the same dimension, 177 00:20:54.840 --> 00:20:58.840 the ability to communicate information from one person to another. 178 00:20:58.840 --> 00:21:10.840 What Hayek means by tacit knowledge is knowledge that cannot be articulated in a way that it could be, for example, transmitted to the central planner, who would then make resource allocation decisions. 179 00:21:10.840 --> 00:21:18.840 But rather this knowledge can only be utilized by actors in the process of action in the marketplace. 180 00:21:18.840 --> 00:21:26.840 You know, Knight's methodological views, as I mentioned before, are somewhat inconsistent, 181 00:21:26.840 --> 00:21:32.800 but he has some very interesting statements that make him sound much like a Misesian praxeologist, 182 00:21:32.800 --> 00:21:34.520 though perhaps not a consistent one. 183 00:21:34.520 --> 00:21:41.280 For example, one of my favorite quotations from Knight about the importance of a priori 184 00:21:41.280 --> 00:21:46.760 theorizing is the following statement, the first fact to be recorded is that economic 185 00:21:46.760 --> 00:21:54.420 like reality exists or is there. This fact cannot be proved or argued or tested. If anyone 186 00:21:54.420 --> 00:21:59.160 denies that men have interests or that we have a considerable amount of knowledge about 187 00:21:59.160 --> 00:22:05.040 them, we meaning the economist using deductive reasoning, economics and its entire works 188 00:22:05.040 --> 00:22:12.160 will simply be to such a person what the world of color is to the blind man. Okay, so if 189 00:22:12.160 --> 00:22:17.960 If you cannot accept the fact that man acts and that we know certain things and can infer 190 00:22:17.960 --> 00:22:22.920 certain things about action and choice and preference and exchange from the primordial 191 00:22:22.920 --> 00:22:27.960 fact of the existence of economic reality, then, you know, economics is going to be to 192 00:22:27.960 --> 00:22:30.240 you what color is to a blind person. 193 00:22:30.240 --> 00:22:32.920 Okay, night continues, but there would still be one difference. 194 00:22:32.920 --> 00:22:37.980 A man who is physically, ocularly blind may still be rated of normal intelligence and 195 00:22:37.980 --> 00:22:42.120 in his right mind. 196 00:22:42.120 --> 00:22:48.640 And he also says, speaking of the kind of positivism that we associate with his Chicago successors, 197 00:22:48.640 --> 00:22:55.480 the positivism of Friedman's 1953 essay, Knight says this positivism is, quote, the emotional 198 00:22:55.480 --> 00:23:01.000 pronouncement of value judgments condemning emotion and value judgments, which seems to 199 00:23:01.000 --> 00:23:06.160 me a symptom of a defective sense of humor. 200 00:23:06.160 --> 00:23:12.160 Now, I've written on previous occasions about Knight's approach to the entrepreneur, and 201 00:23:12.160 --> 00:23:16.840 in fact, part of the reason for giving this talk is to make a plug for my next book, which 202 00:23:16.840 --> 00:23:21.920 will be coming out later this year, co-authored with Nikolai Foss called Entrepreneurial Judgment 203 00:23:21.920 --> 00:23:27.760 and the Firm, published by Cambridge University Press, which elaborates Knight's theory of 204 00:23:27.760 --> 00:23:33.200 judgment, his approach to the entrepreneur, and its implication for market competition 205 00:23:33.200 --> 00:23:40.120 and so on. And just a few points to be made are that for Knight, contrary to the way Knight 206 00:23:40.120 --> 00:23:44.880 has sometimes been interpreted, the model of perfect competition is not meant as a kind 207 00:23:44.880 --> 00:23:49.960 of ideal that we should strive for or that public policy should try to achieve, but rather, 208 00:23:49.960 --> 00:23:55.580 as I mentioned before, a kind of analytical foil against which real world outcomes can 209 00:23:55.580 --> 00:24:01.880 be understood, analyzed and so on. Entrepreneurship is best conceived as this kind of judgmental 210 00:24:01.880 --> 00:24:07.220 Decision Making by Resource Owners under Conditions of Uncertainty. 211 00:24:07.220 --> 00:24:11.280 So as I mentioned before, judgment cannot be hired on the market, according to Knight, 212 00:24:11.280 --> 00:24:16.040 but is exercised through the ownership and control of resources. 213 00:24:16.040 --> 00:24:21.200 Knight says in Risk, Uncertainty and Profit the following, the only risk, quote unquote, 214 00:24:21.200 --> 00:24:28.200 which leads to a profit is a unique uncertainty resulting from an exercise of ultimate responsibility 215 00:24:28.200 --> 00:24:34.040 which in its very nature cannot be insured nor capitalized nor salaried. 216 00:24:34.040 --> 00:24:39.280 Profit arises out of the inherent absolute unpredictability of things, 217 00:24:39.280 --> 00:24:42.120 out of the sheer brute fact 218 00:24:42.120 --> 00:24:45.800 that the results of human activity cannot be anticipated 219 00:24:45.800 --> 00:24:50.120 and then only in so far as even a probability calculation in regard to them 220 00:24:50.120 --> 00:24:52.280 is impossible and meaningless. 221 00:24:52.280 --> 00:24:56.340 In other words, profit arises out of the sheer brute fact 222 00:24:56.340 --> 00:25:01.440 that we cannot predict the consequences of our actions with certainty. 223 00:25:01.440 --> 00:25:07.440 You've got to love anybody who writes about sheer, brute facts in the context of economic analysis. 224 00:25:07.440 --> 00:25:16.540 Now, this is more or less the same formulation that you get in the proto-Austrian account of Richard Cantillon or Cantillon, if you prefer. 225 00:25:16.540 --> 00:25:24.940 It's implicit and partly explicit in Menger's own approach to the entrepreneur in his 1871 Principles. 226 00:25:24.940 --> 00:25:32.460 And it's very close to the way Mises describes the entrepreneur in Human Action and other works. 227 00:25:32.460 --> 00:25:36.900 Just a couple of quotes from Mises, maybe now you can see them in the back. 228 00:25:36.900 --> 00:25:42.540 Mises says, the term entrepreneur, as used by catallactic theory, meaning the theory of markets, 229 00:25:42.540 --> 00:25:50.700 means acting man exclusively seen from the aspect of the uncertainty inherent in every human action. 230 00:25:50.700 --> 00:25:56.500 So the entrepreneur is the agent acting under conditions of uncertainty, 231 00:25:56.500 --> 00:25:59.460 nightian uncertainty, if you like. 232 00:25:59.460 --> 00:26:02.020 Elsewhere in human action, Mises writes, 233 00:26:02.020 --> 00:26:05.540 the real entrepreneur is a speculator, 234 00:26:05.540 --> 00:26:10.060 a man eager to utilize his opinion about the future structure of the market 235 00:26:10.060 --> 00:26:13.700 for business operations promising profits. 236 00:26:13.700 --> 00:26:19.340 This specific, anticipative understanding of the conditions of the uncertain future 237 00:26:19.340 --> 00:26:23.820 defies any rules in systematization. 238 00:26:23.820 --> 00:26:28.420 So think about what Mises is saying. The real entrepreneur is an economic agent 239 00:26:28.420 --> 00:26:33.180 acting under conditions of uncertainty in pursuit of profit. 240 00:26:33.180 --> 00:26:37.420 And these uncertainties defy rules in systematization. 241 00:26:37.420 --> 00:26:40.740 In other words, they cannot be written as a mathematical, 242 00:26:40.740 --> 00:26:46.380 you know, expected value decision problem with known probabilities and so on. 243 00:26:46.380 --> 00:26:49.220 How am I doing on time, Mr. Moderator? 244 00:26:49.220 --> 00:26:51.980 Okay, where's your sign that says... 245 00:26:51.980 --> 00:26:57.340 No warning? Okay, I do get five minutes, okay. 246 00:26:57.340 --> 00:27:00.380 Well, I'm pretty much done anyway. 247 00:27:00.380 --> 00:27:06.580 Yeah, Joe's just enthralled, he's lost track of time. 248 00:27:06.580 --> 00:27:10.780 So, again, to go back to my slightly cheeky 249 00:27:10.780 --> 00:27:16.220 title of Frank Knight as sort of a forgotten Austrian, really what I have in mind 250 00:27:16.220 --> 00:27:21.220 and what I want to challenge you to think about is, you know, sort of a mild reassessment 251 00:27:21.220 --> 00:27:27.020 of the relationship between Austrian and neoclassical economics. 252 00:27:27.020 --> 00:27:36.020 And by neoclassical, I don't mean the Samuelson, de Bru, Krugman version or whatever is sort of the currently, 253 00:27:36.020 --> 00:27:42.220 whatever you consider to be the currently fashionable flavor of highly formal and technical mathematical analysis, 254 00:27:42.220 --> 00:27:48.420 but rather what we might describe more broadly as the theoretical tradition that came from 255 00:27:48.420 --> 00:27:53.620 Walras, William Stanley Jevons, their successors in Europe and so on. 256 00:27:53.620 --> 00:27:59.220 In other words, the main theoretical school of thought that was sort of a friend to, 257 00:27:59.220 --> 00:28:03.220 though sometimes in opposition to, the Austrian School. 258 00:28:03.220 --> 00:28:10.020 So there are aspects of old neoclassical economics, if you like, 259 00:28:10.020 --> 00:28:21.020 from which Austrians can learn a lot and which have a lot more in common with the writings of Menger and his followers than many of us seem to appreciate. 260 00:28:21.020 --> 00:28:32.020 Sometimes people pull up these quotes from writers like Mises and Hayek implying that there isn't much of a difference between the Austrians and the neoclassicals. 261 00:28:32.020 --> 00:28:38.660 Sorry, Mises says in one of his essays that's in Epistemological Problems of Economics, 262 00:28:38.660 --> 00:28:44.180 he says that the three marginalist schools, those of Menger, Jevons and Volra, quote, 263 00:28:44.180 --> 00:28:49.420 differ only in their mode of expressing the same fundamental idea and are divided more 264 00:28:49.420 --> 00:28:55.140 by their terminology and by peculiarities of presentation than by the substance of their 265 00:28:55.140 --> 00:28:56.140 teachings. 266 00:28:56.140 --> 00:29:01.500 Now that's kind of a startling statement to most of us in the room, right? 267 00:29:01.500 --> 00:29:06.940 Mises thinks that the only difference between Austrian economists and Volrasian economists 268 00:29:06.940 --> 00:29:10.140 is language and style rather than substance. 269 00:29:10.140 --> 00:29:12.900 Well, I don't think that's what Mises meant. 270 00:29:12.900 --> 00:29:20.340 What he did mean is that, look, the thinkers and writers with whom Mises had the biggest 271 00:29:20.340 --> 00:29:27.180 beef were not the neoclassical economists of the day, but rather the anti-theoretical 272 00:29:27.180 --> 00:29:33.220 Economists of the German Historical School, the Old American Institutionalist School, and so on. 273 00:29:33.220 --> 00:29:39.100 Mises is, the context here is that Mises is arguing in defense of theoretical economics 274 00:29:39.100 --> 00:29:46.540 as opposed to a theoretical historicist economics, which Mises condemned in very strong terms. 275 00:29:46.540 --> 00:29:53.660 And what he meant is the other schools of theoretical economics are very close to our own Austrian school 276 00:29:53.660 --> 00:29:58.540 in opposition to other kinds of social thought, right? 277 00:29:58.540 --> 00:30:04.180 So even today, if you were in Di Lorenzo's talk yesterday 278 00:30:04.180 --> 00:30:07.300 and other talks about where Austrians have critiqued 279 00:30:07.300 --> 00:30:10.740 behavioral economics and some kinds of experimental economics 280 00:30:10.740 --> 00:30:15.460 and so on, when I read debates between behavioralists 281 00:30:15.460 --> 00:30:18.100 and sort of traditional Chicago price theory 282 00:30:18.100 --> 00:30:20.460 neoclassical economists, I typically 283 00:30:20.460 --> 00:30:23.060 find myself on the side of the ladder thinking, 284 00:30:23.060 --> 00:30:27.060 Hayek says something similar in his entry that was in the International Encyclopedia of the Social Sciences. 285 00:30:27.060 --> 00:30:32.060 Hayek says the Austrian school, quote, can hardly any longer be seen as a separate school in the sense of representing particular doctrines. 286 00:30:32.060 --> 00:30:39.060 A school has its greatest success when it ceases as such to exist because its leading ideas have become a part of the general understanding of the social sciences. 287 00:30:39.060 --> 00:30:46.060 Hayek says the Austrian school, quote, can hardly any longer be seen as a separate school in the sense of representing particular doctrines. 288 00:30:46.060 --> 00:30:50.220 A school has its greatest success when it ceases as such to exist 289 00:30:50.220 --> 00:30:54.660 because its leading ideas have become a part of the general dominant teaching. 290 00:30:54.660 --> 00:30:58.380 The Vienna School has, to a great extent, come to enjoy such a success. 291 00:30:58.380 --> 00:31:01.500 Now, I think that's an overstatement by Hayek. 292 00:31:01.500 --> 00:31:03.300 I'm sure you would probably agree. 293 00:31:03.300 --> 00:31:06.220 But you can sort of see the point that Hayek is making, 294 00:31:06.220 --> 00:31:12.100 that many of the key insights from the Austrian version of marginalism, 295 00:31:12.100 --> 00:31:42.100 Austrian insights on, you know, the theory of distribution and so on. I mean, many of those have to some extent been incorporated into the mainstream quote unquote. If we define the mainstream broadly enough that we don't just mean MIT style micro theory or, you know, certainly not Keynesian macro or whatever. And again, remember that there was an important school of American economists and also some British economists like Wickstede, right, who were 296 00:31:42.100 --> 00:31:55.100 Followers of Menger and worked very hard to develop aspects of Austrian price theory and to incorporate it with some institutionalist and some Marshallian views. 297 00:31:55.100 --> 00:32:03.100 And remember that these so-called American Austrians or Anglo-American Austrians were very influential on Mises and on Rothbard. 298 00:32:03.100 --> 00:32:33.100 and Rothbard. Actually, Joe Salerno has pointed this out, that there's huge influence of J.B. Clark on Mises, that Mises says that in Boehm-Bawerk's seminar, they read a lot of Clark and Clark's development of what became known as comparative static analysis was very influential on Mises in Mises' development of his own sort of set of analytical tools. And of course, Rothbard's Man Economy and State, if you like, can be interpreted as sort 299 00:32:33.100 --> 00:32:41.100 A blend of Viennese-Austrianism and Wickstede, Fetter, Clark, Davenport, and so on, that 300 00:32:41.100 --> 00:32:49.220 Man Economy and State is littered with insights that come out of these so-called Anglo-American 301 00:32:49.220 --> 00:32:53.980 Austrians, insights that were not really appreciated or not incorporated into the works of Mises, 302 00:32:53.980 --> 00:32:57.540 Hayek, and the previous generation of Austrians. 303 00:32:57.540 --> 00:33:04.080 So to conclude, I published an article in 2008 that was called The Mundane Economics 304 00:33:04.080 --> 00:33:09.380 of the Austrian School, which has been extremely influential in my household, but not much 305 00:33:09.380 --> 00:33:18.340 beyond that, where I try to sort of make the case that some parts of contemporary Austrian 306 00:33:18.340 --> 00:33:26.220 economics may have lost their way to an extent by focusing on some of the more exotic aspects 307 00:33:26.220 --> 00:33:32.180 of Austrianism, rather than the more plain vanilla mundane aspects of value and exchange 308 00:33:32.180 --> 00:33:36.940 and price and so on. Those that were developed in particular by scholars like Fetter and 309 00:33:36.940 --> 00:33:43.520 Wickstede and Davenport and Clark, Rothbard, et cetera. And, you know, in the article I 310 00:33:43.520 --> 00:33:47.840 contrast the view that I'm espousing with the view of some other modern Austrians, like 311 00:33:47.840 --> 00:33:55.020 Karen Vaughan, for example, whose 1994 book on the modern Austrian school has been very 312 00:33:55.020 --> 00:34:06.020 She's very influential in sort of interpreting the Austrian, modern Austrianism, but what Karen Vaughan says about Austrian price theory is mostly derogatory, right? 313 00:34:06.020 --> 00:34:12.020 She says Menger's price theory is that of a quote half-formed neoclassical economist. 314 00:34:12.020 --> 00:34:23.020 She likes Menger's second book on institutions and evolution and so on, but thinks that Menger's principles is really not all that radical or important. 315 00:34:23.020 --> 00:34:27.020 She says, Karen Vons is of Human Action, that it combined quote, some fundamental 316 00:34:27.020 --> 00:34:31.020 Mengerian insights with the apparatus of neoclassical price theory 317 00:34:31.020 --> 00:34:35.020 to the detriment of both. Of Man Economy 318 00:34:35.020 --> 00:34:39.020 and State, she says, it quote, must have seemed to a typical reader 319 00:34:39.020 --> 00:34:43.020 to be more or less familiar economics presented almost exclusively 320 00:34:43.020 --> 00:34:47.020 in words with a few controversial definitions 321 00:34:47.020 --> 00:34:51.020 and some strange discontinuous graphs. 322 00:34:51.020 --> 00:35:21.020 So, from the point of view of an Austrian who is less sympathetic to the price theory of Menger, Mises, and Rothbard, that price theory appears to be kind of similar to neoclassical price theory in many ways, with important differences, of course, and my response to that is to agree with it, that I think there are very important similarities between what we might call good neoclassical economics and the price theory of the Austrians. 323 00:35:21.020 --> 00:35:23.120 and the 324 00:35:23.120 --> 00:35:26.120 differences to be sure, but similarities that deserve to be explored. 325 00:35:26.120 --> 00:35:30.400 Joe has pointed this out in his introduction to the new, the second edition, 326 00:35:30.400 --> 00:35:32.700 second scholars edition of Man, Economy and State, 327 00:35:32.700 --> 00:35:35.760 something that many of us have noticed for a long time. If you just look through the 328 00:35:35.760 --> 00:35:37.980 footnotes of Man, Economy and State, 329 00:35:37.980 --> 00:35:41.080 they're shot through with references to the contemporary literature 330 00:35:41.080 --> 00:35:44.820 in the American Economic Review and the Journal of Political Economy and so on. 331 00:35:44.820 --> 00:35:48.620 You know, up through about 1950 or the mid 1950s. 332 00:35:48.620 --> 00:36:18.620 When Rothbard was writing Man Economy and State in the late 50s, he was learning a lot and gaining a lot of insight from much of what was in the mainstream neoclassical literature of his day, criticizing it to be sure and trying to work through its inconsistencies and contrast it with what he found in Menger and Mises and others. But he was still gaining a lot of insight from that. But by the 1960s, 70s, and 80s, at least from personal correspondence, Rothbard 333 00:36:18.620 --> 00:36:23.700 had lost interest in that aspect of the mainstream tradition, thinking that it had gone too far 334 00:36:23.700 --> 00:36:28.300 from its own sort of correct roots, if you like. 335 00:36:28.300 --> 00:36:34.100 So in other words, to make a long story short, if we place Knight in this same context, being 336 00:36:34.100 --> 00:36:41.740 an important early 20th century economist who drew on the so-called Anglo-American Austrians 337 00:36:41.740 --> 00:36:47.060 as Rothbard did, who was part of that intellectual milieu, and who had a lot of ideas on economic 338 00:36:47.060 --> 00:36:52.020 Theory, that are congenial to Austrians, I think the Austrian School can learn quite 339 00:36:52.020 --> 00:36:57.020 a lot from taking night, reconsidering night, and thinking a little bit more about his contributions.