Koppl Ed. - Austrian Economics and Entrepreneurial Studies (

LIST OF CONTRIBUTORS
David B. Audretsch Institute for Development Strategies,

Indiana University, USA
Nicholas W. Balabkins Department of Economics,
Lehigh University, USA
William J. Baumol Department of Economics,
New York University, USA
Markus C. Becker Department of Marketing,
University of Southern Denmark
Peter J. Boettke James M. Buchanan Center for
Political Economy,
George Mason University, USA
William N. Butos Department of Economics,
Trinity College, USA
Young Back Choi Department of Economics and Finance,
St. John’s University, USA
Christopher J. Coyne James M. Buchanan Center for
Political Economy,
Peter E. Earl School of Economics,
University of Queensland, Australia
Geoffrey M. Hodgson The Business School,
University of Hertfordshire, UK
Randall G. Holcombe Department of Economics,
Florida State University, USA
Stavros Ioannides Department of Political Science and History,
Panteion University, Greece
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x
Thorbjørn Knudsen Department of Marketing,

University of Southern Denmark
Roger Koppl Department of Economics and Finance,
Fairleigh Dickinson University, USA
Richard N. Langlois Department of Economics,
The University of Connecticut, USA
Maria Minniti Division of Economics,
Babson College, USA
G. B. Richardson St. John’s College,
Oxford University, UK
Richard Swedberg Department of Sociology,
Cornell University, USA
A. Roy Thurik Tinbergen Institute,
Erasmus University, The Netherlands
Ulrich Witt Max Planck Institute for Research into Economic
Systems,
Jena, Germany
ADVISORY BOARD
Don Bellante Uskali Mäki

University of South Florida, USA University of Helsinki, Finland
James Buchanan Ferdinando Meacci
George Mason University, USA Università degli Studi di Padova,
Italy
Stephan Boehm
University of Graz, Austria Mark Perlman
University of Pittsburgh, USA
Peter J. Boettke
George Mason University, USA John Pheby
University of Luton, England, UK
Bruce Caldwell
University of North Carolina, USA Warren Samuels
Michigan State University, USA
Jacques Garello
Université d’Aix-Marseille, France Barry Smith
State University of New York, USA
Roger Garrison
Auburn University, USA Erich Streissler
University of Vienna, Austria
Jack High
George Mason University, USA Martti Vihanto
Turku University, Finland
Masazumi Ikemoto
Senshu University, Japan Richard Wagner
Richard N. Langlois
The University of Connecticut, USA Lawrence H. White
University of Missouri, USA
Brian Loasby
University of Stirling, Scotland, UK Ulrich Witt
Max Planck Institute, Germany
Ejan Mackaay
University of Montreal, Canada
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EDITORS’ INTRODUCTION
Publication of Advances in Austrian Economics has been interrupted for several

years. This volume marks the return of the series to regular publication. We
anticipate a new volume at least once a year. We wish to connect the Austrian
tradition of economics with other research traditions in economics and related
areas. To that end, we are planning a series of special issues, each devoted to
a separate theme. The current volume is devoted to “Austrian Economics and
Entrepreneurial Studies.” We are planning future volumes on “Austrian Economics
and the Dynamics of Interventionism” and “Austrian Economics and Evolution-
ary Psychology.” We invite both Austrian and non-Austrian contributions that
establish fruitful links between the Austrian tradition and other perspectives
on important theoretical and practical problems. We seek articles from authors
who are interested in constructive exchange between Austrian economists
and specialists in the theme area. All submissions are subject to double-blind
refereeing. Potential guest editors are invited to submit proposals to the editor.
Our editorial policy is based on the conviction that Austrian economics is not
a doctrine or a method, but a rich tradition of research in the social sciences
whose potential has by no means been exhausted. The tradition began with Carl
Menger’s great 1871 work, Principles of Economics. For more or less accidental
and historical reasons, however, the term “Austrian economics” generally refers
only to that part of Menger’s legacy passing through the work of Ludwig von Mises
and F. A. Hayek. In the years since the Second World War, the Austrian tradition
of Mises and Hayek has been cultivated most actively and self-consciously in the
United States. (The story is best told in Vaughn, 1994.) It must be admitted that
some participants in this “American-Austrian” tradition have treated it as a fixed
doctrine (see Vaughn, 1994, pp. 92–111, especially footnotes 20 and 21). Others,
however, have adopted the view we follow, namely, that Austrian economics is a
living tradition and an open inquiry.
If Austrian economics is an open tradition, then it should have the potential to
engage other traditions in dialogue. It is our intention that Advances in Austrian
Economics be a vehicle for such dialogue. It is probably true that only a minority
of contributors to the current volume, for example, are Austrian economists. Some
might be labeled “ambiguous Austrians.” But all are seriously engaging Austrian
issues and Austrian literature. The volume represents, we believe, a serious
dialogue between Austrian and non-Austrian approaches to entrepreneurship. It
xiii
xiv
is our hope that this volume and others to follow will encourage both the export
of Austrian ideas to other traditions and the import of non-Austrian ideas into the
Austrian tradition.
It is not an accident that two of us are Europeans both by birth and institutional
affiliation. Scholars in many European countries, including Austria, Denmark,
France, and Italy are now making serious contributions to Austrian economics.
It is our hope that Advances in Austrian Economics will serve as a vehicle for
increased communication and cooperation between “Austrians” on both sides of
the Atlantic and, indeed, throughout the world.
REFERENCE
Vaughn, K. (1994). Austrian economics in America: The migration of a tradition. Cambridge, UK:
Cambridge University Press.
GAINS FROM TRADE BETWEEN
AUSTRIAN ECONOMICS AND
ENTREPRENEURIAL STUDIES:
AN INTRODUCTION TO THE VOLUME
Roger Koppl
Austrian economics and entrepreneurial studies have both expanded greatly in the
last 20 or 30 years. Unfortunately, they have developed more or less independently
of each other. Austrian economics has enjoyed a revival since 1973 or 1974. In
1973 Israel Kirzner published his classic book, Competition and Entrepreneur-
ship, which outlined an entrepreneurial theory of the market process. In 1974
F. A. Hayek was awarded the Nobel Memorial Prize in Economics. The same year
saw the famous South Royalton conference, which is the traditional origin of the
“Austrian revival.” The intellectual history of entrepreneurial studies reaches back
at least as far as Richard Cantillon (1755). As an intellectual movement, however,
entrepreneurial studies began about the same time as the Austrian revival. The
beginnings of the entrepreneurship movement might be dated to sometime before
1978 when Babson College established its Center for Entrepreneurial Studies,
the first such center in the U.S. In all this time, however, there has been limited
exchange between Austrian economics and entrepreneurial studies. It is high
time we expanded trade across the border between Austrian economics and
entrepreneurial studies.
Intellectual exchange between these two groups has been frustrated by at least
two factors. Austrians have been discouraged from reading entrepreneurial works
because of the frequent repetition of a famous remark of Ludwig von Mises.
Austrian Economics and Entrepreneurial Studies

Advances in Austrian Economics, Volume 6, 1–7
© 2003 Published by Elsevier Science Ltd.
ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06001-0
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2 ROGER KOPPL
Entrepreneurship, Mises said, “defies any rules and systematization. It can be

neither taught nor learned” (Mises, 1949, p. 584). This remark has been repeated
often in Austrian seminars, usually with the purpose of dismissing the notion
that Austrians might gain from exchange with scholars of entrepreneurship. Such
resistance is surprising in a group so uniformly enthusiastic about free trade. Mises’
remark seems to deny that a theory of entrepreneurship is possible. But Mises’
student Israel Kirzner created just such a theory on the very foundations Mises had
laid down (Kirzner, 1973). It is true, of course, that no one can teach an entrepreneur
the specific innovation that he creates. What, indeed, would that mean? But one
can teach business students the tools and skills required to transform a new idea
into a practical business plan. We can also teach them to be not afraid. We can
teach them, that is, that new ideas can become business plans and that they are
perfectly free to found new enterprises and think new things. Mises’ remark should
no longer discourage Austrians from reading in entrepreneurial studies.
Scholars of entrepreneurship have sometimes been discouraged from reading
much Austrian economics by the apparent limits of Kirzner’s theory. Kirzner
seems to neglect the entrepreneurial process, to view profit opportunities as
external to the entrepreneur, and to restrict entrepreneurship to simultaneous
arbitrage. Koppl and Minniti (2003) have argued that these limits to Kirzner’s
theory “are more apparent than real.” When Kirzner’s theory is placed in the
context of a broader Austrian theory of market process, it is revealed to be more
dynamic than it initially appears. More recent developments within the Austrian
tradition also tend to break down the impression that the Austrian theory is static or
otherwise less than useful in entrepreneurial studies. David Harper, for example,
has developed an “Austrian” theory of the entrepreneurial process (Harper, 1996,
1998). Butos and I have outlined a theory of entrepreneurial learning in which
Kirznerian entrepreneurs are Hayekian learners (Butos & Koppl, 1999; Koppl,
2002). Scholars of entrepreneurship should no longer ignore or dismiss Austrian
theory.
It is hard to predict what gains will come from trade between Austrian economics
and entrepreneurial studies. There is some reason to think, however, that Austrian
economics has a comparative advantage in theoretical unity, while entrepreneurial
studies has a comparative advantage in empirical richness.
In her contribution to this volume, Maria Minniti notes the different meanings
of “entrepreneurship.” “In principle,” she notes, “this diversity of meaning is not
necessarily a problem. In practice, however, the result has been that we are getting
more pieces of the puzzle, but no picture is emerging.” She uses “Kirzner’s theory
as the starting point and unifying theme” of her survey. The Austrian school has
an overarching theoretical framework that might be used to organize much of the
literature in entrepreneurial studies.
Gains from Trade between Austrian Economics and Entrepreneurial Studies 3
Austrian economists have probably devoted too little effort to empirical work
in the past. This trend has changed radically in the last few years as Demmert and
Klein (2003), Koppl (2002), and Keeler (2001) illustrate. Nevertheless, Austrian
economics is still not very well endowed with empirical findings. Scholars of
entrepreneurship, by contrast, have been very energetic in confronting theory
with the facts of history. Entrepreneurial studies is rich with empirical studies of
how entrepreneurs think, what they do, how entrepreneurship is geographically
distributed, whether entrepreneurship is correlated with growth, and so on. In
this volume the contribution of Audretsch and Thurik reviews much of the
empirical literature on entrepreneurship and growth. With their co-authors, they
have made many valuable contributions to this literature. Baumol’s contribution
includes a summary treatment of his historical analysis (Baumol, 1990, 2002) of
the institutions encouraging either productive or unproductive entrepreneurship.
Austrian economists considering entrepreneurship as a research topic should
immerse themselves in such empirical results and, in most cases, make their own
contributions to the empirical literature. I believe Austrian economics has much
to add to the conversation. If so, it is likely that an Austrian perspective can lead
to the discovery of new and interesting facts about entrepreneurship. Looking at
the world from a different angle, we are likely to see what others miss.
Continued exchange between Austrian economics and entrepreneurial studies
is likely to lead to changes in the distribution of comparative advantage. It is my
personal hope that continued exchange will help the budding Austrian tradition
of empirical work to develop further. Entrepreneurial studies may gain from the
“epistemic-cognitive turn” (Boettke, 2002) of the Austrian school. The field of
entrepreneurial studies has produced many theoretical insights and models. If
scholars of entrepreneurship import significant portions of Austrian theory, it is
only a matter of time before they will have improved theories ready for export
to Austrian economics. In the meantime, we can make a few more guesses about
where the initial gains from trade may lie.
I have already suggested that Austrian economics has the potential to make
a significant contribution to the literature on entrepreneurship and economic
growth. In this volume, Boettke and Coyne emphasize the Austrian view that
entrepreneurship is an aspect of all human action. They infer (rightly, I believe)
that institutions decide whether the human disposition to entrepreneurship
produces economic growth. In particular, “the two core institutions, necessary for
achieving the goal of encouraging entrepreneurship, are private property and the
rule of law.” The legal structure is a vital factor deciding whether entrepreneurial
calculations will be farsighted and “rational” in Max Weber’s sense. As their paper
illustrates, Austrian economists emphasize the role of culture in determining how
the “same” institutional structure may function very differently in different places.
4 ROGER KOPPL
Scholars interested in entrepreneurship and growth should probably consult

Audretsch, Baumol and Burke (2001) who discuss the migration of Austrian ideas
to the mainstream literature in industrial organization. Their review provides a
good example of the gains from exchange between Austrian and non-Austrian
traditions. They note a fundamental difference between the arguments for laissez
faire coming from the Chicago and Austrian schools. They “both advocate a laissez
faire approach to regulation, but for very different reasons; the former [Chicago]
on the presumption that the supply of entrepreneurs is infinite in the long-run
while the latter [Austrian] concerns itself with the incentives needed to expand the
limited supply of entrepreneurial resources” (p. 620). The model in Yates (2000)
illustrates their point nicely. In his model of the entrepreneurial market process,
“the market adjustment process is consistent with static Walrasian equilibrium”
when “entrepreneurs do not make mistakes.” If, however, “entrepreneurs do make
mistakes, then the market adjustment process is generally consistent with another
kind of equilibrium” in which a uniform price emerges, but not all units are sold.
In his model, the welfare implications of a tax “cannot be studied in isolation from
the features of the disequilibrium adjustment process that directs the market from
one equilibrium to the other.” He thinks this result “suggests that further study of
disequilibrium and, in particular, market process theory, will illuminate interesting
insights into other welfare issues” (p. 81).
Austrian economists constantly investigate the role of knowledge in society. “It
is characteristic of the Austrian approach,” Richardson notes in his contribution, “to
keep the epistemology, as well as the logic, of decision taking in the foreground.”
His notion of the “structure of their awareness” is an essential insight into who
perceives what profit opportunities. Differences in the structures of firm awareness
contribute to the emergence of enduring capabilities that are hard to replicate. They
are an important source of the differentiation and continuity that allow competition
to function reasonably well.
Butos develops a theme briefly touched on at the end of Richardson’s
essay, namely, the growth of knowledge. He examines the role of Kirznerian
entrepreneurs in generating knowledge. Butos argues that entrepreneurs do not
merely use dispersed knowledge, they produce knowledge. Building in part
on McQuade (see Butos & McQuade, 2002; McQuade & Butos, 2003), Butos
argues “market process involves a transformation of knowledge at the individual
level into a new form of quasi-knowledge” existing at the level of markets,
not individuals. (It is quasi-knowledge rather than knowledge because “the
market order is non-teleological and non-conscious.”) Butos describes markets as
“knowledge-generating entities.”
Entrepreneurs are learners. Entrepreneurship is change in knowledge and
knowledge is a foundational concept in Austrian economics. Thus, it seems
reasonable to hope that a serious look at problems in entrepreneurial studies

though the lens of an Austrian view of knowledge will lead to new results. For
example, casual empiricism suggests that immigrants often become entrepreneurs.
Immigrants would seem to have less knowledge of local culture than natives,
and one might expect this knowledge deficit to thwart entrepreneurship. But if
immigrants are often entrepreneurs, then the knowledge deficit would seem to
have benefits. What view of knowledge might clarify the issues and suggest
testable theories of immigrant entrepreneurship? One good candidate is the
connectionist perspective of Peter Earl’s contribution to this volume. Familiarity
consists partly in the strength of connection between certain ideas. These strong
connections may carry the mind away from crosscutting connections, some of
which may represent entrepreneurial opportunities. A more naive observer may
make such connections more easily than cultural insiders.
Austrian perspectives on knowledge also shed light on an important aspect of
entrepreneurship, namely, leadership. In his contribution to this volume as in other
writings, Ulrich Witt address the issue of cognitive leadership within the firm.
Entrepreneurs typically act through firms. They are the founders and leaders of
business enterprises. An essential leadership function within the firm is to induce
employees to adopt the entrepreneur’s basic business conception and the corre-
sponding workplace values. (He notes that Langlois and I offer a “different, though
related, interpretation” of the same issues in Koppl & Langlois, 2001.) Ioannides
notes that failure to achieve cognitive leadership may cause the entrepreneur’s
organization to “dissolve” into a spontaneous order. The firm may carry on, but
it will no longer function effectively to pursue the founder’s business vision.
The complementary analyses of Witt and Ioannides may be useful to scholars
working on problems of family business. In this context, the founder must exercise
cognitive leadership within the firm, within the family, and across generations.
Randy Holcombe argues that the innovating entrepreneur cannot help himself
from acting as a teacher to other potential entrepreneurs, including his potential
competitors. They are made more alert to opportunities by his example and may
recognize errors or insufficiencies in his business model or the possibility of apply-
ing it elsewhere. McDonald’s gives rise to Burger King and Taco Bell. Holcombe’s
paper develops his earlier argument that entrepreneurship breeds entrepreneurship.
This argument has arisen independently in the entrepreneurship literature in the
work of Minniti (Minniti, 1999; Minniti & Bygrave, 2000, 2001), who uses
non-linear stochastic processes to model certain dynamics of entrepreneurial
choice. The striking overlap here suggests the likely benefits of further exchange
across the border between Austrian economics and entrepreneurial studies.
Joseph Schumpeter is a figure of continuing interest to both Austrian economics
and entrepreneurial studies. My co-editors and I were thus very happy to have
6 ROGER KOPPL
this opportunity to publish his 1928 essay “Entrepreneur” as translated by

Markus Becker and Thorbjørn Knudsen. They made one valuable contribution
to scholarship in the translation and a second valuable contribution with their
introduction. We are pleased to have brief comments on Schumpeter’s essay from
Geoffrey Hodgson, Nicholas Balabkins, Young Back Choi and Richard Swedberg.
A more extensive commentary comes from Richard Langlois who may be viewed,
perhaps, as analyzing Das Joseph Schumpeter Problem. Langlois finds that the
real Problem is not any tension between a supposed early and late Schumpeter,
which is often claimed in the Anglo-American literature on technological change.
The real Problem is Schumpeter’s simultaneous adherence to two different views
of knowledge, one “rationalist,” the other “empiricist.”
Langlois’ interpretation returns us to a theme raised in many contributions to
this volume, namely, knowledge. As Israel Kirzner has taught us, entrepreneurs
innovate and, therefore, entrepreneurship entails change in knowledge. It is
reasonable to expect that Austrian and Austrian-inspired contributions to en-
trepreneurial studies will tend to involve the epistemology of decision taking.
They will tend to involve, that is, a dynamic Austrian view of knowledge and its
growth in market economies. Contributions to Austrian economics from scholars
of entrepreneurship are likely to modify those same Austrian views of knowledge
and to enrich them with grounded empirical studies of how entrepreneurship
operates in the world. This volume shows by example, I think, that continued
interaction between Austrian economics and entrepreneurial studies will enrich
our understanding of markets in exciting, if unpredictable ways.
REFERENCES
Audretsch, D. B., Baumol, W. J., & Burke, A. E. (2001). Competition policy in dynamic markets.
International Journal of Industrial Organization, 19, 613–634.
Baumol, W. J. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political
Economy, 98, 893–921.
Baumol, W. J. (2002). The free-market innovation machine: Analysis of the growth miracle of
capitalism. Princeton: Princeton University Press.
Boettke, P. (2002). Information and knowledge: Austrian economics in search of its uniqueness. The
Review of Austrian Economics, 15, 263–274.
Butos, W. N., & Koppl, R. (1999). Hayek and Kirzner at the Keynesian beauty contest. Journal des
Economistes et de Etudes Humaines, 9, 257–298.
Butos, W. N., & McQuade, T. J. (2002). Mind, market, and institutions: The knowledge problem in
Hayek’s thought. In: J. Birner, P. Garrouste & T. Aimar (Eds), F. A. Hayek: A Political Economist
(pp. 113–133). London and New York: Routledge.
Cantillon, R. (1755) [1931]. Essay on the nature of commerce. H. Higgs (Trans.). London:
Macmillan.
Demmert, H., & Klein, D. B. (2003). Experiment on entrepreneurial discovery: An attempt to demon-
strate the conjecture of Hayek and Kirzner. Journal of Economic Behavior and Organization,
50, 295–310.
Harper, D. (1996). Enterpreneurship and the market process: An inquiry into the growth of knowledge.
London: Routledge.
Harper, D. (1998). Institutional conditions for entrepreneurship. Advances in Austrian Economics, 5,
241–275.
Keeler, J. P. (2001). Empirical evidence on the Austrian business cycle theory. The Review of Austrian
Economics, 14, 331–351.
Kirzner, I. M. (1973). Competition and entrepreneurship. Chicago: University of Chicago Press.
Koppl, R. (2002). Big players and the economic theory of expectations. New York and London: Palgrave
Macmillan.
Koppl, R., & Langlois, R. N. (2001). Organizations and language games. Journal of Management and
Governance, 5, 287–305.
Koppl, R., & Minniti, M. (2003). Market processes and entrepreneurial studies. In: Z. Acs & H.
Audretsch (Eds), Handbook of Entrepreneurship Research: An Interdisciplinary Survey and
Introduction. Boston: Kluwer Academic Publishers.
McQuade, T. J., & Butos, W. N. (2003). Order-dependent knowledge and the economics of science.
Review of Austrian Economics (forthcoming).
Minniti, M. (1999). Entrepreneurship and economic growth. Global Business and Economic Review,
11, 31–42.
Minniti, M., & Bygrave, W. (2000). The social dynamics of entrepreneurship. Entrepreneurship: Theory
and Practice, 24, 25–36.
Minniti, M., & Bygrave, W. (2001). A dynamic model of entrepreneurial learning. Entrepreneurship:
Theory and Practice, 25, 5–16.
Mises, L. von (1949). Human action: A treatise on economics. New Haven, CT: Yale University Press.
Yates, A. J. (2000). The knowledge problem, entrepreneurial discovery, and Austrian market process
theory. Journal of Economic Theory, 91, 59–85.
ENTREPRENEURSHIP STUDIES:
A STOCKTAKING
Maria Minniti
ABSTRACT
In recent years, the topic of entrepreneurship has attracted increasing
attention from academics and policy makers. Although much of the debate
has taken place in business schools, its protagonists are sociologists, psy-
chologists, organization theorists, and, of course, economists. The purpose
of this paper is to take stock of this debate and of what we have learned so
far about entrepreneurship. Using Kirzner’s theory as the starting point and
unifying theme, the paper reviews works about entrepreneurs and what they
do, the socio-economic factors influencing entrepreneurial decisions, the
relationship between entrepreneurship and organizations, and the possible
links between entrepreneurial activity and economic growth.
1. INTRODUCTION
In recent years, the topic of entrepreneurship, broadly defined, has attracted
increasing attention from both policy makers and academics. In 1998, for example,
the OECD launched the program Fostering Entrepreneurship, while the European
Union released the report Fostering Entrepreneurship: Priorities for the Future.
Also, in the last few years, the governments of Finland, Germany, Israel, Italy,
United Kingdom and several other countries have launched a series of initiatives
designed to enhance entrepreneurship and to promote it as a source of employment

Copyright © 2003 by Elsevier Science Ltd.
All rights of reproduction in any form reserved
ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06002-2
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10 MARIA MINNITI
and economic growth (Reynolds et al., 1999). Entrepreneurship is now at center

stage in the public policy arena of many countries and international organizations.
Entrepreneurship has also gained increasing popularity among academics.
Although much of the debate has taken place in business schools, it has had as
protagonists, scholars from a variety of disciplines such as sociology, psychology,
organization theory, and, of course, economics. Unfortunately, because of the
variety of methodological approaches, it is difficult to gain a comprehensive
view of what the academic community at large has learned, if anything, about
entrepreneurship. The purpose of this paper is to take stock of what we have
learned.
Using Kirzner’s theory as the starting point and unifying theme, the purpose of
this paper is to provide a survey of the literature on entrepreneurship for scholars,
in various disciplines, who may be interested in entrepreneurship in general or in
some specific aspect of the entrepreneurial process. Entrepreneurship is clearly a
multifaceted phenomenon. The paper reviews contributions in various disciplines
in the hope of capturing the potential richness that a diverse mix of approaches
can bring to our understanding of the subject. The survey is introductory and does
not pretend to be comprehensive. The list of references, however, should suffice
to provide interested readers with a wide springboard of suggestions.
A proper analysis of the literature requires first a clear understanding of
what the subject of inquiry is about. Unfortunately, one of the limiting features
of entrepreneurship literature is the variety of meaning attributed to the word
entrepreneurship. Already in 1990, Gartner’s survey of business and academic
professionals revealed a diversity of concepts falling under the label “entrepreneur-
ship.” In particular, Gartner’s cluster analysis showed that there exist at least
two different basic concepts of entrepreneurship. The first concept is concerned
with the “characteristics of entrepreneurship”; the second with the “outcomes
of entrepreneurship.” Thus, sometimes entrepreneurship means what the actor is
like; sometimes it means what the actor does. This inconsistency is present even
in research within the same discipline (Gartner, 2001). In principle, this diversity
of meaning is not necessarily a problem. In practice, however, the result has been
that we are getting more pieces of the puzzle, but no picture is emerging and
scholars of entrepreneurship find themselves in the awkward position of using the
same word to identify very different things (Shane & Venkataraman, 2000).
Koppl and Minniti (2003) argue that Kirzner (1973, 1979) provides a
definition in which what the entrepreneur is like determines necessarily what
the entrepreneur does. “In Kirzner’s work, entrepreneurship is first the ‘alert-
ness’ to new opportunities. Entrepreneurs are alert; this is what they are like.
Second, entrepreneurship is seizing an opportunity by taking innovative actions.
Entrepreneurs innovate; this is what they do. Alertness leads to the discovery of
Entrepreneurship Studies 11
new opportunities. If the opportunity discovered is a real one, the entrepreneur

acts on it. Alertness necessarily leads to innovative actions such as founding a
new venture” (Koppl & Minniti, 2003, p. 87). Thus, in Kirzner’s theory, what
the entrepreneur is like determines necessarily what the entrepreneur does.
According to Kirzner, entrepreneurship is a change in the ends-means framework
of the actor. Such change happens because the entrepreneur is “alert” to new
possibilities for action. If the entrepreneur were not alert, he would never adopt
a new ends-means framework, and change in economic life would be impossible.
As a result, alertness is a necessary feature of all human action.
Under the umbrella of Kirzner’s work on entrepreneurship, it is possible to
address, from a variety of angles, the questions of why, when, and how oppor-
tunities arise, and why, when, and how some individuals become entrepreneurs
while others do not. Furthermore, Kirzner’s view allows the investigation of the
connection between individual actions and market dynamics. Thus, it allows
questions about how firms can behave entrepreneurially and about the strategic
implications and the macroeconomic consequences of entrepreneurial activity.
To summarize, Kirzner’s work provides the soundest theoretical framework
for a comprehensive theory of entrepreneurship and, therefore, it is used as the
theoretical umbrella for this paper. Throughout the paper, I move in logical
sequence from microeconomic to macroeconomic topics, and discuss recent
contributions about entrepreneurship and entrepreneurial behavior. Section 2
reviews works about who entrepreneurs are and what they do. Section 3 reviews
contributions related to the socio-economic context within which entrepreneurial
decisions are made. Section 4 reviews the relationship between entrepreneurship
and organizations, and the strategic implications of entrepreneurial behavior.
Section 5 reviews the links between entrepreneurial activity and the economy.
Finally, Section 6 summarizes the discussion, identifies strengths and weaknesses
in the existing literature and suggests directions for further research.
2. ENTREPRENEURS AND NEW VENTURE CREATION

A crucial question in entrepreneurship asks who the entrepreneur is and in what
ways and why he is different from other individuals. An increasing number of
scholars agree that opportunity recognition represents the most distinctive and
fundamental entrepreneurial behavior (Stevenson & Jarillo, 1990; Venkataraman,
1997). In fact, there is wide agreement that entrepreneurs are individuals who
are more likely than others to be “alert” to the identification and exploitation of
profit opportunities (Kirzner, 1973; Low & MacMillan, 1988; Schumpeter, 1934;
Shane & Venkataraman, 2000). As a result, understanding the opportunity
12 MARIA MINNITI
recognition process represents one of the crucial questions for the domain of
entrepreneurship.
Kirzner (1973, 1985) defines alertness as the entrepreneurial element in people’s
actions responsible for our understanding of action as active, creative, and human
rather than as passive, automatic and mechanical. In particular, in his discussion
of alertness, Kirzner argues that the difference between alert and non-alert
individuals lay in the different decisions they make about their circumstances.
Non-alert individuals fail to take advantage of entrepreneurial opportunities
because they misinterpret their market environment and the behaviors appropriate
for their environment. Building upon Kirzner’s theory, Gaglio and Katz (2001)
take a cognitive psychology approach and suggest the existence of a “schema” of
entrepreneurial alertness. They argue that “schema are dynamic, evolving mental
models that represent an individual’s knowledge and beliefs about how physical
and social worlds work” (p. 97). These mental models help direct attention and
guide information processing and reasoning for any specific event. The schema
content and complexity, however, vary among individuals. Thus, perceptions and
interpretations of the world vary among individuals too.
Schema theory assumes that individuals engage in a sort of matching game
between contextual motivations and the content stored in the activated schema
(Fiske & Taylor, 1991; Mitchell & Beach, 1990). Gaglio and Katz (2001) explain
that if the match is sufficiently good, alertness turns into action. If the match is
not good, the collection of additional information is required. In this case, when
contextual motivations are perceived as being unusual or unpredictable, many
individuals never follow the activation of the schema with actions. Under the same
circumstances, however, some individuals do integrate the new information in their
existing schema and, as a result, create new subcategories and causal links. Alert
individuals are those who update their schema to accommodate non-matching
information. Non-alert individuals, instead, only switch the informational content
of their schema. For alert individuals, the enriched complexity and richness of
their schema leads to action even in unusual or unpredictable situations (Fiske &
Taylor, 1991; Sherman et al., 1989).
Alert individuals have more complex schema about change than non-alert
individuals. Their ability to construct and use more complex patterns as a single
unit of information is the mechanism that produces opportunity identification
and, more important, the ability to act upon them. To summarize, according
to Gaglio and Katz (2001), alert individuals possess the ability to adapt to
changing contextual cues and realize that the appropriate behavior at that moment
requires a re-evaluation of their environment. This argument is consistent with
Kirzner’s claim that alert individuals are especially sensitive to signals of market
disequilibrium.
In general, in cognitive psychology, perceptions and interpretations are said to

vary as a result of the schema activated in response to a particular event. Chase
and Simon (1973) and Chi et al. (1982), for example, suggest that differences
in decisions and performances between creative and non-creative individuals can
be traced back to differences in schema content. Differences in activated schema
produce different actions. Individuals possessing more accurate schema do a better
job at projecting expected changes and are able to better tailor their actions to the
changing environment.
Along similar lines, Koppl (2002a, b) adds a more subjective and internal
perspective to the study of entrepreneurial behavior by bringing in the phenomeno-
logical psychology of Alfred Schutz. In Schutz’s system, human knowledge is a
system of typifications, a system of stereotypes and recipes that guide individuals
through our daily activities (Schutz, 1951). The entrepreneur’s knowledge, for
example, is such a structure. According to Koppl, the entrepreneur organizes
his collection of typifications through a system of relevancies. This system of
relevancies guides the entrepreneur and influences the sorts of discoveries he can
make. Any act of entrepreneurship has its meaning for the entrepreneur within
his system of relevancy even as it transforms that system.
From the previous discussion, entrepreneurs emerge as alert and innovative
individuals. Alert is what they are like. There is also general agreement that en-
trepreneurship is seizing an opportunity by taking innovative actions. Innovate is
what entrepreneurs do. Alertness leads to the discovery of new opportunities. If
the opportunity discovered is a real one, the entrepreneur acts on it. Thus, alertness
necessarily leads to innovative actions such as the founding of a new venture.
After having analyzed what prompt alertness, the issue becomes why certain
individuals start new businesses while others do not. A variety of causes has been
indicated as the reasons why some individuals become entrepreneurs. Often, re-
searchers have focused on differences caused by the resources at one’s disposal.
For example, Schumpeter (1934) and Kirzner (1973) discuss the importance of
people’s expectations about the value of available resources. Evans and Jovanovic
(1989), Evans and Leighton (1989), and Kihlstrom and Laffont (1979) discuss
the importance of financial resources. Amit, Mueller and Cockburn (1995), and
Minniti (forthcoming) focus on individuals’ opportunity costs while choosing
between alternative income producing activities. Cooper, Woo and Dunkelberg
(1989), Leazar (2002) and Otani (1996) concentrate on prior experience in deter-
mining employment status choices. Finally, Begley and Boyd (1987) and Minniti
(2001) discuss individuals’ tolerance toward ambiguity.
In general, the question of why certain individuals start new businesses while
others under similar circumstances do not has been related, in both the psychology
and economics literature, to the issue of intentionality and locus of control. Clearly,
14 MARIA MINNITI
starting a business is an intentional act that involves repeated attempts to exercise

control over the process in order to achieve the desired outcome. Although, in some
cases, the environment’s contribution to success may exceed the contribution of
the individual, the act of business creation is clearly intentional. Attribution theory
has been used effectively to address this issue (Shaver et al., 2001).
In general, attribution theory is a tool used by psychologists to account for the
way in which people explain their own actions and the actions of others (Heider,
1958). If the event to be explained consists in performing a task, such as starting a
new business, attribution theory concentrates on the individual’s ability, the indi-
vidual’s effort, the difficulty of the task, and the presence of luck in the performing
of the task. An individual is able to perform a task successfully if his ability exceeds
the task difficulty. In addition to the previous four explanatory factors, attribution
theory takes into account the degree to which the individual intends to produce the
event and whether the individual has enough control over the situation to make the
event happen. If an individual imagines a price discrepancy, thus the opportunity
for entrepreneurial arbitrage, but does not act upon it, whatever the reason, it
means that the price discrepancy does not correspond to an opportunity for him.
In other words, that there is not imagined change in plans that the individual really
prefers to his pre-existing course of action. If the individual does not act upon a
perceived opportunity, it means that there is no opportunity for him. Starting a
business is clearly an intentional act requiring internal control (Shaver et al., 2001).
In attribution theory, the criterion used in making the locus of causality judgment
consists in asking if, under the same circumstances, all individuals would behave in
the same way. If the answer is yes, the cause of action is external to the individual,
and there is no need for internal control. If the answer is no, the cause of action
is internal to the individual, and the latter possess internal control. In the case
of new business creation, the answer is clearly no. The process necessary for the
creation of a new business is multi-layered, complex, and requiring a significant
amount of internal control. The more an event appears to be the product of an
internal cause and under internal control, the more the individual can be held
accountable for that event (Shaver et al., 2001). Of course, the choice to undertake
the steps necessary to the creation of a new venture implies that such actions are
most likely to be acted upon when individuals believe that they will be able to
perform them successfully. Both individual factors and contextual variables enter
into the individual’s judgments. Judgments may be affected by perceptions of one’s
own skills and abilities, generalizations from past entrepreneurial experiences,
the perceived difficulty of the task, or the amount of effort required (Katzell &
Thompson, 1990). Judgments may be also affected by perceptions of contextual
constraints, such as the availability of capital, network contacts, and potential
market demand for the product or service.
Overall, the psychology literature and, in particular, Shaver’s attribution argu-

ment complement Harper’s claim that entrepreneurs tend to have an internal locus
of control (Harper, 1998). Harper draws on Gilad (1982) to argue that an individ-
ual’s “locus of control” influences his degree of alertness. An individual with an
internal locus of control tends to believe that events are “contingent upon his own
behavior or his own relatively permanent characteristics” (Rotter, 1966, p. 1 as
cited in Harper, 1998, p. 248). People with external locus of control tend to see
their actions as less effective in producing outcomes. They see events “as under
the control of powerful others, or as unpredictable because of the great complex-
ity of the forces surrounding them” (Rotter, 1966, p. 1 as cited in Harper, 1998,
p. 249). In Harper’s theory, an internal locus of control increases entrepreneurial
alertness. This increased alertness leads to more learning and, therefore, to more
entrepreneurship.
The locus of control literature draws attention to the fact that the entrepreneurial
process is a multi-layered, complex phenomenon requiring a significant amount
of internal control. Within this context, an additional contribution to our under-
standing of new venture creation comes from sociologists who have focused
on the distinction between “nascent entrepreneurs” and “entrepreneurial cycles”
(Reynolds & White, 1997). A nascent entrepreneur is defined as someone who
initiates activities that are intended to culminate in a viable business start-up. A
nascent entrepreneur is the alert individual who discovers the opportunity and
acts upon it. The “entrepreneurial cycle,” instead, is a sequence of four stages.
The four stages include conception, gestation, infancy and adolescence, and
account for the transition from an individual with a business idea to an individual
entrepreneur, to an infant firm, and, finally, to an established new firm (Reynolds,
1994).
Since entrepreneurship is clearly a process involving many stages of action,
the entrepreneurial cycle concept allows the study of the many different decisions
required of an entrepreneur. If we look at the process from a sufficiently distant
and abstract perspective the particulars fall out of view. This perspective is the one
Kirzner has adopted. In his theory, the stages of the discovery process fall out of
view. But if we look closely, we notice separate stages occurring at different times.
Kirzner’s lack of interest in the stages of the entrepreneurial discovery process
does not imply that they do not exist or that his theory denies their existence. Thus,
the distinction between nascent entrepreneur and the entrepreneurial cycle is
important because it allows researchers to consider new firms as just one possible
outcome, and indeed not the most common, of the entrepreneurial process (Aldrich
& Martinez, 2001). Entrepreneurs are alert to new opportunities. When one is
found, Kirzner says, the entrepreneur has discovered it. Whether the opportunity
the entrepreneur acts upon was already out there, or the entrepreneur creates it,
16 MARIA MINNITI
the opportunity must fit reality and it must conform to its external context and
constraints.
Understanding the sequence of actions required by the entrepreneurial process
and the nature of their outcomes is, to a large extent, contingent upon the context
in which they are taken.
3. THE ENTREPRENEURIAL CONTEXT

Entrepreneurs do not act in a vacuum and entrepreneurial actions take place in
well-defined contexts. Thus, understanding the entrepreneurial process requires
that we consider the context in which entrepreneurs develop their efforts. For
any individual, the entrepreneurial context consists of the knowledge required
by the individual and of the set of more or less binding constraints that are a
function of his social and economic circumstances. Sue Birley, for example,
argues that “there is no dichotomy between entrepreneurs and non-entrepreneurs;
with the right stimulus, the most unexpected people can become entrepreneurs”
(Wright, 2001, pp. 37–38). As a result, understanding the entrepreneurial context
requires the understanding of what socio-economic variables provide incentives
for individuals to become entrepreneurs, whether or not certain conditions are
more conducive to entrepreneurial success than others, and, most important, what
knowledge potential entrepreneurs possess of their environment.
Much of the literature on entrepreneurial knowledge is consistent with the
literature discussing internal control and with the methodological subjectivism
and process orientation of the Austrian approach. Different people know different
things. Knowledge is contextual. Thus, the knowledge that guides economic
decision-making is dispersed among many independently acting agents (Yates,
2000). The knowledge of what to produce, how to produce it, and so on is scattered
across many different economic actors. The Austrian knowledge problem is that of
coordinating this dispersed knowledge. Entrepreneurial knowledge is just a specific
case of the Austrian knowledge problem. Hayek recognized that the division of
labor produces a division of knowledge and showed how the market process solves
the knowledge problem through decentralized decision-making (Hayek, 1948). If
the market is a spontaneous order in Hayek’s sense, then market participants have
only partial understandings of it. Because of this knowledge asymmetry, alert
individuals in the market can always profit from the discovery of new opportunities
within the system. This is why Hayek was led to describe the market competition
as a “discovery procedure” (Hayek, 1978). Hayek’s theory of the market as a
discovery procedure forms an essential part of Kirzner’s notion of entrepreneurial
discovery.
In Kirzner’s theory of entrepreneurship, discovery is not only possible in the

market; it is necessary. Those who discover new techniques enjoy profits. Those
sticking to the old ways of doing things suffer losses. The idea of entrepreneurial
discovery is important for understanding the acquisition of knowledge for
entrepreneurial activities. In the case of entrepreneurship, the knowledge required
is often knowledge about opportunities created by the environment or by the
possibility of a new product or process. The founding of a new business often
requires entrepreneurs to improvise. Because of the trial and error period charac-
teristic of any improvisation, the entrepreneurial process is a non-institutionalized
form of acquiring knowledge. “Their heuristic-based logic gives entrepreneurs
a competitive advantage in quickly learning about new changes and what the
implication of those changes are for the development of specific discoveries”
(Aldrich & Martinez, 2001, p. 50).
Along complementary lines, Choi (1993a, b) argues that, in society, people
have the possibility of acquiring knowledge from others’ practices. Trial and error
processes in society generate conventions. That is, people identify mutually com-
patible “paradigms.” These conventions make social life possible. Their stability,
however, makes innovation difficult. Social and economic practices, therefore,
tend to continue through time, even as experiences of different individuals might
suggest to some that by adopting alternative paradigms, profit is possible. The
entrepreneur discovers the neglected opportunities and tries to capture them. In
the process, the prevailing practices are transformed. Choi calls the process of
entrepreneurial discoveries and their eventual adoption by the rest of the society
a social learning process.
When studying the context of entrepreneurial decisions, in addition to issues
related to knowledge, Low and MacMillan (1988) stress the importance of study-
ing entrepreneurship in a contextual and process-oriented way. In particular, they
view entrepreneurship as either the result of strategic adaptation, or as emerging
from the ecology of a given population. The strategic adaptation perspective
emphasizes the pro-active behavior of individuals whom, after having identified
opportunities, gather the resources necessary to exploit these opportunities and
create the strategies required for their exploitation. The crucial issue in this line
of research is entrepreneurial knowledge. The population ecology approach,
instead, emphasizes external factors such as the sources of opportunities and the
mechanisms used for selecting specific sets of actions necessary to increase the
likelihood of exploiting successfully any particular opportunity. The underlying
assumption of this line of research is that the environment of entrepreneurial
decisions is formed, among other things, by the characteristics of other orga-
nizations in the population. The crucial issue in this line of research is social
capital.
18 MARIA MINNITI
Social capital is important because it allows individuals to obtain resources that

are otherwise unavailable to them (Aldrich, 1999; Davidsson & Honig, 2002).
Transforming an idea into a new organization requires entrepreneurs to acquire
a variety of resources and to allocate attention among multiple tasks (Greene &
Brown, 1997). In this context, social capital is important because actions involving
innovation and multiple tasks present ambiguous environments (March & Olsen,
1976). In the case of entrepreneurship, for example, the individual may lack knowl-
edge about the subsidiary activities necessary to the working of the venture. When
the business environment is not transparent, the set of necessary tasks and their
characteristics is fuzzy and the entrepreneur cannot be assumed to know the true
structure of his decision-making model. If an entrepreneur is willing to act on a
perceived opportunity, it is because he believes to possess a comparative advantage
in that specific market. But he does not have a comparative advantage in coping
with ambiguity. Thus, he focuses his attention on his specific talent while coping
with ambiguity by leveraging cues and information provided by the behavior of
other entrepreneurs.
Everything else being the same, the larger the number of entrepreneurs he
observes, the lower the ambiguity he experiences (Minniti, 2001). By observing
others, our potential entrepreneur acquires information and skills. He meets other
individuals who have similar or complementary expertise. Throughout this process
his social environment becomes important and the access to a certain amount of
broadly defined social capital helps him to define the set of his entrepreneurial
tasks. The existence of a significant number of entrepreneurs also legitimizes
his activity and enables him to exploit a number of established routines. In fact,
researchers have shown that when choosing in an ambiguous environment, agents
tend to base their decisions on social cues (Aldrich, 1999). Aldrich and Zimmer
(1986), in particular, have shown that participation in social networks is a
crucial element for entrepreneurs. Saxenian (1990) has argued that much of
the success of Silicon Valley is to be attributed to its availability of social
capital.
The role played by social capital in entrepreneurial decisions is best understood
in the context of the literature on embeddedness (Jack & Anderson, 2002), and
the literature on social networks (Aldrich, 1999; Aldrich & Fiol, 1994).
Embeddedness defined as the nature, depth, and extent of an individual’s ties
into the environment, has recently been indicated as one of the relevant elements
of the market process (Dacin et al., 1999; Jack & Anderson, 2002; Uzzi, 1997).
Individuals are viewed as being embedded in ongoing systems of social relations
(Granovetter, 1985). In the context of entrepreneurship Carsrud and Johnson
(1989) argue that the exploitation of business opportunities is strongly influ-
enced by interdependencies that mold the patterns of social interactions among
individuals. Embeddedness is relevant to entrepreneurship because it helps the

entrepreneur to identify resources and constraints when committing to founding
a new organization. Jack and Anderson (2002) argue that entrepreneurship is
not merely an economic process but draws from the social context which shapes
and forms entrepreneurial outcomes. According to their analysis, embedding
is the mechanism whereby an entrepreneur becomes part of the local structure
and learns how to draw upon and use the resources provided by available social
capital.
Much research about embeddedness exploits Giddens’ view of structuration as
a theoretical framework to explore the link between the entrepreneur and his social
context (Giddens, 1979, 1984). Applying structuration to the study of entrepreneur-
ship enables sociologists to recognize how social structures affect and encourage
entrepreneurial activity, particularly in terms of resource availability or constraint
(Jack & Anderson, 2002). As a result, this approach contributes directly to our
understanding of what external conditions are more conducive to entrepreneurial
behavior and, possibly, entrepreneurial success. In fact, some researchers claim
that embedding enables entrepreneurs to recognize and realize opportunities that
fit the specific needs of a local situation and, under certain conditions, endows
entrepreneurs with a competitive advantage. Chell and Baines (2000), for example,
find that the information and resources gathered by being embedded compensated
for environmental constraints and, as a result, facilitate the entrepreneurial
process.
In her work in development, Emily Chamlee-Wright takes an Austrian view
of entrepreneurship and explains how cultural meanings influence entrepreneurs
(Chamlee-Wright, 1997). Her ethnographic approach complements and supports
the embeddedness view. Among other things, Chamlee-Wright provides useful
case studies illustrating the importance of trust, reputation, and personal rela-
tionships in regulating the supposedly anonymous forces of the market. Each
culture and each market has its own mechanisms for producing trust. Thus,
Chamlee-Wright shows that entrepreneurs are cultural figures. One the one hand,
entrepreneurs’ actions reflect the cultural environment in which they act. On the
other hand, their actions are an important influence on the culture in which they
operate. Development theory should take account of the role of entrepreneurs as
cultural figures.
The embedding process embraces the cultural structure of a community and
consists in understanding the nature of the structure and the perpetuation of the
structure while enriching its complexity (Johannisson, 1988; Weick, 1969). The
networks, ties and relationships of the entrepreneur determine the level of his
embeddedness in the environment. Thus, social networks provide the mechanism
for becoming embedded.
20 MARIA MINNITI
The contribution of the literature on social networks to our understanding of

the entrepreneurial process lies in its illustration of how entrepreneurs embed as
a mechanism to pursue and exploit opportunities. The social network approach
illustrates how opportunity recognition and realization are conditioned by the
dynamics of the entrepreneur and the social structure (Aldrich & Martinez, 2001).
If entrepreneurship is embedded in a social context, then it must build upon
society. The implicit argument is that when studying the entrepreneur, the context
has to be taken into account because the social environment is more than simply
the sum of its individual components (Minniti, 2001).
A network of social relationships is important to an entrepreneur because it
gives him access to the resources possessed by others in the community or industry.
The location of the entrepreneur within the larger community is important because
it affects his ability to acquire resources. Finally, the strength of the relationship
with contacts is important because it determines the entrepreneur’s ability to
exploit the resources provided by his community. In fact, entrepreneurial actions
are conditioned by ongoing structures of social relations (Jack & Anderson,
2002). Aldrich and Zimmer (1986), for example, argue that entrepreneurship
is embedded in a social context. Also, Carsrud and Johnson (1989) claim that
entrepreneurial activity is encouraged or inhibited by individuals’ positions in a
social network and that entrepreneurs are dependent upon the information and
resources provided by social networks.
In the context of social networks, population density and relational density
have been shown to affect the survival of new businesses too (Baum & Mezias,
1992; Hannan & Carroll, 1992; Hannan & Freeman, 1989). Individuals trying
to create new ventures in populations with high density find more opportunities
to learn effective knowledge and create extensive social networks, but they also
encounter more intense competition (Baum & Oliver, 1992; Delacroix & Rao,
1994). Relational density, by increasing the legitimacy of a whole population,
protects new entrepreneurs from potential constraints from other social forces
(Zucker, 1989).
Clearly, other contextual variables are relevant for entrepreneurship. In addition
to knowledge and social capital, several economic circumstances are crucial to
entrepreneurial behavior. Variables relating to external conditions such as the
availability of financing, labor markets, and quality of existing infrastructure, in
other words, issues related to the economy, have all been shown to be important.
Most of the work in those areas has been conducted by economists who study
these topics in finance, labor economics and industrial organization. Although
an extended review of this literature is beyond the scope of this survey, it is
worth listing some of the contributions that, in various fields, deal directly with
entrepreneurs and entrepreneurship as discussed in the two previous sections
of this paper. Among others, Evans and Jovanovic (1989), Evans and Leighton
(1989), and Kihlstrom and Laffont (1979) discuss the importance of financial
resources and constraints on entrepreneurial decisions. Gifford (1998) and
Murphy et al. (1991) discuss the optimal allocation of human resources. Gromb
and Scharfstein (2002) and Hamilton (2000) discuss the interdependence between
entrepreneurial decisions and conditions in the labor market. Leazar (2002) argues
that entrepreneurs are jacks-of-all-trades who may not excel at any one skill
but are competent in many, and links entrepreneurial decisions to the previous
work experiences of the entrepreneur. Gompers and Lerner (2001), Kortum
and Lerner (2001), and Lerner and Gompers (2001) discuss entrepreneurship
and venture capital. Finally Gompers and Lerner (forthcoming) discuss initial
private offerings. In line with neoclassical methodology, most of these studies
use representative agent models and focus on issues of scarcity and allocational
efficiency rather than on the behavioral attributes of the individual.
4. ENTREPRENEURIAL FIRMS AND STRATEGIC

DECISIONS
The discussion of the discovery and exploitation of opportunities expands often
from individuals’ actions to the actions of firms and organizations. Gartner
(1985, 1990) argues that entrepreneurship is about “organizing” and that the
entrepreneurial process is more likely to be understood through the study of
firms’ behavior. Thus, research on the characteristics, context and actions of the
individual entrepreneur leads to research into the nature, antecedents and effects
of firm-level entrepreneurial activities.
The identification of entrepreneurial behavior at the firm level is a difficult task
though some consensus exists around the idea that entrepreneurship is a resource
for the firm and, when properly exploited, contributes to the firm’s profitability
and competitive position. In recent years, the literature in industrial organization,
strategy, and organization theory has moved from discussing how to re-engineer
firms to how to “re-invent” them, a process in which firms are continuously
refocused as they search for new opportunities (Oster, 1999). In this area,
entrepreneurship becomes a strategic capability of the firm and the integration
between entrepreneurship, industrial organization and strategy occurs naturally
(McGrath & MacMillan, 2000). Along similar lines, Barney (2002) defines the
field of strategy as the study of firms’ theories about how to gain competitive
advantages. Indeed, one way for firms to earn economic profits is to see and
seize new lucrative opportunities before entry has accomplished its profit leveling
function in the industry. Firms exhibiting this ability are entrepreneurial firms. In
22 MARIA MINNITI
particular, entrepreneurial firms may be described as those exhibiting openness to

new ideas, the willingness to commit resources to the exploitation of these ideas,
and the ability to match opportunities to their core competencies (Oster, 1999).
The bulk of this research belongs in the realm of organization theory and of
the theory of the firm. Although strong links exist, a review of works in these
areas is beyond the scope of a survey on entrepreneurship studies. An exception,
however, must be made for recent studies on corporate entrepreneurship. Research
on corporate entrepreneurship tries to identify organizational and environ-
mental factors that affect a company’s entrepreneurial activities (Peterson &
Berger, 1972; Zahra, 1991). Earlier researchers in this area give special attention
to the process by which established firms venture into new business fields and
discuss the factors that influence the success of corporate ventures (Burgelman,
1983a, b, c). More recently, however, researchers have begun examining the
linkages between environmental, strategic, and organizational variables, and a
company’s entrepreneurial activities (Miller, 1983).
Stopford and Baden-Fuller (1994) summarize how the strategy literature
identifies three types of corporate entrepreneurship. The first type is the creation
of new ventures within an existing organization. The second type is the broader
activity associated with transforming the structure of an existing firm. The third
type is found when a firm is able to change the competitive environment of
its industry, for example, by introducing a significant innovation in product or
process. Finally, additional works distinguish between entrepreneurial disposition
(Covin & Slevin, 1988; Miller, 1983), orientation (Lumpkin & Dess, 1996) and
actions (Zahra, 1995) in the context of corporate competitive behavior.
Clearly, it is not easy for a firm to behave “entrepreneurially.” Organizations,
especially large ones, tend to be characterized by significant inertia. It is a human
tendency to shape expectations about the future on the basis of the past and, as
a result, to create incentives that promote an entrepreneurial attitude at the level
of organization is difficult. To behave entrepreneurially, in addition to a flexible
organizational structure, firms need a variety of tangible and intangible assets.
Stevenson and Jarillo (1990), for example, focus on the principal-agent issues
related to the fact that, for a firm to behave entrepreneurially, management is
dependent on other individuals and groups within the firm and discuss to the impor-
tance of firm culture. Guth and Ginsberg (1990) develop a more specific argument
and claim that firm-level entrepreneurship embodies the two key components of
innovation and new venture creation. Among other things, firms need the ability
to match perceived opportunities with their core competencies and the willingness
and ability to commit resources to the exploitation of those opportunities. On
the latter point, the literature in strategy and organization theory has become
increasingly aware of the importance of heterogeneous firm assets in achieving a
firm’s sustainable competitive advantage. In particular, the role of entrepreneur-

ship as one of the heterogeneous assets available to the firm has been addressed
in the context of the resource-based and transaction costs views of the firm
(Alvarez, 2003).
Barney (1986) and Dierickx and Cool (1989) were the first to draw attention
to the importance of tacit, socially complex, assets, and to argue that the behavior
of the entrepreneurial firm is best understood using the resource-based and the
transactions cost views of the firm (Alvarez, 2003). The resource-based approach
to firm behavior suggests that the returns earned by firms are largely attributable
to the resources they held. Specifically, the resource-based view implies that firm
resources, capabilities, and competencies facilitate the development of sustainable
competitive advantages (Barney, 1986, 1991; Hitt & Ireland, 1985; Rumelt,
1991). The intuition is that strategic behavior is contingent and dependent upon
the specific resources available to a firm and that competitive advantages are
achieved when firms are successful in leveraging the resources. Winter has argued
that an organization’s knowledge, for example, is a profitable strategic asset
if meets three criteria: (1) the knowledge is tacit rather than articulate; (2) the
knowledge is not observable in use; and (3) the knowledge is complex rather than
simple (Winter, 1987). But if it is true that a firm’s competitive position is defined
by its unique resources and their continuous adjustment over time in response to
competitive pressures, then entrepreneurship and resource heterogeneity become
complementary (Alvarez, 2003). Kirzner (1997) too argues that heterogeneous
resources are a necessary condition for entrepreneurial behavior to exist. In
addition, entrepreneurial opportunities exist if, and only if, individuals perceive
resources as having different values, and if individuals with high perceived values
are willing and capable of mobilizing the unexploited potential (Casson, 1982;
Kirzner, 1979).
While the resource-based view of the firm focuses on the role played by hetero-
geneous resources on entrepreneurial behavior, the transaction costs approach
to the firm provides a way to analyze the relationship between entrepreneurial
behavior and firm profitability. Both Kirzner (1979) and Schumpeter (1934)
describe the entrepreneur as an individual capable of improving upon the current
allocation of resources by directing inputs into certain processes rather than others.
In this context, the role of the entrepreneur is to use his knowledge to redistribute
undervalued resources thereby improving allocative and productive efficiency. The
transactions cost approach addresses the production and organizational activities
of the firm as unique coordination activities in which entrepreneurial actions result
in superior firm performance and a potential source of competitive advantage.
Coase (1937) suggests that as a firm’s size increases, the costs of organizing
additional internal transactions rise and, as a result, the returns to entrepreneurial
24 MARIA MINNITI
behavior decrease. Thus, Coase (1937) attributes to the entrepreneur the role of
coordinator of production within the firm. The need for coordination arises from
the fact that the internal allocation of resources is not subject to the discipline
imposed by the market. The transaction cost view illustrates how, as the size of
the firm increases, the critical role played by the entrepreneur is lost because the
knowledge the entrepreneur possesses about the resource structure within the firm
is diluted. Williamson (1975, 1985) develops this point further and argues that a
primary role of the firm is to economize on transaction costs and that, as a result,
innovation is more likely to occur in smaller than larger firms though larger firms
are more effective at manufacturing and distributing innovations (Oster, 1999).
Unfortunately, no general agreement exists on what makes a firm entre-
preneurial. Even more, no general agreement exists on the role played by
entrepreneurship on firm profitability. Jennings and Seaman (1994), for example,
argue that there may be no performance differences between entrepreneurial and
conservative firms. Although it is easy to see that first-mover firms that incur
the greatest risk and expenditure on innovative activities are often rewarded in
the marketplace, it is also true that firms may enjoy greater long-term benefits
from imitation strategies than from high levels of innovation (Nelson & Winter,
1982).
As the discussion about entrepreneurship progresses and moves from the
individual to the firm level, the question of the potential aggregate effects of
entrepreneurial behavior arises. Is more entrepreneurship desirable? Is there a
relationship between entrepreneurial behavior and economic growth? Recent
empirical studies have shown that economic activity in the 1980s shifted from
large firms to small firms (Acs & Audretsch, 1993; Carlsson, 1992) and that the
amount of entrepreneurial activity differs significantly across countries and across
different regions of the same country (Reynolds et al., 2001).
5. ENTREPRENEURSHIP AND
MACROECONOMIC ACTIVITY
Since Schumpeter’s 1934 classic work, the study of possible linkages between
entrepreneurship and economic growth has remained the domain of economists.
The topic, however, has been largely ignored for a long time as neo-classical growth
theory concentrated mainly on the contribution of labor and capital to the growth
process (Denison, 1985; Solow, 1970). Since it did not fit in standard neo-classical
systems, theorists working with analytical models neglected entrepreneurship and
simply treated it as part of the residuals that cannot be attributed to any measurable
productive input (Baumol, 1983, 1993a). Only recently, new growth theory has
provided ways to endogenize the long-run rate of economic growth and, as a

result, entrepreneurship has been considered explicitly as a form of human capital
accumulation usually linked to the long run size of the firm (Bates, 1990; Iyigun
& Owen, 1998; Otani, 1996; Schmitz, 1989) or as the engine for innovation and
productivity increases (Aghion & Howitt, 1992; Calvo & Wellisz, 1980).
Baumol (1983, 1990, 1993b) provides a comprehensive approach to the study
of entrepreneurship and its relationship to economic growth. Baumol’s theory
unites entrepreneurs in their common motivation, but segregates them based on
their contribution to society. In particular, Baumol (1990) classifies entrepreneurs
into the three distinct groups of productive, unproductive and destructive. When
linking entrepreneurship to economic growth, Baumol relies on productive
entrepreneurs and identifies the two main contributions of entrepreneurship to
economic activity as the productions of new entry and of innovation. Also,
Baumol (1993a) convincingly argues that, as a result of entry and innovativeness,
the channel through which entrepreneurship influences growth is productivity. He
identifies entrepreneurship, investment in innovation, and technology transfers,
together with contextual variables such as capital investment and education, as the
endogenous variables in an iterative process in which the first group of variables
affect productivity, which, in turn, influences the contextual variables after
some lag.
In the wake of the new growth theory literature, a few complementary
models have been proposed for the study of entrepreneurship and its impact
on macroeconomic variables. Iyigun and Owen (1998) propose variations of
endogenous growth models in which entrepreneurship appears as a special form
of human capital. Aghion and Howitt (1992), instead, build directly on Romer’s
(1990) classic model of endogenous growth and focus on the role played by the
R&D sector in providing new production techniques. In their view, a producer
adopting an innovation is rewarded with economic profits until a new technique is
found which replaces his innovation. The intermediate variable of innovativeness,
because of its ability to produce change, is shown to be an engine of growth. To
some extent, Aghion and Howitt capture the substance of Schumpeter’s idea of
creative destruction. In other words, the fact that economic change results from the
actions of profit-seeking entrepreneurs, whose quest for monopoly rents produces
innovation, new products, and, indirectly, economic growth (Wennekers &
Thurik, 1999).
Since Aghion and Howitt, much of this literature has come to identify
entrepreneurship with the engine behind innovation. Lumpkin and Dess (1996)
argue that a key dimension of an entrepreneurial orientation is an emphasis
on innovation. Wennekers and Thurik (1999) claim that the ability to produce
innovation is the main contribution of entrepreneurship to macroeconomic
26 MARIA MINNITI
dynamics. Finally, Acs (1992) identifies the entrepreneurial sector with small
firms and argues that the latter play an important role in the economy because
of their ability and propensity to innovate, their contribution to employment, and
their ability to stimulate industry evolution.
Unlike previous neoclassical models, the endogenous growth literature allows
the study of entrepreneurial behavior because of its ability to move beyond
representative agent models and to include issues related to increasing returns,
spillovers and multiple equilibria. The introduction of increasing returns and
spillovers allows the construction of formal models that can account for en-
trepreneurial learning and for the role of social capital on entrepreneurial decisions.
The possibility of multiple equilibria, instead, allows the construction of formal
models in which entrepreneurial behavior and the resulting level of entrepreneurial
activity emerge as the unintended and unpredictable consequences of the norms
and history of a community. Combined, these features allow economics models
to incorporate insights from sociology and evolutionary psychology into the
study of entrepreneurship. In fact, increasing returns and multiple equilibria have
both been used to study the relationship between entrepreneurship and economic
growth in alternative approaches that complement the neoclassical view.
Minniti (1999, 2001, forthcoming) links complexity theory to the study of
entrepreneurship. Her work provides a model of the relationship between en-
trepreneurial behavior and aggregate entrepreneurial activity in which increasing
returns to local knowledge and social capital spillovers create non-pecuniary
externalities that reduce ambiguity and encourage entrepreneurship. These
dimensions are consistent with Hayek’s notion of spontaneous order in the
sense that, as in many complex phenomena, the aggregate outcome “cannot
be reduced to the regularities of the parts” (Hayek, 1967, p. 74). In particular,
Minniti (forthcoming) shows that, when information is evenly distributed, the
number of entrepreneurs remains low even when agents are highly alert, whereas,
when information is asymmetrically distributed, entrepreneurship increases and
concentrates geographically. Her results are consistent with observed clustering
of entrepreneurial activity in otherwise similar regions.
Minniti (2001) also shows that if the entrepreneur is a catalyst of further
economic activity then entrepreneurship breeds entrepreneurship, the aggregate
level of entrepreneurial activity within an economy is uncertain, and that the
level of entrepreneurship is determined through a path dependent process. Along
similar lines, Holcombe (1998, 2003) argues that every time an entrepreneur
seizes a new opportunity, the possibility for new markets is created. When an
entrepreneur fills a niche in his market, resources are mobilized, the possi-
bility of complementary products or services is created and, as a result, new
entrepreneurial opportunities exist. Thus, the entrepreneur is an equilibrator
within his market and, simultaneously, a catalyst of activity for the economy as
a whole.
An additional framework helpful when analyzing the relationship between
entrepreneurship and the macroeconomy is the evolutionary approach developed
by Nelson and Winter. Nelson and Winter (1982) argue that technical change
is the driving force of long-run growth and that, in order to understand their
interdependence, it is necessary to consider the variety of behavior and perfor-
mance of individual firms, as well as the dynamics of the competitive process.
Although they do not consider entrepreneurship explicitly, Nelson and Winter’s
argument relies on Schumpeter’s (1934) view of economic development and
Simon’s (1991) explanations of human and organizational behavior. Instead of
the standard neo-classical concept of equilibrium and optimization, they take
an evolutionary approach and use the concepts of tendencies and decision rules.
Nelson and Winter borrow from biology and view firms as possessing a genetic
endowment of technical routines and procedures that, over time, evolve and adapt.
In the end, the competitive process at the sector level selects the most successful
routines and weeds out the routines, which are no longer suitable. So innovation
and selection are the engines of growth. The process of allocating resources and
their distribution through the entry and exit of firms constitutes the mechanism of
competitive selection among different business ideas and projects.
The evolutionary approach of Nelson and Winter is complementary to Audretsch
and Thurik’s (1997) argument that economic growth results from the straggle of
the managed and the entrepreneurial sectors. Audretsch and Thurik (1997) is just
an example of a small but significant body of recent literature addressing explicitly
the relationship between the small business sector and economic growth (Acs &
Audretsch, 1993; Acs et al., 1999; Carree et al., 2000; Thurik, 1996; Wennekers
& Thurik, 1999). Like Acs (1992), these works identify entrepreneurship with the
small business sector and study industry dynamics and the contribution to GDP
growth of various groups of firms classified by size. These works take an eco-
nomic approach and contribute significantly to our understanding of the dynamic
of business ownership and its impact on development, of the relationship between
employment, self-employment and development, and of firm-size distribution and
economic growth.
Finally, when discussing the relationship, if any, between entrepreneurship and
macroeconomic activity, it is important to consider the role paid by government
regulation and public policy. In addition to the cultural norms discussed in
Section 3, governments and political activity in general also influence the context
within which individuals make entrepreneurial decisions. Government actions
and political events create new institutional structures for entrepreneurial action,
encouraging some activities and discouraging others (Dobbin & Dowd, 1997).
28 MARIA MINNITI
Public policy shapes the rules of competition and creates niches where investment
and entrepreneurial activities may be perceived as being more or less attractive.
Harper (1998) argues explicitly that the nature of our political and economic
institutions influences alertness. Those institutions and policies that improve
transparency and entitlement tend to increase the subjective perception of the link
between actions and outcome. They increase, therefore, the number of individuals
who have an internal locus of control. Harper’s central argument is that “an
environment of freedom is more likely than other environments to generate
internal locus of control beliefs and acute entrepreneurial alertness” (1998,
p. 253). Government regulation also affects the fate of individual organizations
and entire industries as well, for example, by disrupting established ties between
organizations and resources (Carroll, Delacroix & Goodstein, 1988; Stinchcombe,
1965). Finally, Baumol (1990) argues that institutional arrangements affect
the quantity and type of entrepreneurial efforts and that “. . . the exercise of
entrepreneurship can sometimes be unproductive or even destructive, and that
whether it takes one of these directions or one that is more benign depends heavily
on the structure of payoffs in the economy – the rules of the game” (Baumol, 1990,
pp. 898–899).
In general, the legal and institutional framework is crucial in determining
the quantity and quality of entrepreneurial behavior. Legal incentives for en-
trepreneurship are mainly rooted in the fiscal regime and in the laws concerning
bankruptcy, they also influence individuals’ perceptions of legal transparency
and entitlement. Competition rules, instead, address the regulation of entry, trade
barriers and anti-trust policy. Overall, the institutional framework defines the
incentives for individuals to transform perceived opportunities into actions, and
contribute significantly to determine to what extent the external environment is
supportive of and conducive to entrepreneurial behavior.
6. CONCLUSION
Using Kirzner’s theory as the starting point and unifying theme, this paper
provides a survey of the literature on entrepreneurship in various disciplines.
Who is the entrepreneur? According to Kirzner, the entrepreneur is an alert
individual. Entrepreneurship is a change in the ends-means framework of this
individual. Such change happens because the potential entrepreneur is “alert”
to new possibilities for action. Kirzner argues that the differences between alert
and non-alert individuals lay in the alternative evaluations they make about their
circumstances. Similarly, cognitive psychology suggests the existence of schema.
That is, evolving mental models of entrepreneurial alertness. Alert individuals
have more complex schema about change than non-alert individuals. The
phenomenological psychology view is consistent with this interpretation and adds
systems of typification and relevancy. Any act of entrepreneurship has its meaning
for the entrepreneur within his system of relevancy. Systems of typification and
schema differ across individuals and, in some cases, prompt alertness.
Why do systems of typification and entrepreneurial schema vary across individ-
uals? This question is addressed, in both the psychology and economics literature,
by looking at intentionality and locus of control. Individuals with an internal locus
of control believe that events are contingent upon their own behavior. Thus, an
internal locus of control increases entrepreneurial alertness and, as a result, leads
to more entrepreneurship. The locus of control literature draws attention to the fact
that the entrepreneurial process is a multi-layered and complex phenomenon.
What does the entrepreneur do? The entrepreneur innovates and, by doing so,
creates new ventures of some sort. The sociology literature addresses this issue
by distinguishing between nascent entrepreneurs and entrepreneurial cycles. The
entrepreneurial cycle is the sequence of stages necessary for the transition from
an individual with an opportunity to an established new firm. The establishment
of a new venture requires the choice and the commitment to a specific set
of actions.
What determines the specific sequence of entrepreneurial actions selected by
the entrepreneur? The actions required by the entrepreneurial cycle are contingent
upon the context in which they are taken. Understanding the entrepreneurial
context requires the understanding of what socio-economic variables provide
incentives for individuals to become entrepreneurs, and, most important, what
knowledge entrepreneurs possess of their environment. The Austrian literature
suggests that the knowledge problem is that of coordinating dispersed knowledge.
Entrepreneurial knowledge is just a specific case of the Austrian knowledge
problem. To complement the Austrian view, the strategic adaptation literature
emphasizes the pro-active behavior of individuals whom, after having identified
opportunities, gather the resources necessary to exploit these opportunities. The
population ecology approach, instead, emphasizes external factors such as the
sources of opportunities and the availability of social capital.
Is social capital relevant to entrepreneurial decisions? The sociology literature
stresses that social capital is important because it allows individuals to obtain
resources that are otherwise unavailable to them. The role played by social capital
in entrepreneurial decisions is best understood in the context of embeddedness and
social networks. Embeddedness is relevant to entrepreneurship because it helps the
entrepreneur to identify resources and constraints when committing to founding
a new organization. Social networks, instead, improve the entreprenur’s ability to
pursue and exploit commercial opportunities.
30 MARIA MINNITI
But what happens after the initial stages of the entrepreneurial process have
taken place? Does entrepreneurship cease to exist or does it become irrelevant?
The study of the entrepreneurial context leads organically to research into firm-level
entrepreneurial activities. In this context, the literature on strategy and corporate
entrepreneurship identifies organizational and environmental factors that affect a
firm’s entrepreneurial behavior. For example, the resource-based approach views
entrepreneurship as one of the possible resources upon which the competitive
advantage of the firm is built. The transaction costs approach, instead, analyzes the
relationship between entrepreneurial behavior and firm profitability and identifies
entrepreneurial actions as the source of coordination activities that result in superior
performance.
As the discussion about entrepreneurship progresses and moves from the
individual to the firm level, the question of the aggregate effects of entrepreneurial
behavior arises. Is more entrepreneurship desirable? Is there a relationship
between entrepreneurial behavior and economic growth? Recent empirical
studies show that the amount of entrepreneurial activity differs significantly
across countries and across different regions of the same country with potentially
significant effects on business activity and development. The neo-classical
economics approach argues that, as a result of entry and innovativeness, the
channel through which entrepreneurship influences growth is productivity.
Complementary models exploit the insight of complexity and evolutionary theory
to add social and cultural circumstances to the allocational and distributional
issues raised by endogenous growth studies.
Finally, is there a connection between entrepreneurship, governments, and
institutions? Government actions and political events certainly create institutional
structures that may encourage or thwart entrepreneurial action. Those institutions
and policies that improve transparency and entitlement tend to increase the
subjective perception of the link between actions and outcome. This is so because
they ultimately increase the number of individuals who have an internal locus of
control.
Overall, and in spite of so many different approaches, there seems to be a
movement towards agreeing that entrepreneurship is about emergence. Low and
MacMillan (1988) suggest that research on entrepreneurship should focus on
new firm creation and its role in promoting economic progress. Shane and
Venkataraman (2000), on the other hand, suggest that the field of entrepreneurship
should study the discovery and exploitation of entrepreneurial opportunities, the
individuals involved, and the modes of action used to exploit the opportunities.
Both views focus on the creation of new economic activity. In contrast, Gartner
(1985, 1990, 2001) takes the position that entrepreneurship is about organiz-
ing and that it has a greater likelihood of being understood through the study
of firm creation. Importantly, both Low and MacMillan (1988) and Shane and
Venkataraman (2000) also include in the stated purpose of entrepreneurship a clear
interest in societal-level outcomes. Aldrich and Martinez (2001), while applying
a view similar to Gartner’s on entrepreneurship as “the creation of new organiza-
tions,” start from the more aggregate-level interest of sociology and hence find it
natural for entrepreneurship to consider societal-level outcomes.
The review of topic and approaches presented in this paper shows clearly that
entrepreneurship is a multi-faceted phenomenon. Further research is needed in
all areas to understand the motivations and logic behind entrepreneurial behavior
and its impact on individuals, firms, and macroeconomic activity. If we take
entrepreneurship seriously, we recognize its complexity. The rules and practices
of the entrepreneurial processes are complex. They are embedded in the socio-
economic environment of the entrepreneur and include past experiences, culture
and institutions, and random accidents. Hopefully, we are on our way to studying
better entrepreneurial behavior and to find new ways to understand the complex.
ACKNOWLEDGMENTS
Financial support from the W. F. Glavin Center for Global Management is
gratefully acknowledged. Many thanks go to Roger Koppl and an anonymous
referee for helpful comments and suggestions. All errors are mine.
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ENTREPRENEURSHIP,
INDUSTRY EVOLUTION AND
ECONOMIC GROWTH
David B. Audretsch and A. Roy Thurik
ABSTRACT
The purpose of this paper is to provide a link between entrepreneurial activity
on the one hand, and industry evolution and economic growth on the other.
The role that entrepreneurship plays in innovative activity is explained. The
link between entrepreneurship and industry evolution through the spillover
of knowledge in generating entrepreneurial activity is analyzed. This implies
that the relationship between entrepreneurship and growth is identified. In
particular, this paper finds that entrepreneurship generates a positive pulse
in the evolution of industries in such a way that fosters economic growth.
1. INTRODUCTION
Explanations for economic growth have generally been restricted to the realm of
macroeconomics (Krugman, 1991; Romer, 1990). However, a different scholarly
tradition linking growth to industrial organization dates back at least to Schumpeter
(1934). In his 1911 classic treatise, Theorie der wirtschaftlichen Entwicklung,
Schumpeter proposed a theory of creative destruction, where new firms with
entrepreneurial spirit displace the tired old incumbents, ultimately leading to a
higher degree of economic growth. Even in his 1942 classic, Capitalism, Socialism

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06003-4
39
40 DAVID B. AUDRETSCH AND A. ROY THURIK
and Democracy, Schumpeter (1942, p. 13) still argued that entrenched large
corporations tend to resist change, forcing entrepreneurs to start new firms in order
to pursue innovative activity, “The function of entrepreneurs is to reform or revo-
lutionize the pattern of production by exploring an invention, or more generally, an
untried technological possibility for producing a new commodity or producing an
old one in a new way . . . To undertake such new things is difficult and constitutes
a distinct economic function, first because they lie outside of the routine tasks
which everybody understands, and secondly, because the environment resists in
many ways.”
The purpose of this paper is to provide a link between entrepreneurial activity
on the one hand, and industry evolution and economic growth on the other. In
Section 2 of this paper, the role that entrepreneurship plays in innovative activity
is explained. The link between entrepreneurship and industry evolution is the focus
of Section 3. In Section 4, the spillover of knowledge in generating entrepreneurial
activity is analyzed. In Section 5, the relationship between entrepreneurship and
growth is identified. Finally, in Section 6 conclusions are presented. In particular,
this paper finds that entrepreneurship generates a positive pulse in the evolution of
industries in such a way that fosters economic growth.
2. INNOVATION AND ENTREPRENEURSHIP

The increased importance of knowledge as a source of competitiveness for OECD
countries suggests that the organization of industries most conducive to innovative
activity will be linked to higher growth rates (Audretsch & Thurik, 2000, 2001).
The starting point for most theories of innovation is the firm. In such theories the
firms are exogenous and their performance in generating technological change is
endogenous. For example, in the most prevalent model found in the literature of
technological change, the model of the knowledge production function, formalized
by Griliches (1979), firms exist exogenously and then engage in the pursuit of
new economic knowledge as an input into the process of generating innovative
activity.
The most decisive input in the knowledge production function is new economic
knowledge. And as Cohen and Klepper (1991, 1992) conclude, the greatest source
generating new economic knowledge is generally considered to be R&D. Certainly
a large body of empirical work has found a strong and positive relationship between
knowledge inputs, such as R&D, on the one hand, and innovative outputs on the
other hand.
The knowledge production function has been found to hold most strongly at
broader levels of aggregation. The most innovative countries are those with the
Entrepreneurship, Industry Evolution and Economic Growth 41
greatest investments to R&D. Little innovative output is associated with less

developed countries, which are characterized by a paucity of production of new
economic knowledge. Similarly, the most innovative industries, also tend to be
characterized by considerable investments in R&D and new economic knowledge.
Not only are industries such as computers, pharmaceuticals and instruments
high in R&D inputs that generate new economic knowledge, but also in terms
of innovative outputs (Audretsch, 1995). By contrast, industries with little R&D,
such as wood products, textiles and paper, also tend to produce only a negligible
amount of innovative output. Thus, the knowledge production model linking
knowledge generating inputs to outputs certainly holds at the more aggregated
levels of economic activity.
Where the relationship becomes less compelling is at the disaggregated
microeconomic level of the enterprise, establishment, or even line of business.
For example, while Acs and Audretsch (1990) found that the simple correlation
between R&D inputs and innovative output was 0.84 for four-digit standard
industrial classification (SIC) manufacturing industries in the United States, it
was only about half, 0.40 among the largest U.S. corporations.
The model of the knowledge production function becomes even less compelling
in view of the recent wave of studies revealing that small enterprises serve as
the engine of innovative activity in certain industries. These results are startling,
because as Scherer (1991) observes, the bulk of industrial R&D is undertaken in
the largest corporations; small enterprises account only for a minor share of R&D
inputs. Thus the knowledge production function seemingly implies that, as the
Schumpeterian Hypothesis predicts, innovative activity favors those organizations
with access to knowledge-producing inputs – the large incumbent organization.
The more recent evidence identifying the strong innovative activity raises the
question, “Where do new and small firms get the innovation producing inputs, that
is the knowledge?”
One answer, proposed by Audretsch (1995), is that, although the model of the
knowledge production function may still be valid, the implicitly assumed unit of
observation – at the level of the firm – may be less valid. The reason why the
knowledge production function holds more closely for more aggregated degrees
of observation may be that investment in R&D and other sources of new knowledge
spills over for economic exploitation by third-party firms.
This spillover can occur in various ways: social interaction, change of employer
and, the main focus of this paper, the exploitation of that knowledge in a new
organization. Stinchcombe (1965) distinguishes five conditions under which
people will be motivated to form an organization. First of all, they know a better
way of doing things that are not easily done within the existing organization.
Second, they believe that the new organization will be profitable enough to pay
for the trouble of building it. Third, they will receive some of the benefits. Fourth,
they can lay hold of the resources and, finally, they can defeat, or at least avoid
being defeated by their opponents.
Concerning the second condition, a large literature has emerged focusing
on what has become known as the appropriability problem. The underlying
issue revolves around how firms that invest in the creation of new economic
knowledge can best appropriate the economic returns from that knowledge
(Arrow, 1962). Audretsch (1995) proposes shifting the unit of observation away
from exogenously assumed firms to individuals – agents with endowments of
new economic knowledge. But when the lens is shifted away from focusing upon
the firm as the relevant unit of observation to individuals, the relevant question
becomes, How can economic agents with a given endowment of new knowledge
best appropriate the returns from that knowledge?
The appropriability problem confronting the individual may converge with that
confronting the firm. Economic agents can and do work for firms, and even if they
do not, they can potentially be employed by an incumbent firm. In fact, in a model
of perfect information with no agency costs, any positive economies of scale or
scope will ensure that the appropriability problems of the firm and individual con-
verge. If an agent has an idea for doing something different than is currently being
practiced by the incumbent enterprises – both in terms of a new product or process
and in terms of organization – the idea, which can be termed as an innovation, will
be presented to the incumbent enterprise. Because of the assumption of perfect
knowledge, both the firm and the agent would agree upon the expected value of
the innovation. But to the degree that any economies of scale or scope exist, the
expected value of implementing the innovation within the incumbent enterprise
will exceed that of taking the innovation outside of the incumbent firm to start a
new enterprise. Thus, the incumbent firm and the inventor of the idea would be
expected to reach a bargain splitting the value added to the firm contributed by the
innovation. The payment to the inventor – either in terms of a higher wage or some
other means of remuneration – would be bounded between the expected value of
the innovation if it implemented by the incumbent enterprise on the upper end,
and by the return that the agent could expect to earn if he used it to launch a new
enterprise on the lower end. Thus, each economic agent would choose how to best
appropriate the value of his endowment of economic knowledge by comparing the
wage he would earn if he remains employed by an incumbent enterprise, w, to the
expected net present discounted value of the profits accruing from starting a new
firm, ␲. If these two values are relatively close, the probability that he would choose
to appropriate the value of his knowledge through an external mechanism such as
starting a new firm, Pr(e), would be relatively low. On the other hand, as the gap be-
tween w and ␲ becomes larger, the likelihood of an agent choosing to appropriate
the value of his knowledge externally through starting a new enterprise becomes
greater, or
Pr(e) = f (␲ − w) (1)
This model refocuses the unit of observation away from firms deciding whether to
increase their output from a level of zero to some positive amount in a new industry,
to individual agents in possession of new knowledge that, due to uncertainty, may
or may not have some positive economic value. Once one drops the assumption
of perfect information, both firm and economic agent are confronted with uncer-
tainty. It is this uncertainty inherent in new economic knowledge, combined with
asymmetries between the agent possessing that knowledge and the decision mak-
ing vertical hierarchy of the incumbent organization with respect to its expected
value, that potentially leads to a gap between the valuation of that knowledge.
How the economic agent chooses to appropriate the value of his knowledge, that
is either within an incumbent firm or by starting or joining a new enterprise will be
shaped by the knowledge conditions underlying the industry. Under what Nelson
and Winter (1982) term as the routinized technological regime the knowledge
conditions will be favorable to innovation by established firms. Secrecy, patent
protection or difficulties to imitate will tend the agent to appropriate the value of
his new ideas within the boundaries of incumbent firms. Thus, the propensity for
new firms to be started should be relatively low in industries characterized by the
routinized technological regime.
By contrast, under the entrepreneurial regime the agent will tend to appropriate
the value of his new ideas outside of the boundaries of incumbent firms by starting
a new enterprise. Thus, the propensity for new firms to enter should be relatively
high in industries characterized by the entrepreneurial regime.
Audretsch (1995) suggests that divergences in the expected value regarding new
knowledge will, under certain conditions, lead an agent to exercise what Albert
O. Hirschman (1970) has termed as exit rather than voice, and depart from an
incumbent enterprise to launch a new firm. But who is right, the departing agents
or those agents remaining in the organizational decision making hierarchy who,
by assigning the new idea a relatively low value, have effectively driven the agent
with the potential innovation away? Ex post the answer may not be too difficult.
But given the uncertainty inherent in new knowledge, the answer is anything but
trivial a priori.
Thus, when a new firm is launched, its prospects are shrouded in uncertainty.
If the new firm is built around a new idea, i.e. potential innovation, it is uncertain
whether there is sufficient demand for the new idea or if some competitor will
have the same or even a superior idea. Even if the new firm is formed to be an
exact replica of a successful incumbent enterprise, it is uncertain whether sufficient
demand for a new clone, or even for the existing incumbent, will prevail in the
future. Tastes can change, and new ideas emerging from other firms will certainty
influence those tastes.
Finally, an additional layer of uncertainty pervades a new enterprise.
Stinchcombe (1965) named four conditions that make up his “liability of new-
ness”; social conditions that affect the survival rate of new organizations. These
conditions are: the ease of obtaining skills; the degree of initiative and responsibil-
ity within the workforce; the trustworthiness of strangers; and finally, the strength
of the ties between customers and established firms.
In our modern society, with extensive law and emancipated customers, the
third and fourth condition are such that they usually do not affect the survival
rate in a negative way. But the first two conditions still remain. It is not known
how competent the new firm really is, in terms of management, organization, and
workforce. At least incumbent enterprises know something about their underlying
competencies from past experience. Which is to say that a new enterprise is
burdened with uncertainty as to whether it can produce and market the intended
product as well as sell it. In both cases the degree of uncertainty will typically
exceed that confronting incumbent enterprises.
3. INDUSTRY EVOLUTION
This initial condition of not just uncertainty, but greater degree of uncertainty
vis-à-vis incumbent enterprises in the industry is captured in the theory of firm
selection and industry evolution proposed by Boyan Jovanovic (1982). Jovanovic
presents a model in which the new firms, which he terms entrepreneurs, face costs
that are not only random but also differ across firms. A central feature of the model is
that a new firm does not know what its cost function is, that is its relative efficiency,
but rather discovers this through the process of learning from its actual post-entry
performance. In particular, Jovanovic (1982) assumes that entrepreneurs are unsure
about their ability to manage a new-firm startup and therefore their prospects for
success. Although entrepreneurs may launch a new firm based on a vague sense of
expected post-entry performance, they only discover their true ability – in terms of
managerial competence and of having based the firm on an idea that is viable on the
market – once their business is established. Those entrepreneurs who discover that
their ability exceeds their expectations expand the scale of their business, whereas
those discovering that their post-entry performance is less than commensurate
with their expectations will contact the scale of output and possibly exit from the
industry. Thus, Jovanovic’s model is a theory of noisy selection, where efficient
firms grow and survive and inefficient firms decline and fail.
The theory of firm selection is particularly appealing in view of the rather

startling size of most new firms. For example, the mean size of more than 11,000
new-firm startups in the manufacturing sector in the United States was found
to be fewer than eight workers per firm (Audretsch, 1995). While the minimum
efficient scale (MES) varies substantially across industries, and even to some
degree across various product classes within any given industry, the observed size
of most new firms is sufficiently small to ensure that the bulk of new firms will
be operating at a suboptimal scale of output. Why would an entrepreneur start a
new firm that would immediately be confronted by scale disadvantages?
An implication of the theory of firm selection is that new firms may begin
at a small, even suboptimal, scale of output, and then if merited by subsequent
performance expand. Those new firms that are successful will grow, whereas those
that are not successful will remain small and may ultimately be forced to exit from
the industry if they are operating at a suboptimal scale of output. See Audretsch,
van Leeuwen, Menkveld and Thurik (2001).
An important implication of the dynamic process of firm selection and industry
evolution is that new firms are more likely to be operating at a suboptimal scale
of output if the underlying technological conditions are such that there is a greater
chance of making an innovation, that is under the entrepreneurial regime. If new
firms successfully learn and adapt, or are just plain lucky, they grow into viably
sized enterprises. If not, they stagnate and may ultimately exit from the industry.
This suggests, that entry and the startup of new firms may not be greatly deterred
in the presence of scale economies. As long as entrepreneurs perceive that there is
some prospect for growth and ultimately survival, such entry will occur. Thus, in
industries where the MES is high, it follows from the observed general small size
of new-firm startups that the growth rate of the surviving firms would presumably
be relatively high.
At the same time, those new firms not able to grow and attain the MES level of
output would presumably be forced to exit from the industry, resulting in a relatively
low likelihood of survival. In industries characterized by a low MES, neither the
need for growth, nor the consequences of its absence are as severe, so that relatively
lower growth rates but higher survival rates would be expected. Similarly, in indus-
tries where the probability of innovating is greater, more entrepreneurs may actu-
ally take a chance that they will succeed by growing into a viably sized enterprise.
In such industries, one would expect that the growth of successful enterprises would
be greater, but that the likelihood of survival would be correspondingly lower.
How are the new firms, many of which operate at a suboptimal scale of output,
able to exist? The answer according to the studies on post-entry survival and
growth is that they cannot – at least not indefinitely. Rather, they must growth to
at least approach the MES level of output. An alternative answer is provided by
recent studies focusing on the relationship between firm size, age and employee
compensation (Audretsch, 1995). By deploying a strategy of compensating factor
differentials, where factor inputs are both deployed and remunerated differently
than they are by the larger incumbent enterprises, suboptimal scale enterprises
are to some extent able to offset their size-related cost disadvantages.
Just as it has been found that the gap between the MES and firm size lowers
the likelihood of survival, there is evidence suggesting that factors of production,
and in particular labor, tend to be used more intensively (that is, in terms of hours
worked) and remunerated at lower levels (in terms of employee compensation).
Taken together, the empirical evidence on survival and growth combined with that
on wages and firm size suggests how it is that small, suboptimal scale enterprises
are able to exist in the short run. In the initial period of learning, during which
time the entrepreneur discovers whether he has the right stuff and whether he is
able to adapt to market conditions, new firms are apparently able to reduce the
cost of production in order to compensate for their small scale of production.
In the current debate on the relationship between employment and wages it is
typically argued that the existence of small firms which are sub-optimal within
the organization of an industry represents a loss in economic efficiency. This
argument is based on a static analysis, however. When viewed through a dynamic
lens a different conclusion emerges. One of the most striking results is the finding
of a positive impact of firm age on productivity and employee compensation, even
after controlling for the size of the firm. Given the strongly confirmed stylized fact
linking both firm size and age to a negative rate of growth (that is the smaller and
younger a firm, that faster it will grow but the lower is its likelihood of survival),
this new finding linking firm age to employee compensation and productivity sug-
gests that not only will some of the small and sub-optimal firms of today become
the large and optimal firms of tomorrow, but there is at least a tendency for the
low productivity and wage of today to become the high productivity and wage of
tomorrow.
What emerges from the new theories and empirical evidence on innovation
and industry evolution is that markets are in motion, with many firms entering the
industry and a large number of firms exiting from the industry. But is this motion
horizontal, in that the bulk of firms exiting are comprised of firms that had entered
relatively recently, or vertical, in that a significant share of the exiting firms had
been established incumbents that were displaced by younger firms? In trying
to shed some light on this question, Audretsch (1995) proposes two different
models of the evolutionary process of industries over time. Some industries
can be best characterized by the model of the conical revolving door, where
new businesses enter, but where there is a high propensity to subsequently exit
from the market. Other industries may be better characterized by the metaphor
of the forest, where incumbent establishments are displaced by new entrants.

Which view is more applicable apparently depends on three major factors – the
underlying technological conditions, scale economies, and demand. Where scale
economies play an important role, the model of the revolving door seems to be
more applicable. While the rather starting result discussed above that the startup
and entry of new businesses is apparently not deterred by the presence of high
scale economies, a process of firm selection analogous to a revolving door ensures
that only those establishments successful enough to grow will be able to survive
beyond more than a few years. Thus, the bulk of new entrants that are not so
successful ultimately exit within a few years subsequent to entry.
There is at least some evidence also suggesting that the underlying technological
regime influences the process of firm selection and therefore the type of firm with
a higher propensity to exit. Under the entrepreneurial regime new entrants have a
greater likelihood of making an innovation. Thus, they are less likely to decide to
exit from the industry, even in the face of negative profits. By contrast, under the
routinized regime the incumbent businesses tend to have the innovative advantage,
so that a higher portion of exiting businesses tend to be new entrants. Thus, the
model of the revolving door is more applicable under technological conditions
consistent with the routinized regime, and the metaphor of the forest, where the
new entrants displace the incumbents – is more applicable to the entrepreneurial
regime.
Why is the general shape of the firm-size distribution not only strikingly
similar across virtually every industry – that is, skewed with only a few large
enterprises and numerous small ones – but has persisted with tenacity not only
across developed countries but even over a long period of time? The evolutionary
view of the process of industry evolution is that new firms typically start at a very
small scale of output. They are motivated by the desire to appropriate the expected
value of new economic knowledge. But, depending upon the extent of scale
economies in the industry, the firm may not be able to remain viable indefinitely at
its startup size. Rather, if scale economies are anything other than negligible, the
new firm is likely to have to grow to survival. The temporary survival of new firms
is presumably supported through the deployment of a strategy of compensating
factor differentials that enables the firm to discover whether or not it has a viable
product.
The empirical evidence supports such an evolutionary view of the role of new
firms in manufacturing, because the post-entry growth of firms that survive tends
to be spurred by the extent to which there is a gap between the MES level of
output and the size of the firm. However, the likelihood of any particular new
firm surviving tends to decrease as this gap increases. Such new suboptimal
scale firms are apparently engaged in the selection process. Only those firms
offering a viable product that can be produced efficiently will grow and ultimately
approach or attain the MES level of output. The remainder will stagnate, and
depending upon the severity of the other selection mechanism – the extent
of scale economies – may ultimately be forced to exit out of the industry.
Thus, the persistence of an asymmetric firm-size distribution biased towards
small-scale enterprise reflects the continuing process of the entry of new firms
into industries and not necessarily the permanence of such small and sub-optimal
enterprises over the long run. Although the skewed size distribution of firms
persists with remarkable stability over long periods of time, a constant set of small
and suboptimal scale firms does not appear to be responsible for this skewed
distribution.
4. KNOWLEDGE SPILLOVERS
The recent wave of studies revealing that small enterprises serve as the engine of
innovative activity in certain industries (Acs & Audretsch, 1988, 1990; Audretsch,
1995) is particularly startling, because the bulk of industrial R&D is undertaken
in the largest corporations; small enterprises account for only a minor share
of R&D inputs (Cohen & Klepper, 1992; Scherer, 1992). Thus, the model of
the knowledge production function seemingly implies that innovative activity
favors those organizations with access to knowledge-producing inputs – large
organizations. The more recent evidence identifying the role of small firms as a
source of innovative activity raises the question, Where do entrepreneurial small
firms get the innovation producing inputs, that is the knowledge?
One suggested answer is that although the model of the knowledge production
function may certainly be valid, the implicitly assumed unit of observation
which links the knowledge inputs with the innovative outputs – at the level of
the establishment or firm – may be less valid. Instead, a new literature suggests
that knowledge spills over from the firm or research institute producing it to a
different firm commercializing that knowledge (Griliches, 1992). This view is
supported by theoretical models which have focused on the role that spillovers
of knowledge across firms play in generating increasing returns and ultimately
economic growth (Krugman, 1991; Romer, 1986).
An important theoretical development is that geography may provide a relevant
unit of observation within which knowledge spillovers occur. The theory of local-
ization suggests that because geographic proximity is needed to transmit knowl-
edge and especially tacit knowledge, knowledge spillovers tend to be localized
within a geographic region. The importance of geographic proximity for knowl-
edge spillovers has been supported in a wave of recent empirical studies by Jaffe
(1989), Jaffe, Trajtenberg and Henderson (1993), Acs, Audretsch and Feldman
(1992, 1994), Audretsch and Feldman (1996) and Audretsch and Stephan (1996).
That knowledge spills over is barely disputed. In disputing the importance of
knowledge externalities in explaining the geographic concentration of economic
activity, Krugman (1991) and others do not question the existence or importance
of such knowledge spillovers. In fact, they argue that such knowledge externalities
are so important and forceful that there is no compelling reason for a geographic
boundary to limit the spatial extent of the spillover. According to this line of
thinking, the concern is not that knowledge does not spill over but that it should
stop spilling over just because it hits a geographic border, such as a city limit, state
line, or national boundary. The claim that geographic location is important to the
process linking knowledge spillovers to innovative activity in a world of e-mail,
fax machines and cyberspace may seem surprising and even paradoxical. The res-
olution to the paradox posed by the localization of knowledge spillovers in an era
where the telecommunications revolution has drastically reduced the cost of com-
munication lies in a distinction between knowledge and information. Information,
such as the price of gold on the New York Stock Exchange, or the value of the Yen
in London, can be easily codified and has a singular meaning and interpretation.
By contrast, knowledge is vague, difficult to codify and often only serendipitously
recognized. While the marginal cost of transmitting information across geographic
space has been rendered invariant by the telecommunications revolution, the
marginal cost of transmitting knowledge, and especially tacit knowledge, rises with
distance.
Von Hipple (1994) demonstrates that high context, uncertain knowledge, or
what he terms as sticky knowledge, is best transmitted via face-to-face interaction
and through frequent and repeated contact. Geographic proximity matters in
transmitting knowledge, because as Kenneth Arrow (1962) pointed out some
three decades ago, such tacit knowledge is inherently non-rival in nature, and
knowledge developed for any particular application can easily spill over and have
economic value in very different applications. As Glaeser, Kallal, Scheinkman
and Shleifer (1992, p. 1126) have observed, “intellectual breakthroughs must
cross hallways and streets more easily than oceans and continents.”
The importance of local proximity for the transmission of knowledge spillovers
has been observed in many different contexts. It has been pointed out that, “business
is a social activity, and you have to be where important work is taking place.”1 A sur-
vey of nearly one thousand executives located in America’s sixty largest metropoli-
tan areas ranked Raleigh/Durham as the best city for knowledge workers and for
innovative activity.2 The reason is that “A lot of brainy types who made their way to
Raleigh/Durham were drawn by three top research universities . . . U.S. businesses,
especially those whose success depends on staying at the top of new technologies
and processes, increasingly want to be where hot new ideas are percolating. A pres-
ence in brain-power centers like Raleigh/Durham pays off in new products and new
ways of doing business. Dozens of small biotechnology and software operations
are starting up each year and growing like kudzu in the fertile climate.”3 Almeida
(1996) shows that foreign firms use local plants to tap in to local knowledge.
Not only did Krugman (1991, p. 53) doubt that knowledge spillovers are not ge-
ographically constrained but he also argued that they were impossible to measure
because “knowledge flows are invisible, they leave no paper trail by which they
may be measured and tracked.” However, an emerging literature (Jaffe, Trajtenberg
& Henderson, 1993) has overcome data constraints to measure the extent of knowl-
edge spillovers and link them to the geography of innovative activity. Jaffe (1989),
Feldman (1994) and Audretsch and Feldman (1996) modified the model of the
knowledge production function to include an explicit specification for both the spa-
tial and product dimensions. Jaffe (1989) used the number of inventions registered
with the United States patent office as a measure of innovative activity. By contrast,
Audretsch and Feldman (1996) and Acs, Audretsch and Feldman (1992) developed
a direct measure of innovative output consisting of new product introductions.
The consistent empirical evidence supports the notion knowledge spills over
for third-party use from university research laboratories as well as industry R&D
laboratories. This empirical evidence suggests that location and proximity clearly
matter in exploiting knowledge spillovers. Not only have Jaffe, Trajtenberg and
Henderson (1993) found that patent citations tend to occur more frequently within
the state in which they were patented than outside of that state, but Audretsch
and Feldman (1996) found that the propensity of innovative activity to cluster
geographically tends to be greater in industries where new economic knowledge
plays a more important role. Prevezer (1997) and Zucker, Darby and Armstrong
(1994) show that in biotechnology, which is an industry based almost exclusively on
new knowledge, the firms tend to cluster together in just a handful of locations. This
finding is supported by Audretsch and Stephan (1996) who examine the geographic
relationships of scientists working with biotechnology firms. The importance of
geographic proximity is clearly shaped by the role played by the scientist. The
scientist is more likely to be located in the same region as the firm when the relation-
ship involves the transfer of new economic knowledge. However, when the scientist
is providing a service to the company that does not involve knowledge transfer,
local proximity becomes much less important. Zucker, Darby and Armstrong
(1998) show that the most productive scientists in the California biotechnology
are connected to firms through employment or ownership. Spillovers occur in this
industry for the scientist to financially exploit his knowledge.
There is reason to believe that knowledge spillovers are not homogeneous across
firms. In analyzing the role of spillovers for large and small enterprises separately,
Acs, Audretsch and Feldman (1994) provide some insight into the puzzle posed by
the recent wave of studies identifying vigorous innovative activity emanating from
small firms in certain industries. How are these small, and frequently new, firms
able to generate innovative output while undertaking generally negligible amounts
of investment into knowledge generating inputs, such as R&D? The answer
appears to be through exploiting knowledge created by expenditures on research
in universities and on R&D in large corporations. Their findings suggest that the
innovative output of all firms rises along with an increase in the amount of R&D
inputs, both in private corporations as well as in university laboratories. However,
R&D expenditures made by private companies play a particularly important role
in providing knowledge inputs to the innovative activity of large firms, while
expenditures on research made by universities serve as an especially key input for
generating innovative activity in small enterprises. Apparently large firms are more
adept at exploiting knowledge created in their own laboratories, while their smaller
counterparts have a comparative advantage at exploiting spillovers from university
laboratories.
In addressing the questions how and why knowledge spills over, an assumption
implicit to the model of the knowledge production function is challenged – that
firms exist exogenously and then endogenously seek out and apply knowledge
inputs to generate innovative output. Although this may be valid some, if not most
of the time, the evidence from biotechnology suggests that, at least in some cases, it
is the knowledge in the possession of economic agents that is exogenous. In an effort
to appropriate the returns from that knowledge, the scientist then endogenously
creates a new firm. Thus, the spillover of knowledge from the source creating it,
such as a university, research institute, or industrial corporation, to a new-firm
startup facilitates the appropriation of knowledge for the individual scientist(s) but
not necessarily for the organization creating that new knowledge in the first place
(Audretsch & Stephan, 1996).
While Romer (1990, 1994) and Krugman (1991) identified the role that
knowledge spillovers and externalities play in generating endogenous growth,
they are less precise about the actual mechanism by which knowledge spills over.
Entrepreneurial small firms are one such mechanism transmitting the spillover
of knowledge. Thus, an increase in the role of entrepreneurship activity may
facilitate such knowledge spillovers and therefore subsequent growth.
5. ECONOMIC GROWTH
There is a considerable gap of research linking entrepreneurship to economic
growth. The reasons for this void in the state of knowledge about the impact
of entrepreneurship on economic growth may be attributable to a paucity of

theoretical frameworks linking entrepreneurship to growth as well as severe
constraints in measuring entrepreneurship, let alone entrepreneurship within a
cross-national context. See Audretsch and Thurik (2000) and Carree and Thurik
(2003) for an extensive review to the literature.
The last two decades have seen an explosion in studies analyzing the determi-
nants of entrepreneurship. While some of these studies are theoretical (Holmes &
Schmitz, 1990), others are empirical (Evans & Jovanovic, 1989; Evans & Leighton,
1990; Reynolds, 1997) or eclectic (Audretsch & Thurik, 2001; Audretsch, Thurik,
Verheul & Wennekers, 2002). What they have in common is to pose the questions,
“Why do people start firms and what determines who becomes an entrepreneur?”
The consequences of entrepreneurship, in terms of economic performance,
have also generated a large literature. However, this literature has been restricted
to two units of observations – at the level of the establishment or enterprise, and
for regions. Noticeably absent are studies linking the impact of entrepreneurship
on performance for the unit of observation of the country (Audretsch, Carree &
Thurik, 2001). In fact, a large literature has emerged analyzing the impact of en-
trepreneurship on economic performance at the level of the firm or establishment.
These studies typically measure economic performance in terms of enterprise
growth and survival (Audretsch, 1995; Caves, 1998; Sutton, 1997). The com-
pelling stylized facts that have emerged from this literature is that entrepreneurial
activity, measured in terms of firm size and age, is positively related to growth. The
growth of new firms and small firms is systematically greater than for large and es-
tablished incumbents. These findings hold across OECD countries and across time
periods.
The link between entrepreneurship and performance has also been extended
beyond the unit of observation of the firm to include a geographic region. A rich
literature exists linking measures of entrepreneurial activity for regions to the eco-
nomic performance of those regions (Audretsch & Fritsch, 2002; Reynolds, Miller
& Maki, 1995; Reynolds, Storey & Westhead, 1994). While Reynolds, Miller and
Maki (1995) find that the degree of entrepreneurship has a positive impact on
regional economic growth in the U.S., Audretsch and Fritsch (2002) find that
for Germany the relationship shifted from negative in the 1980s to positive in
the 1990s.
However, when it comes to linking entrepreneurship to growth at the national
level, only a few studies exist. Audretsch et al. (2002) and Carree and Thurik (1999)
offer two distinct approaches, based on two different measures of entrepreneurship
– the relative share of economic activity accounted for by small firms, and the self-
employment rate. In addition, two different measures of performance of economic
activity are also analyzed – economic growth and reduction of unemployment – to
link changes in entrepreneurship to changes in economic performance. Different

samples including OECD countries over different time periods reach consistent
results – increases in entrepreneurial activity tends to result in higher subsequent
growth rates and a reduction of unemployment. Audretsch et al. (2001) provide
empirical evidence for a panel of OECD countries, which suggests that those
countries that have experienced an increase in entrepreneurial activity have also
enjoyed higher rates of growth and greater reductions in unemployment. By
contrast, those countries that have not increased the degree of entrepreneurial
activity have had less growth and less reductions in unemployment.
Entrepreneurship generates growth because it serves as a vehicle for innovation
and change, and therefore as a conduit for knowledge spillovers. Thus, in a
regime of increased globalization, where the comparative advantage of the leading
developed countries is shifting towards knowledge-based economic activity, not
only does entrepreneurship play a more important role, but the impact of that
entrepreneurship is to generate growth.
6. CONCLUSIONS
While economic growth has traditionally remained in the analytic domain of
macroeconomics, the lens of evolutionary economics provides linkages across
multiple units of observation, spanning the individual, the firm, the industry, and
ultimately macroeconomic growth. Entrepreneurship plays a central role in the
growth process, because it is the assessment of ideas that leads not just to change
and growth, but also does this through the mechanism of starting a new firm.
Higher rates of entrepreneurship tend to generate a greater degree of turbulence
within industries. Not only do more firms enter industries, but the exit rates are
also greater, reflecting a greater degree of search activity relative to routinized
activity.
The positive relationships found between entrepreneurship and industry
turbulence do not necessarily imply a superior economic performance. However,
an emerging body of empirical evidence clearly suggests a positive link between
entrepreneurship and growth that holds not just for firms, but also for geographic
units of observation, including the city, region and even country. Those regions
and countries that have a greater degree of entrepreneurial activity also enjoy
higher rates of growth.
A question still to be answered is from where does the new knowledge originate.
Is it the R&D activities within the young firm, synergies within networks of small
firms, spillovers from universities or from larger incumbent firms. A follow-up
question is why and how these spillovers occur and how they can be stimulated.
The eclectic framework of the determinants of entrepreneurship as presented in

Audretsch, Thurik, Verheul and Wennekers (2002) may be a starting point for
investigating the mechanisms and stimulation of these spillovers.
NOTES
1. “The Best Cities for Knowledge Workers,” Fortune, 15 November, 1993, p. 44.
2. The survey was carried out in 1993 by the management consulting firm of Moran,
Stahl and Boyer of New York City.
3. “The Best Cities for Knowledge Workers,” Fortune, 15 November, 1993, p. 44.
ACKNOWLEDGMENTS
This paper is the result of a series of visits by David Audretsch as a Visiting
Research Fellow at the Tinbergen Institute and by Roy Thurik as the Ameritech
Research Scholar at the Institute for Development Strategies, Indiana University.
We would like to thank Candice Henriquez, Hidde Wiersma and an anonymous
referee for their helpful comments and suggestions.
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ON AUSTRIAN ANALYSIS OF
ENTREPRENEURSHIP AND MY OWN
William J. Baumol
ABSTRACT
All of economics recognizes the importance of entrepreneurship, but until
the work of the Austrians, little was done about it. Neoclassical economics
could not deal with it in its models, because formal optimization is largely
irrelevant and because the entrepreneur’s innovation is, by definition, purely
heterogeneous. The Austrians, with their flexibility of method, were able to
break through, following Schumpeter’s great contribution. My own work on
the subject solved the method problem by discussing not what activities the
entrepreneurs undertake, but how their services are allocated between such
things as contributions to production and rent seeking.
INTRODUCTION
It is not accidental that what the literature has produced on the theory of
entrepreneurship is largely attributable to the Austrian economists, including in
this group their successors in other countries. In contrast, one can say of the role
of the entrepreneur in the mainstream mathematical writings of the firm much
what Mark Twain said of the weather – everyone talks about the subject but no
one does anything about it. Every economist surely must be prepared to concede
that entrepreneurs are (even if for reasons not fully specified) of great importance.
But in standard microtheory they are completely invisible.

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06004-6
57
58 WILLIAM J. BAUMOL
First, let me recall the two senses in which the term is used and indicate
why neither of them permits it a role in the standard models. Sometimes, as
in the writings of Sharon Gifford (see particularly 1998), or the teachings in
the business schools, the entrepreneur is the organizer of new firms, whether
or not the enterprises are novel in operation or organization, and that is surely
the meaning of the French or the German terms for the activity. But for other
writers, following Schumpeter (as I usually do) the entrepreneur is an inno-
vator, who is always engaged in doing something that was never done before,
and not just founding yet another business entity of a sort often in existence
before.
Now there are two reasons why neither entrepreneur fits comfortably and
perhaps does not fit at all into the current mainstream formulation of the firm.
First, the product of the entrepreneur’s activity is markedly heterogeneous.
It is, perhaps, even the ultimate extreme among the products that are not
identical. Indeed, as I have argued, it is mere tautology that tells us the output of
Schumpeter’s entrepreneur must be a heterogeneous product. Though mainstream
theorists have recently begun to find ways to incorporate imperfect substitutes
even into their general equilibrium models, here the differentiation of the products
is so fundamental as to resist the standard mathematical treatments of the
firm.
Even more critical is the orientation of the mathematical models to optimization
and maximization, which certainly fits in well with routine business decisions.
Gifford has shown in her book that even such an approach can cast valuable light
on the structure of entrepreneurial decisions. But the fact remains that much of
entrepreneurial decision making has little or nothing to do with optimization
(or even with Herbert Simon’s “satisficing”) so that the writers in the arena
under discussion are forced to conclude that, though the entrepreneur is almost
all-important, they have nothing to say on the subject.
Austrian economics, because it is not so tightly constrained by unswerving
allegiance to any particular analytical method or such a method’s peculiar
strengths and limitations, can, in contrast, provide significant insights on this
important but highly elusive subject. The classic Schumpeterian model in which
the entrepreneur finds he can earn profits only by innovating, and can obtain an
enduring flow of profits only by constantly innovating, is the prime example. And
it is an example important for the discussion here because it is so clearly not the
end of the story. That is, it can be used to make clear that Austrian analysis is not
designed to terminate examination of any phenomenon such as entrepreneurship,
but is rather calculated to invite further investigation in search of additional
insights.
On Austrian Analysis of Entrepreneurship and My Own 59
THE ENTREPRENEUR AS EQUILIBRIUM AND

DISEQUILIBRIUM CREATOR
The approach of Israel Kirzner (1979, 1997) brings this out very clearly. It does
not only go beyond Schumpeter and provide novel avenues of analysis and novel
insights. It actually provides a critical result that, in one sense, contradicts a
Schumpeterian conclusion, but basically is complementary with the latter. In
Kirzner’s work, what distinguishes the entrepreneur is superior alertness to busi-
ness opportunities. The successful entrepreneur is the one who is first to spot such
opportunities and to take advantage of them. The prototype case is an opportunity
for profitable arbitrage. But arbitrage has a close relation to equilibrium. An
arbitrage opportunity can occur only in the absence of equilibrium because, by
definition, in equilibrium all avenues for enhancement of earnings through change
must have been employed to exhaustion. Moreover, arbitrage is a process that is
constructed so as to move matters toward equilibrium. In other words, the side of
entrepreneurship on which Kirzner focuses entails unrelenting pressure moving
matters toward equilibration whenever the state of affairs is not an equilibrium. The
alert entrepreneur observes a state of disequilibrium that constitutes an opportunity
for profitable arbitrage, and then quickly inaugurates measures that, by taking
advantage of the opportunity, work toward elimination of the disequilibrium. The
disequilibrium may or may not be eliminated entirely, but the entrepreneur’s stan-
dard activities certainly work toward reduction of its severity and toward bringing
it to an end.
But in a significant sense, this is the reverse of Schumpeter’s story, though
it is important to recognize that there is no conflict between the two. Rather, it
is only when we consider the two analyses together that we become aware of
the two crucial sides of the story. In Kirzner, the entrepreneur’s activities cannot
abide continuation of disequilibrium, and can be relied upon to work toward its
elimination. In contrast, Schumpeter’s entrepreneur constitutionally cannot abide
continuation of an equilibrium. He is driven to search constantly for innovation
opportunities, but an innovation, by its very nature, upsets any equilibrium that
provided the opportunity for the novel product or process that the entrepreneur
introduces.
Thus, we have the Kirzner entrepreneur who cannot abide disequilibrium, and
Schumpeter’s entrepreneur who cannot abide its absence. But the two, seemingly
conflicting, observations only together enable us understand what is going on. In
sum, the entrepreneur is the agent of change, no matter what the situation. It is
the status quo, whatever it may be, that he is impelled to disturb. From these two
parts of the story we end up not only with a better understanding of the role of the
entrepreneur, but also of the pertinence of the concept of equilibrium itself for the
behavior of the economy in reality.
PRODUCTIVE AND UNPRODUCTIVE

ENTREPRENEURSHIP
In my own work I have taken off from such Austrian analyses and concepts and
have sought to extract further insights on the subject. Here I will summarize
two of my attempts to analyze the role of the entrepreneur: first the notion that
societies can experience apparently autonomous outbursts of entrepreneurship
and equally independent declines and near disappearance of this individual whose
activities are so critical for growth. Is there an economic explanation for such
developments that can perhaps enable us to do something about them, or must
they be treated as fundamentally fortuitous and inexplicable events? Second, I
will discuss Schumpeter’s observation in his later writings that the innovation
process is undergoing routinization. The questions to which this view gives rise
are whether it is in fact true and, if so, where it leaves the entrepreneur, whether
it threatens to deprive him of his role. I begin with the first of these issues
(summarizing the analysis in my book on the subject, 1993).
In my view the perception that entrepreneurship has a disturbing tendency to
dry up unexpectedly or to spring forth unexpectedly like Athena from the head of
Zeus, stems from a basic misunderstanding. The source of this misunderstanding
is a propensity to equate entrepreneurship with virtuous behavior. Because we
recognize that it can bring innovation and growth, we are misled into thinking that
it must always contribute to economic abundance and expansion. But there is no
reason why this must be so, and it patently is not true in reality.
First, one must recognize that the class of individuals who constitute the
economy’s entrepreneurs are not selected to be, uniformly, a collection of
archangels. Like professors or lawyers or doctors, the strength of their dedication
to morality will vary from one such individual to another. It is, indeed, a plausible
hypothesis that the typical entrepreneur has a tendency toward amorality in
his professional activities, neither accepting major sacrifices on behalf of the
general welfare nor deliberately seeking to damage it. The entrepreneur’s goal
is acquisition and accumulation of wealth, power and prestige, and he uses
innovation as his primary weapon in pursuit of those objectives. If his innovations
happen to yield social benefits, so much the better. But if those benefits are
questionable, that need not put a stop to his activities.
The point is that entrepreneurship, like any other input in the economy, is an
allocable resource, and pursuit of profit – the profit motive – will determine where
it will be allocated. Now one can be innovative and enterprising in a variety of

ways. The gangster godfather who invents a new instrument for extortion and the
warlord who invents a new military tactic to tighten his grip on his domain are
surely being entrepreneurial. These extreme examples are chosen deliberately, to
show how far the conventional notion of entrepreneurship invites extension.
It is, of course, true that the U.S. economy has no warlords, though it does have
its godfathers. But consider what would happen if something were to change the
situation to one resembling that of the central Middle Ages. Then, as we know,
the entrepreneur innovators were the unruly barons, who not only conducted
continual warfare with one another, but even with their kings, as in England in the
reigns of Stephen and Matilda, John, Henry III, Richard II, Henry VI and Richard
III. The point is that society’s most enterprising individuals were in these societies
driven by their ambition to innovative aggression rather than to production. The
class of entrepreneurs did not vanish. Rather, they were induced to go where the
most promising opportunities for enrichment and acquisition of power were to
be found.
All of this may (or may not) seem convincing but largely irrelevant for the
most pressing economic issues facing today’s society. But that is only because
of the extreme examples on which I have focused to dramatize my point. Today,
criminal activity aside, the primary type of effort that competes with production
as an attraction to entrepreneurs is something far less dramatic than military
violence, but nevertheless important. This alternative is rent seeking, the pursuit
of earnings primarily through redistribution in one’s own favor, rather than in
return for productive accomplishment. The lawsuit is a prime example of such
an activity, and the number of firms that participate in such activities is hardly
negligible. Vast resources are devoted to representatives of the firm in the courts,
the regulatory agencies and other such instrumentalities, whose job it is to seek
special economic advantages such as court-imposed protection from disturbingly
vigorous competition and direct enrichment through vast court-ordered damage
payments. Such activities can and often are carried out in an innovative manner
with full exercise of entrepreneurial vigor. And it is easy to provide examples
of firms that participate in both types of activity – production and litigation.
But where the damage payment being sought in a lawsuit is (as I have more
than once experienced) equal to something like a decade of the firm’s usual
profits, it is easy to imagine where primary attention is given by the firm’s
decision makers.
As is well recognized, rent seeking takes many forms beyond litigative activity.
There is, for example, pursuit of an exclusive license to operate a public utility,
lobbying in Congress, efforts to extend the life of patents by means of inventions
whose primary purpose is to exclude competition and many additional variants,
all of which are pursued entrepreneurially, with constant alertness for innovation
opportunities.
The central point here is that the rules of the game – the structure of the
economy’s payoffs – can and do change. And when they change they can
confidently be expected to modify the allocation of the economy’s entrepreneurs
between production and rent seeking. History readily provides striking examples.
Thus, during the reigns of the last Plantagenets and the early Tudors, service to
the King was a primary source of income, privilege and perhaps most critical,
landed property. As a result, the evidence indicates, economic activity by leading
subjects was focused in this direction, with productive investment by the magnates
a very new phenomenon, following the innovative example of Edward IV. And
during the reign of the Stuarts, when Parliament succeeded in circumscribing
the rent-granting powers of the monarch, it is arguable that the economy’s
entrepreneurs’ activities were redirected toward commerce and production,
thereby providing part of the explanation for the subsequent British economic
success in the European economy of the early 19th century.
What was true on those occasions remains true now. Entrepreneurs can still
be tempted to redirect their efforts by changes in the structure of payoffs. This
indicates the importance of avoidance of governmental forms of intervention that
end up providing significant opportunities for rent seeking, and for the benefits of
foreclosure of rent seeking opportunities that derive from other sources. Thus, I
maintain that the analysis that takes entrepreneurship as another allocable resource
not only possesses explanatory power, but also can be helpful for design of policy.
The analysis also helps us to see why free market economies are characterized
by so much greater an abundance of productive entrepreneurship than was found
in earlier societies. The rule of law, along with rights of property and its protection
from arbitrary confiscation, the enforceability of contracts and a variety of other
protections have made productive activities less risky and more effective avenues to
wealth than they were before. This along with some closing down of rent-seeking
opportunities and opportunities for respectable wealth acquisition though orga-
nized violence have reallocated entrepreneurial effort in directions that contribute
to prosperity and growth. Entrepreneurship in the free market was not created by
mysterious means, by spontaneous generation – it was merely redirected from
what it had previously been doing.
ROUTINIZATION OF INNOVATION AND THE

ENTREPRENEUR’S CONTINUING ROLE
My research on entrepreneurship has continued since the preceding ideas were first
formulated, and the resulting later observations are contained in my most recent
book (2002). The central topic of that book is the extraordinary growth record
of the free market economies, and the reasons why no other form of economic
organization has come close to its productive and innovative accomplishments
over any protracted period of time. The relevance to the discussion here should
already be clear from my previous observations on the attributes of the free
market economy that apparently have contributed so substantially to the volume
of activity in productive entrepreneurship. But there is much more to the story,
in particular in the drive toward routinization of innovation and its implications
for entrepreneurship.
The story here, in brief, is that in the market economies the most visible and
active forms of competition are found in oligopolistic industries, where rivals’
surveillance of one another’s activities is direct and where the actions of any
one enterprise in a market can be expected to elicit rivalrous responses from
the others. Directly relevant to the discussion here is the important subsector of
the group of oligopolistic industries that are characterized as “high-tech” and
that are responsible for the bulk of innovative activities that take place within
established firms. For many of such firms innovation is not only important,
it can be a matter of life and death. The resulting pressures have led those
enterprises to take whatever measures they can to minimize their risk of falling
behind rivals in the innovation “arms race” that encompasses the industry. To
do so, they have, as far as they could, taken the innovative activities on which
they depend out of the hands of the independent inventors and entrepreneurs,
and brought them inside the firm, into business operated and controlled R&D
facilities.
This is the sense in which innovation activity has indeed grown more routine and,
according to government statistics, some 70% of R&D activity is now conducted
in this way in the United States. The activity as carried out by private business has
become routine in many ways. Its budget is determined centrally, in competition
with the firm’s expenditures on all of its other major activities such as advertising
and plant construction. The firm’s management may select its R&D subsidiary’s
organization structure, decide on its facilities and even, in a surprising number of
cases, it will decide what should be invented. As this is being written, for example,
it has been announced by Microsoft that its R&D is about to be redirected from the
addition of new working features to increases of the users’ security from invasion of
viruses as well as the confidentiality of what is written and saved on the computer.
This presumably will be a centrally directed reorientation of the activities of the
firm’s R&D personnel, and it is a pattern that is to be encountered throughout
industrial research. This is a far cry from the inspired and heterodox efforts of
legend, toiling in attic and basement to come up with a working version of an
invention that exists initially only in the inventor’s mind, and the work of the
entrepreneur whose alertness enables him to observe the existence or prospect of
this invention and whose efforts are designed to see it to completion, all the way
to the marketplace.
Yet the routinization story by itself is surely an exaggeration. Neither the inde-
pendent innovator nor the independent entrepreneur has vanished from the face
of the earth. On the contrary, they are alive and well and appear to be as active and
productive as ever. There are lists of the important innovative breakthroughs of
the 20th century and a substantial number of them if not the majority are derived
from these sources rather than from the laboratories of business enterprises. Of
course, once they become successful, the individuals involved typically organize
themselves into business firms such as Xerox, Polaroid and Microsoft, and those
firms in turn often turn to routinization of their innovation activities. But they, in
turn, are followed by still other entrepreneurs and inventors, and the process goes
on, bringing ever more new products and new processes to the economy.
These developments have evolved in a way that appears to fall into a pattern.
Rather than serving primarily as substitutes, the continuing activities of the
entrepreneurs and inventor have followed a direction rather different from the
routinized activities of the firm’s innovating personnel.
The most obvious direction has been that of the business firms, whose routinized
innovation tended to follow relatively routine directions. They have been slanted
toward incremental improvements rather than revolutionary breakthroughs. User
friendliness, increased reliability, marginal additions to application, expansions of
capacity, flexibility in design, these and many other types of improvement have
come out of the industrial R&D facilities, with impressive consistency, year after
year, and often pre-announced and pre-advertised.
In contrast, if one takes any of the lists of the primary conceptual breakthroughs
of the century that has just come to an end, the great leaps forward in unanticipated
directions, an impressive proportion is seen to have stemmed from the indepen-
dent innovators’ sector, as has just been said. It is the unaffiliated inventors and
entrepreneurs who have tended to be the suppliers of the dramatic breakthroughs,
the ones that deservedly receive the most attention and are most widely recognized
and remembered.
One is tempted to draw from this description the conclusion that the lone
inventors and the entrepreneurs are the clear winners as prime contributors to
economic growth and standards of living, but this is by no means an open and shut
case. Without in any way seeking to denigrate the entrepreneurs’ enormous con-
tribution, it is nevertheless appropriate to reconsider what the routine innovative
activities of the large firms have accomplished. And indeed, it is possible to argue
that though their outputs have usually been less dramatic and less spectacular, tak-
ing the incremental contributions together and summing their accomplishments,
one comes away with the judgment that their accomplishment is not compara-
tively minuscule. Indeed, there are many cases where the summed incremental
contributions plainly outperform the contribution of the original breakthrough.
A very clear example is the electronic computer. The first computer obviously
constituted a revolutionary breakthrough in concept. But, as has often been done,
we can easily compare its speed, computing capacity and memory with what is
available today in instruments with tiny fractions of the earliest instruments’ bulk
and weight and a spectacular reduction in cost. We realize quickly that a fairly
low-end personal computer today can outperform the original in each of these
attributes by a vast multiple, and with far greater reliability, user friendliness and
range of applications. Accordingly, the bulk of the speed, computing power and
memory capacity of today’s computers is probably attributable to the combined
increment additions made by routine research activities in corporate facilities.
Other careful observers have extended such examples, and have concluded that
incremental and routinized innovation activities have been responsible for a very
respectable share of the contribution of innovation to economic growth in the
20th century.
Yet there is something misleading about such a comparison, because it casts
the innovative activity in the large firms and that of the independent innovative
in the role of rivals, as producers of substitute products, each vying for victory
over the other. But it seems clear that this is not generally what has happened.
Rather, there has tended to be specialization, with the outputs of the two groups
tending to complementarity rather than rivalry. More than that, there is a tendency
toward serendipity between the two, with each facilitating and supplementing the
work of the other. The nature of the specialization is suggested by the preceding
discussion. The independent inventor and his entrepreneur partner have tended
to be those who produced the radical departures from what were then current
products and processes. The big novel idea, the unprecedented way of thinking,
the heterodox approach, has been disproportionately in their hands. But with such
breakthroughs as raw materials, the groups specializing in routinized innovation
have taken over and gone on with the task of transforming the breakthrough models
into more easily usable, more powerful and more marketable products, raising them
from infancy into mature products with substantial markets and massive outputs.
Thus, the result has arguably been super-additive, with the total contribution to the
economy’s productive powers greater than the sum of the contributions for which
each was individually responsible.
The firms’ takeover of the original inventions from the unaffiliated inventors and
entrepreneurs have contributed compensation to the latter, thereby encouraging
their activity. Moreover, the inventors have often learned from the less spectacular
discoveries in the industrial labs and this has aided them in their subsequent work.
The other side of the matter is the fact that the initial breakthrough has so often
served as the vital ingredient in the work of improvement that was subsequently
undertaken by routinized innovation activity. Thus, albeit not perfectly clean-cut,
there has been specialization, with considerable benefits to both parties, and the
economy has been better off as a result.
More than that, it follows that the growth of routinization in the innovation
process has not threatened the entrepreneur with obsolescence. He seems in no
danger of disappearance or of being deprived of a market for his activities. In this
respect, Schumpeter’s remark on the growth of routinization, while not incorrect,
may be somewhat misleading.
CONCLUDING COMMENT
One of the hallmarks of Austrian economics has been its unwillingness to be
tied down to any dogma on method, and certainly has resisted pressures for
rigid formalism in analysis. It is this that has enabled it to begin to shed light
on subjects such as entrepreneurship, that are ill-suited to formalistic treatment,
for reasons I have already suggested. And this is of critical importance, because
entrepreneurship is widely accepted as a vital activity, one without understanding
of which the market economy’s workings really cannot be comprehended.
On this, let me not be misunderstood. I believe that formal analysis has accom-
plished much and will continue to contribute both understanding and powerful
analytic methods. But in an arena such as economics there is no one set of
methods that is the right approach everywhere, and this, too, Austrian analysis has
demonstrated.
Here, I have tried to go one step further, and show how someone not raised
in the Austrian tradition can nevertheless build on the Austrian approaches and
accomplishments and perhaps even add something more to the insights they have
provided.
REFERENCES
Baumol, W. J. (1993). Entrepreneurship, management and the structure of payoffs. Cambridge, MA:
MIT Press.
Baumol, W. J. (2002). The free-market innovation machine: Analyzing the growth miracle of capitalism.
Princeton, NJ: Princeton University Press.
Gifford, S. (1998). The allocation of limited entrepreneurial attention. Boston, MA: Kluwer Academic
Publishers.
Kirzner, I. (1979). Perception, opportunity and profit. Chicago, IL: University of Chicago Press.
Kirzner, I. (1997). Entrepreneurial discovery and the market process: An Austrian approach. Journal
of Economic Literature, 35, 60–85.
ENTREPRENEURSHIP AND
DEVELOPMENT: CAUSE OR
CONSEQUENCE?
Peter J. Boettke and Christopher J. Coyne
ABSTRACT
This paper discusses the inherent tension in the notion of entrepreneurship as
developed by Ludwig von Mises and Israel Kirzner. Given that entrepreneur-
ship is an omnipresent aspect of human action, it cannot also be the “cause”
of economic development. Rather, for economic development to take place,
certain institutions must be present in order for the entrepreneurial aspect
of human action to flourish. After further developing this theoretical insight,
an in-depth analysis of the institutions necessary for entrepreneurship
is considered.
Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism,
but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about
by the natural course of things. All governments which thwart this natural course, which force
things into another channel or which endeavor to arrest this progress of society at a particular
point, are unnatural, and to support themselves are obliged to be oppressive and tyrannical.
Adam Smith (1776, p. xliii)
1. INTRODUCTION
The question of why some nations are rich and others are poor has been at
the center of economic debate for over two centuries. While the post-WWII

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06005-8
67
68 PETER J. BOETTKE AND CHRISTOPHER J. COYNE
Keynesian-dominated discussion of economic development focused on and

emphasized the importance of such factors as foreign aid and government
planning, it is now widely agreed that the entrepreneur is the prime driver of
economic progress (Kasper & Streit, 1998, pp. 1–23; Leff, 1979). It is also
accepted that the institutions that economic agents (including entrepreneurs)
operate in – political, legal and cultural – directly influence their activity and hence
economic development (Baumol, 1990; Olson, 1996). Institutions, or the rules of
the game, provide a framework which guides activity, removes uncertainty and
makes the actions of others predictable. In short, institutions serve to reduce the
costs of action and facilitate the coordination of knowledge dispersed throughout
society.
Economists associated with the Austrian school of economics have long
focused their attention on the study of entrepreneurship and the economic analysis
of institutions, providing a robust literature emphasizing the importance of these
areas (Boettke, 1994, 2001, pp. 234–247; Foss, 1997; Wubben, 1997). In contrast
to other schools of economic thought, the Austrians have not only realized the
importance of institutions, but have attempted to provide a connection between
the market process and an economic understanding of institutions. Moreover,
Austrians stress that entrepreneurship does not describe a distinct group of
individuals, but rather, is an omnipresent aspect of human action. As Mises wrote:
In any real and living economy, every actor is always an entrepreneur and speculator . . . Eco-
nomics, in speaking of entrepreneurs, has in view not men, but a definite function. This function
is not the particular feature of a particular special group or class of men; it is inherent in every
action and burdens every actor . . . The term entrepreneur as used in catallactic theory means:
acting man exclusively seen from the aspect of the uncertainty inherent in every action (1949,
pp. 252–253).
Economic decision makers do not simply react to given data and allocate their
scarce means to realize given ends. The entrepreneurial element in human action
entails the discovery of new data and information; discovering anew each day not
only the appropriate means, but the ends that are to be pursued (Kirzner, 1973,
pp. 30–87). Moreover, the ability to spot changes in information is not limited to
a selective group of agents – all agents posses the capacity to do so.
Herein lies the dilemma in the literature on entrepreneurship and economic
development. Given the Austrian insight that entrepreneurship is omnipresent, en-
trepreneurship cannot also be claimed to be the “cause” of economic development.
There are countries that have not achieved a level of economic development consis-
tent with their endowment, the state of technology, and the level of human capital
investment in the country, yet economic actors are still coping with uncertainty
and striving to be alert to hitherto unrecognized opportunities for gain. Obviously,
Entrepreneurship and Development 69
a narrow reading of entrepreneurship cannot help us explain why some nations

are rich and other nations languish in poverty. To explore the causal relationship
between entrepreneurship and economic growth, we must think more broadly.
Entrepreneurship manifests itself differently across alternative institutional
regimes and some of these manifestations are consistent with economic develop-
ment, while others are not. The realization of the role that the rules of the game
play in guiding action provides an analytical framework in which we can consider
the link between economic progress and entrepreneurship. That is, we must
consider the institutions that comprise the societal organizational environment
and consider how they serve to channel entrepreneurial activity in one direction
or another.
The question that motivates us is one that has motivated economists at least
since the time of Adam Smith – Why are some nations rich while others are poor?
Olson (1996) highlighted an interesting dilemma, namely that there are huge
opportunities for mutual gain that continue to go unrealized in the less developed
areas of the world. In considering why such opportunities are not exploited in
terms of the previously mentioned analytical framework, we must look at the
rules of the game which provide incentives to economic actors as entrepreneurs.
Simply put, economic growth, driven by entrepreneurship, cannot be explained
without reference to institutions. In this paper, we will argue that entrepreneurship
cannot be the cause of development, but rather, that the type of entrepreneurship
associated with economic development is a consequence of it. That is, develop-
ment is caused by the adoption of certain institutions, which in turn channel and
encourage the entrepreneurial aspect of human action in a direction that spurs
economic growth. Given our thesis, in those countries where opportunities are left
unexploited, we would expect to find either a lack of institutions or an institutional
structure that discourages certain types of entrepreneurship. Likewise, in those
developed countries where opportunities for mutual gain are exploited, we
would expect to see an institutional environment that encourages entrepreneurial
discovery of the type that generates greater gains from exchange. Entrepreneurship
comes in the form of either arbitrage or innovative action, but some arbitrage
and innovative actions are limited in scope, while other steps in the arbitrage or
innovative direction are transformative in terms of economic development.
Section 2 of this paper will serve as an overview of the varying notions of the
entrepreneur and his role in economic development. Focus will be placed on the
implications of the rules of the game on each particular concept of entrepreneur-
ship. Section 3 will address the mechanics of economic development. We will
discuss the neoclassical growth model with particular focus on the critical role
that institutions play in economic development. The shortcomings of the model
in capturing these critical elements will be discussed. Section 4 will consider
empirical studies of the various institutions that are the causes of entrepreneurship.
Finally, in Section 5, we summarize our findings and provide concluding remarks.
2. ENTREPRENEURSHIP IN THE LITERATURE

In this section we will provide an overview of the three main views of the notion of
the entrepreneurial process: Schumpeter’s view of the entrepreneur as innovator,
Kirzner’s notion of entrepreneurship as arbitrage and the view of entrepreneurship
in history as one of betting on ideas.1 In considering each of these views, we will
pay particular attention to the implications of the institutional environment on the
particular notion of entrepreneurship.2
Before considering Schumpeter’s notion of entrepreneurship and economic
development, it is important to clarify his view of the market and his understanding
of the capitalist system – his characterization of capitalism is directly tied to
the role the entrepreneur occupies within it. While rejecting the widely accepted
view of the market as a perfectly competitive construct, Schumpeter couched his
analysis in an initial state of general equilibrium.3 He viewed the market process
as a dynamic process driven by creative destruction: “It [referring to the market
process] must be seen in its role in the perennial gale of creative destruction;
it cannot be understood irrespective of it . . .” (1950, p. 83). Schumpeter linked
the market process of creative destruction – which he associated with “new
combinations” – and therefore economic development and progress, to innovation
and distinguished the entrepreneur as the prime innovator.4 In addition to being an
innovator, the entrepreneur is a leader. His actions channel the means of production
into previously unexploited markets and other producers follow him into these
new markets (1961, p. 89). Perhaps Kirzner best described the market impact
of Schumpeter’s entrepreneur when he wrote: “. . . for Schumpeter the essence
of entrepreneurship is the ability to break away from routine, to destroy existing
structures, to move the system away from the even, circular flow of equilibrium”
(1973, p. 127).
Although not the emphasis of his analysis, Schumpeter recognized that the
entrepreneur (in addition to all economic actors) would have to adapt to his sur-
rounding institutional environment:
. . . the field of individual choice is always, though in very different ways and very different
degrees, fenced in by social habits or conventions and the likes: it still remains broadly true
that, within the circular flow, everyone adapts himself to his environment so as to best satisfy
given wants . . . as best he can (1960, p. 91).
Moreover, Schumpeter realized the necessity of private property in providing

financial motives for entrepreneurial action and hence economic development.5
The entrepreneur, working within the societal institutional framework will

adjust and adopt his actions based on the incentive structure he faces. Without
a conducive framework in which he can pursue the activities of innovation and
leadership, Schumpeter’s entrepreneur will fail to carry out his function.
While there are similarities between Schumpeter’s and Kirzner’s notion of
entrepreneurship, there is a foundational juxtaposition between each author’s
understanding of the market process which leads to differing views of the role
of the entrepreneur.6 As compared to Schumpeter’s characterization of the
market process as creative destruction, Kirzner emphasized that markets “tend
continually . . . towards equilibrium, as the consequence of continually-stimulated
entrepreneurial discoveries” (1999, p. 6). The key concept in Kirzner’s notion of
entrepreneurship is the alertness to opportunities – i.e. the discovery of knowledge
previously unknown (1973, p. 35, 1979, p. 139). Entrepreneurial discoveries are
realizations of ex-post errors made by market participants which either caused
them to be, ex-ante, over or under pessimistic in their expectations (1999, p. 6).
The existence of error provides scope for profit opportunities that actors can
realize if they move in a direction less erroneous than before.7 For Kirzner,
alertness, and therefore discovery, is characterized as “knowing where to look for
knowledge” (1973, pp. 66–68). While both Schumpeter’s and Kirzner’s notions
of entrepreneurship grounded in the exploitation of profit opportunities, the
greatest difference is that the former shifts the market away from equilibrium
while the latter serves to continually move the market toward equilibrium.8 While
Schumpeter’s entrepreneur is an innovator who destroys the current structure,
Kirzner’s entrepreneur is alert to arbitrage opportunities based on past errors and
serves to exploit and correct those errors, and in doing so, directs the market
towards equilibrium.
Kirzner recognized the role that the entrepreneur would play in economic
development. “In economic development, too, the entrepreneur is to be seen
as responding to opportunities rather then creating them; as capturing profit
opportunities rather then generating them . . . Without entrepreneurship, without
alertness to the new possibility, the long-term benefits may remain untapped”
(1973, p. 74). For Kirzner, the competitive market and entrepreneurship are
inseparable – the competitive process is in essence entrepreneurial (1973, pp.
15–16). The consideration of economic progress and the institutions that facilitate
that development through entrepreneurship occurs here on two levels. First,
given that competition and entrepreneurship are inseparable, we must evaluate
if the institutional framework provides a structure for competition. Second, we
must consider if the institutional framework provides the incentive structure for
the entrepreneur to: (1) exercise his subconscious alertness; and (2) act on his
alertness to exploit arbitrage opportunities.
According to Kirzner, competition exists as long as there are no arbitrary

barriers to entry (1973, p. 97; 1985, pp. 130, 142). The competitive process
necessarily must allow those who are able and willing to provide a potential offer
the ability to do so. Only when barriers have been erected to prevent potential
competitors from entering the market and offering a more attractive deal will
competition be retarded. Furthermore, there can be only two possible restrictions
to entry – the lack of resources needed for an activity or government-imposed
restrictions. Entrepreneurial activity, according to Kirzner, does not require any
initial resources so the only means of restricting the competitive process is the
latter – government-imposed restrictions (1973, pp. 99–100). If we are looking for
the connection between economic development and the entrepreneur and accept
Kirzner’s notion, then one institution we must consider is the presence of barriers
to entry. If Kirzner’s notion of entrepreneurship and competition is accurate,
we would expect to see countries with high barriers to entry less economically
developed than those where the competitive process is largely uninhibited.
As discussed, alertness is the key element of Kirzner’s entrepreneur: “. . . the
market performs a crucial function in discovering knowledge nobody knows
exists . . .” (1979, p. 139). Kirzner also realized that the institutional structure
could influence this aspect of human action: “it must appear highly desirable
to choose among alternative social institutional arrangements those modes of
organization that generate the greatest volume of spontaneous, undeliberate
learning” (ibid., p. 147). If the goal is to encourage the entrepreneurial aspect of
human action, the best institutions are those that promote alertness to previously
unknown knowledge.
For Kirzner, entrepreneurship does not just involve alertness, but also the
exploitation of the opportunity realized through alertness:
It follows, then, that for opportunities for social improvement to be more rapidly discovered
and exploited, these opportunities must be translated into opportunities that are not merely
encountered . . . but into opportunities that are to the advantage of these potential entrepreneurs,
and that most effectively excite their interest and alertness . . . (ibid., p. 149).
Given such, we must also consider the societal institutional environment in terms
of the incentives it provides the entrepreneur in exploiting potential arbitrage
opportunities. Here we can make a connection with the motives of Schumpeter’s
entrepreneur in terms of the necessity of private property. However, we must
be careful to avoid distorting Kirzner’s notion of entrepreneurship. It is critical
to remember that Kirzner’s entrepreneur need not own any resources to fulfill
his function:
The pure entrepreneur . . . proceeds by his alertness to discover and exploit situations in which
he is able to sell for high prices that which he can buy for low prices . . . It is not yielded by
exchanging something the entrepreneur values less for something he values more highly. It
comes from discovering sellers and buyers of something for which the latter will pay more that
the former demand. The discovery of a profit opportunity means the discovery of something
obtainable for nothing at all. No investment is required; the free ten-dollar bill is discovered to
already be within one’s grasp (1973, p. 48).
However, as Harper (1998) has pointed out, although the ownership of property
is not a necessary condition for alertness, it would be extremely difficult for
entrepreneurs to execute on the opportunities they have observed without it (in
Kirzner’s example the “sellers” and “buyers” involved in the transaction did not
have known control of the related resources). Moreover, although the entrepreneur
need not start with any assets, it is quite possible that he will own some of the
capital necessary to execute on his plan (Kirzner, 1973, p. 49, 1985).
The third view that we will consider is the notion of entrepreneurship in history as
one of “betting on ideas” (Brenner, 1985; Mokyr, 1990). Historians, in an attempt to
explain the economic advancement of developed countries, often use this notion
of entrepreneurship. Its main focus is on the uncertainty of innovation as well
as the risks and gambles involved in changing a known production process, or
introducing a new product. Through historical analysis of economic development,
this notion concludes that a number of institutions facilitated entrepreneurs in
their role as risk takers and innovators. That is, the rules of the game provided the
stability and incentive for individuals to take risks. Examples include the creation
of firms to diversify risk (Mokyr, 1990), a stable monetary policy (Brenner, 1985),
a predictable rule of law, the introduction of bills of exchange, insurance, private
property, a standardized accounting methodology, the development of a widely
understood business ethic and a regular and systematic code of government taxation
(Birdzell & Rosenberg, 1986, pp. 29–30, 113–139). These institutions served to
facilitate innovative behavior due to decreased uncertainty and therefore decreased
risks. Prior to the development of these institutions, the gamble of undertaking
potentially innovative activities was in many cases too high. With these institutions
in place, prospective entrepreneurs were able to shed a portion of the risk and
participate in such activities. This notion of entrepreneurship provides insight into
the impact of various institutions on the risk/reward tradeoff that economic agents,
acting within them, face.
Despite differences in the notion of entrepreneurship, each of the notions
emphasizes the dual role of entrepreneurship in the economic process – this is
represented in Fig. 1. The entrepreneur, in discovering previously unexploited
profit opportunities, pushes the economy from an economically (and techno-
logically) inefficient point (A) towards the economically (and technologically)
efficient production point (B). Moreover, in discovering new technology and
new production processes, which use resources in a more efficient manner, the
Fig. 1.
entrepreneurial process shifts the entire production possibility curve out from
“pp 1” to “pp 2” (Kirzner, 1985).9 This shift represents the essence of economic
growth – an increase in real output due to increases in real productivity.
Additionally, we can find further parallels that tie the varying concepts of
entrepreneurship together – specifically the institutions or environment that are
necessary for the entrepreneur to fulfill his function. We have already discussed
the importance of private property for all three notions of entrepreneurship.
Moreover, we can put forth several other general categories of institutions which
apply to all three views of entrepreneurship: a notion of freedom, a rule of law
which is certain, general and equally applicable to all, freedom of choice, and
the ability to freely contract with others (Birdzell & Rosenberg, 1986; Brenner,
1994; Harper, 1998; Mokyr, 1990; North, 1994; Olson, 1996).10 We will return
to a discussion of the institutions that encourage entrepreneurship in Section 5 of
this paper when we consider empirical studies on the topic.
3. MECHANICS OF ECONOMIC DEVELOPMENT

We have established that the entrepreneurial aspect of human action is the prime
catalyst of economic growth. Moreover, we have discussed several notions of
the entrepreneurial function and the role that institutions play in encouraging
or discouraging that aspect of human action. We now turn to a discussion
of neoclassical growth economics and the role – or lack thereof – that the
entrepreneur and institutional organization play in that framework.
Neoclassical growth theory has long overlooked the importance that institutions
play in economic growth (Kirzner, 1985; North, 1994). Simply put, for Neoclas-
sical economists, institutions did not matter. Instead, they focused on calculating
equilibrium as well as the relevant prices, variables and outputs for arriving at that
end state. It was not until the postwar period that economists began to realize the
importance of the entrepreneur as the driver of economic progress. Several decades
later (1960s–1970s), economists began to focus on institutions in their analysis of
economic growth (Kasper & Streit, 1998). As Stiglitz writes:
The neoclassical view prevailed until 30–40 years ago, when people became convinced that
the laws of supply and demand did not explain everything about economic equilibria . . . The
breakthrough came when people began to recognize that economic theory ought to be able to
explain the reason for institutions in a society, the functions they serve and the forms they take
(2000, pp. 2–3).
The standard neoclassical growth model is defined as:
Y = K, L, Tech, SK, NR, ST
Capital (K) was originally deemed important for long-term growth since it was
assumed that growth was positively correlated to the accumulation of capital,
which in turn is a function of savings and net investment. Soon thereafter,
economists began focusing on the relationship between capital, labor (L) and
technology (Tech). An increase in labor was seen as having a positive influence
on growth. Likewise, technological advances shifted the production function out,
allowing for increased levels of output. Growth theory was further refined when
economists realized the importance of human capital. Increases in the skills and
knowledge (SK) of the labor force had a positive correlation with increases in
productivity. Moreover, natural resources (NR) were included as an important
determinant in economic growth. This was a logical inclusion because natural
resources, like all other factors, are scarce and there was rising concern in the late
1960s that the supply of some natural resources might soon become exhausted.
Finally, in the 1970s some studies indicated that the structural organization of
economic activity changes (ST) as income changes, or that macroeconomic
growth was an extension of microeconomic foundations.
While not denying the importance of the factors mentioned above, the
neo-classical growth model suffers from its inability to incorporate the relation-
ship between time and the institutional structure.11 In short, the neoclassical model
fails to ask the pertinent questions why? and what? Why is there capital accumula-
tion through forgone consumption and investment or a lack thereof? Why are there
new technological advances in some countries and not others? Why is existing
technology used more efficiently in some places as compared to others? What
causes laborers to invest in their own development and what causes employers
to invest in their employees? Why are natural resources used in different ways in
different countries and why are the same resources used more efficiently in some
countries as compared to others? What are the incentives that economic actors
face and why do they act as they do? These questions can only be answered in the
institutional context. If some countries have higher capital accumulation than oth-
ers, or faster and more innovative technological advances, or a more highly skilled
labor force, we can conclude that there are incentives in place to encourage this
behavior. The neoclassical growth paradigm is incapable of capturing this infor-
mation and therefore is unable to accurately predict economic development.12 As
North writes:
Neoclassical theory is simply an inappropriate tool to analyze and prescribe policies that will
induce development. It is concerned with the operation of markets, not with how markets
develop . . . When applied to economic history and development it . . . ignored the incentive
structure embodied in institutions . . . In the analysis of economic performance through time it
contained two erroneous assumptions: (i) that institutions do not matter; and (ii) that time does
not matter (1994, p. 359).
The emptiness of growth theory is present not only in its inability to consider
the rules of the game and the incentives that those rules provide, but also in its
failure to understand the growth process itself. An economic analysis lacking
institutional considerations has led many economists to offer misguided policy
advice. For an example of this, one need only look at the fall of the Soviet empire
and the inability of western economists to both predict its occurrence and to offer
pertinent development advice directly after the fact.
Human interaction in an economy relies on regular, expected patterns of
behavior. The rules of the game facilitate interaction and reduce the coordination
costs of undertaking economic activities by making actions more predictable. In
addition, the institutions that arise provide an incentive structure that influences
the actions that economic agents, including entrepreneurs, will take. Given that
the entrepreneur is the catalyst of economic growth, any theory of economic
development must consider the deeper issues that effect the entrepreneurial aspect
of human action. These issues include a broad range of institutions including
political, legal and sociological considerations such as culture, ideology, values
and preferences.13 Additionally, in order to arrive at more robust results, economic
growth theorists must recognize that development is the result of a mixture of
formal and informal rules and that the same rules will have different consequences
when applied to different economies. Moreover, political regimes directly influ-
ence development through both the intended and unintended consequences of their
involvement in the institutional environment. Finally, adaptive institutions, which

are able to change and evolve over time, are more likely to lead to faster economic
development as compared to institutions that are inflexible (North, 1994).
In order to continue to develop an understanding of economic growth, one
constructive endeavor for both Austrians and Neoclassicals to undertake is
the development of an analytical framework which can be used to judge the
effectiveness of various institutions. There is a great opportunity for the further
development of this analytical construct. Initially, some measurement must be de-
veloped to identify “good” institutions from “bad” institutions. Stiglitz (2000) has
suggested a basic benchmark of a good institution as one that fulfills its function.
This, of course, is a very general benchmark which would need clarification to
be effective. Additionally, this point of reference only considers the stated goals
versus the performance. Other considerations include the allocation of resources
or services due to the operation of the institution – that is, does the institution
grant favors or special privilege to some while excluding others? If it is agreed
that the entrepreneur is the driver of economic progress, economists should also
continue to develop measurements to determine the impact of certain institutions
on that function of entrepreneurship. Creating an analytical framework with which
economists can study the rules of the game will only help in better understanding
economic development.
4. INSTITUTIONS AS CAUSE, ENTREPRENEURSHIP

AS CONSEQUENCE
Having concluded that the entrepreneur is indeed the prime driver of economic
progress within a certain institutional framework, we now turn to a survey of
the literature on entrepreneurship in the developing market context. In these
contexts, the institutions within which economic actors transact are undergoing
a process of transformation. As discussed, it is widely agreed that the incentive
structure influences the action of economic agents. This allows us to rule out
such considerations as the availability of technological knowledge, the population
level, migration, etc. as factors which can serve to explain the differences in
wealth across countries (Olson, 1996). Instead, we can focus on the institutional
environment and consider its influence on economic activity.14
The two most important “core” institutions for encouraging entrepreneurship
are well-defined property rights and the rule of law. It is well established that
those countries where these core institutions are developed have a record of strong
economic growth (Boettke & Subrick, forthcoming; Gwartney, Holcombe &
Lawson, 1998, 1999; Scully, 1988). Moreover, a majority of the other institutions
that are correlated with economic growth are grounded in these two institutions.
In a study of five post-communist countries, it was found that the two countries
(Russia and Ukraine) placed in the “backward group” diverged from the others
largely due to differences in protection of property. The study also confirmed that
these countries had the weakest rule of law. Courts were used less and the cost of
interacting with government was higher in these countries (Johnson, McMillan
& Woodruff, 2000). In addition to property and the rule of law, the previously
mentioned survey also considered firm performance (growth, contraction and
start-ups) and the development of market infrastructure – which are directly linked
to the core institutions.
One is able to further realize the importance of the core institutions by analyzing
the “unofficial economy.” We normally see an underground economy in those
countries where property rights and the rule of law do not exist or are poorly
defined or enforced. Extralegal activities evolve in order to circumvent the current
institutional structure which prevents or retards key economic activities. This
usually occurs through the prohibition of certain transactions, or the failure to
enforce transactions due to poorly defined property rights or rule of law. Examples
of institutions that stunt economic growth include government, police and/or court
corruption, excessive taxation and/or regulation, unstable and/or inconsistent
monetary and fiscal policy (Frye & Shleifer, 1997; Gwartney, Holcombe &
Lawson, 1998, 1999; Johnson, Kaufmann & Zoido-Lobaton, 1998; Johnson,
McMillan & Woodruff, 1999, 2000; Schleifer, 1997; Schleifer & Vishney, 1993,
1994; de Soto, 1989, 2000).
There have been several studies which attempt to measure the unofficial
economy and the variables that cause its existence (Enste & Schneider, 2000;
Johnson, Kaufmann & Shleifer, 1997; Johnson, Kaufmann & Zoido-Lobaton,
1998). The findings of these studies serve to highlight the institutional structure – or
lack thereof – which encourages underground activity. These studies have identified
several general relationships between the institutional structure and underground
economic activity. First, there is high correlation between the percentage of total
GDP comprised by the unofficial economy and the level of regulation – the unof-
ficial economy comprises a large share of GDP in those countries with stringent
and excessive regulations. Second, higher taxes on businesses lead to higher levels
of unofficial economic activity. Third, higher levels of corruption – government,
police, and courts – lead to higher levels of unofficial economic activity. The study
of five post-communist countries discussed above supports these findings. Russia
scored a 4 out of 5 in terms of regulation (the higher the score the worse the regu-
lations for business) and scored last in regulatory discretion and lax enforcement
of rules (Johnson, McMillan & Woodruff, 2000). Furthermore, in a separate but
related study, Ukraine scored last in terms of tax structures that helped business
with Russia not far behind. Both countries also scored extremely low in terms of
rule of law (Johnson, Kaufmann & Zoido-Lobaton, 1998). Clearly the lack of insti-
tutions in these countries is highly correlated with their lack of economic growth.
Capital flight is yet another indicator which highlights the influence of the in-
stitutional environment on entrepreneurship and hence, economic growth. Again,
the issue of capital flight is directly linked to the core institutions – private prop-
erty and the rule of law. It has been established that foreign capital only matters
after private property has been established. Even with capital at the entrepreneur’s
disposal, there will be little incentive for him to invest it without property rights
(Johnson, McMillan & Woodruff, 2000).15 Additionally, as discussed in Section
2, the notion of entrepreneurship – especially for Kirzner – does not require the
ownership of any resources to undertake entrepreneurial activities. However, as
indicated, it is often the case that the entrepreneur does own resources that are
used in the execution of his plan. Furthermore, even if the entrepreneur does not
own or contribute any of his own capital, it is a safe assumption that capital will
be needed from some source to accomplish his plan. It is in this aspect that we can
make the connection between the importance of well-defined property rights and
the notion of capital.
Property rights, while critical in encouraging capital flow into a country, are not
the only influencing factors. Other variables that play a key role in attracting capital
are the stability and certainty of the tax structure, macroeconomic stability (includ-
ing controlled inflation and stable monetary policy), trade rules and regulations
and the ability of agents to develop their own businesses and firms which in turn
allows for the development of investor confidence (Bhattacharya, 1999; Sheets,
1996; Wintrobe, 1998). Hernando de Soto has identified the following “effects”
that have allowed the West to develop capital:
(1) defining the economic potential of assets through securities, title, contract,
etc.;
(2) integrating legal information into one system;
(3) making people accountable through the legal system;
(4) making assets fungible by representing them in some standard form facilitating
interaction and exchange;
(5) forming a network of people which allows assets to move between agents; and
(6) protecting transactions via the rule of law (2000, pp. 49–62).
Recalling that the role of institutions is to remove uncertainty and facilitate social
interaction, the effects identified by de Soto make logical sense. In those countries
where the environment is characterized by uncertainty and riskiness, there is great
potential for a lack of capital which makes it difficult for entrepreneurs to carry
their plans to fruition.
In discussing overall economic development as well as capital flight, one of

the key factors is the ability of agents to form firms.16 The firm is important
to economic development for several reasons. As discussed in Section 2, the
firm allows for the diversification of risk and encourages research, development
and innovation. Moreover, the firm enables workers to specialize and allows for
different individuals with varying skills, knowledge and ideas to interact, poten-
tially spurring innovation. Given this, we can learn much about an institutional
structure by considering its effect on startups and spin-offs.17 This indicator is
closely tied to the previously discussed notion of capital. The ability to attract
capital, in part, relies on how capable firms are in attracting investors. However, to
grow and become more stable, firms need capital to fund their expansion. There
is a circularity here that can lead to continued difficulty and economic stagnation
if it is not remedied. If there is a shortage of capital, firms may have a difficult
time expanding operations and gaining stability which in turn, may sour investor
confidence to supply capital. Much depends on how institutions are implemented
and the signals that those institutions send to foreign investors. Returning to the
study of five post-communist countries, startups and spin-offs were “stagnant”
in the “backward group” while the other three countries considered (Poland,
Slovakia, and Romania) were much more “dynamic” (Johnson, McMillan &
Woodruff, 2000). Again, this is in line with our conclusion that those countries
with well-defined property rights and the rule of law develop at a faster rate than
their counterparts.
Having concluded that the core institutions for economic development are well-
defined property rights and the rule of law, we must address the issue of transition.
There is much literature on this topic but we will limit ourselves here to a discussion
of some of the issues that a country faces when attempting to implement these
institutions. Institutional change is often met with many barriers – new rules and
institutions often clash with their longer-established counterparts. Additionally,
there is often corruption, rent seeking and power grabbing by government officials
and those who seek privilege from them. Finally, even with institutional change, the
underlying values and culture of a country may be slow to change and prohibit the
new institutions from being effective. Regarding privatization and deregulation,
there are many issues that must be decided including the valuation and sale of public
assets, distribution of sale proceeds, the speed and sequence of privatization, what
sectors or industries to privatize and how much of the economy to privatize, as well
as the many political and bureaucratic barriers that are sure to arise. Establishing
a rule of law that is conducive to economic growth suffers from the problems
discussed above as well as coordination with privatization and deregulation.
Historically, those countries that have well-defined property rights and a strong
rule of law also have a high growth rate. In considering developing countries,
those that have adopted these core institutions as well as others that stem from it
– freedom of choice, predictable government activity, rules conducive to market
and firm development, freedom of contract and exchange, etc. – have also grown
at a faster rate as compared to their counterparts which have adopted different
institutions. The adoption of these institutions has provided an incentive structure
which encourages the entrepreneurial aspect of human action, and hence continued
economic progress.
5. CONCLUSION
While economists have a difficult time arriving at unanimous agreement, there are
a few general principles where the profession is able to find common ground. It is
agreed that incentives matter and that the institutional environment in which the
economic agent acts serves as an incentive structure which guides and influences
action. Moreover, it is widely agreed that the entrepreneur is the catalyst of
economic progress.
The Austrians have long realized the importance of the entrepreneur and the need
for economic analysis of the institutional organization that influences economic
actors. For the Austrians, the entrepreneurs are not a separate class of individuals
who fulfill an entrepreneurial function. Rather, entrepreneurship is an omnipresent
aspect of human action such that all individuals are entrepreneurs. Given this,
entrepreneurship cannot be the cause of economic development. Instead, we must
look at the rules of the game and determine the behaviors which those incentives
encourage and discourage. We have demonstrated that entrepreneurship is a con-
sequence of a country’s development – specifically the adoption and development
of institutions that encourage the entrepreneurial aspect of human action. Stimu-
lating entrepreneurial action will in turn spur economic development and growth.
Therefore, if economic growth is the goal, attention should be paid to achieving
the institutional mix that encourages the entrepreneurial aspect of human action.
Neoclassical growth theory is ill equipped to deal with the time and institutional
aspects that are critical for a firm understanding of economic development. The
formalized models overlook the deeper issues – institutional evolution, political,
legal and sociological – that influence entrepreneurship. There is a robust research
program for Austrians and Neoclassicals alike in determining an analytical
framework by which we are able to evaluate the effectiveness of institutions on
growth and development.
We determined that the two core institutions necessary for achieving the goal
of encouraging entrepreneurship are private property and the rule of law. While
these are not the only institutions that influence entrepreneurship, the impact of all
other institutions stems from the adoption of these core institutions. Determining
the institutions which encourage entrepreneurship and implementing them are
very different endeavors. There are many barriers to transition including political,
bureaucratic, and resistance to change. Institutions which are effective in one
country may fail to have the same impact in other countries. This is due to the fact
that institutions operate in a moral and cultural context, which in some cases may
hamper the workings of the market. This is not a result of the market as such, but
rather how agents decide to act within it.
NOTES
1. For further discussion on entrepreneurship in the literature (see Kirzner, 1973, pp.
75–84). For a discussion of the historical role of the entrepreneur in economic theory (see
Blaug, 1998; Soltow, 1968). For a discussion of the development of entrepreneurship in
the Austrian school (see Kirzner, 1994).
2. Baumol (1990) makes the distinction between “productive” and “unproductive”
entrepreneurship. If anything, his analysis further highlights the simple fact that institutions
matter. Our analysis of the institutional structure dovetails nicely with Baumol’s thesis in
that we realize that the societal organization channels the entrepreneurial aspect of human
action towards certain activities. However, while Baumol focuses on productive (i.e. inno-
vation, etc.) versus unproductive (i.e. rent seeking and organized crime) entrepreneurship
we focus on this aspect of human action as being transformative or not. Transformative
entrepreneurship requires alertness to hitherto unknown opportunities. An example of this
is the recent trend of drug dealers in Baltimore lowering the age of their distributors and
providing them with mopeds. This entrepreneurial activity (in the sense that it reflected
alertness to a previously unknown opportunity) lowers the cost of getting caught and
raises the cost of the police catching the distributors. Furthermore, this activity is neither
productive nor unproductive in the sense that Baumol uses these terms.
3. For a further discussion of Schumpeter’s analysis of entrepreneurship grounded in
Walrasian general equilibrium (see Rothbard, 1997).
4. Schumpeter was careful to distinguish between “innovation” and “invention”:
This function does not essentially consist in either inventing anything or otherwise creating the
conditions which the enterprise exploits. It consists in getting things done (1950, p. 132).
And further juxtaposing the role of inventor with the entrepreneurial role of innovation:
As long as they are not carried into practice, inventions are economically irrelevant. And to carry
any improvement into effect is a task entirely different from the inventing of it . . . Although
entrepreneurs of course may be inventors . . . they are inventors not by nature of their function
but by coincidence and vice versa (1960, pp. 88–89).
Innovation on the other hand can be characterized as the introduction of a new good(s),
introducing new production or technical method(s), opening a new market, new sources of
raw materials or new forms of industry organization (1960, p. 66).
5. In his analysis of the entrepreneur, Schumpeter attempted to consider the various

motives that may drive his efforts. In doing so, he put forth three groups of motives:
power and independence, to succeed simply for the intrinsic value of success (i.e. for
success’ sake), and the joy of creating and achieving. Schumpeter postulated that only
the first group of motives required the institution of private property. He also realized that
discarding this motive would retard development: “These and other peculiarities incident
to the mechanism of ‘acquisitive’ society make it very difficult to replace it as a motor of
industrial development . . .” (1960, pp. 93–94).
6. It is well known that the differing views of the two authors on the notion of
entrepreneurship has led to continued debate and a great deal of literature. Kirzner has
recently put forth a reconsideration of both his and Schumpeter’s entrepreneur. In so doing,
he has drawn several new connections between both notions of entrepreneurship and
responded to a number of the criticisms of his earlier work on this topic (see Kirzner, 1999).
7. On a theoretical level, the importance of Kirzner’s insight should not be understated
because his work provides us with the disequilibrium foundations for the equilibrium
economics that underlies standard price theory. Without these disequilibrium foundations,
as Franklin Fisher (1983) has argued, our intellectual confidence in the teachings of
standard microeconomics would have to fade away.
8. It must be made clear that for Schumpeter, innovation in technology is the only source
of change. Since he started from a Walrasian general equilibrium, tastes and resources
could not be the source of change.
9. Another relevant point here is the “spillover” effect of entrepreneurship. When
entrepreneurs exploit profit opportunities, they simultaneously create new entrepreneurial
opportunities for others to exploit (Holcombe, 1998). The entrepreneurial process is reliant
on an incentive structure which encourages the entrepreneurial aspect of human action.
Additionally, the entrepreneurial aspect of human action is, in a sense, self-sustaining since
it creates an environment of further discovery.
10. This is hardly a complete list of the freedoms sufficient or necessary for
entrepreneurship. (See Harper, 1998 for a more complete list.)
11. In the neo-classical effort to develop a mathematically formal model, this exclusion
makes logical sense. The other variables in the growth model are for the most part easily
quantifiable while the institutional structure and its evolution over time are difficult if not
impossible to capture in mathematical form.
12. It must be noted that there have been some attempts to incorporate rule of law
and private property indexes in studies of economic growth (Barro, 1997). However, these
attempts still suffer from the fact that that these indexes fail to capture the institutional
process – i.e. the development of institutions over time. At best, these studies are able to
compare two sets of historical data to observe the changes at two distinct points in time.
13. Olson found that differences in personal culture explain only a small part of dif-
ferences in per capita income between the rich and poor countries (1996, p. 19). However,
culture and ideology do have an important influence on the development of entrepreneurship
(Boettke, 2001, pp. 248–265). Culture plays a key role in encouraging certain characteristics
and values – independence, risk-taking, innovation, competitive aggressiveness (Lee &
Peterson, 2000) – which will influence the impact that institutions have.
14. A finding in the literature on development is that foreign aid tends to be ineffective in
countries that lack good governance, but effective in countries that have good governance.
The trouble with this conclusion is that countries that have good governance tend to be
countries that do not need foreign aid. Our argument about entrepreneurship and the institu-
tional environment is simply a variant of this empirical claim – entrepreneurship generates
economic growth within the right institutional environment. Entrepreneurial activity outside
of that institutional environment will not be effective in generating economic growth. Our
argument leads us back to the quote from Adam Smith that is at the beginning of this paper
– if you get the right basic institutions, all else takes care of itself in the natural course of
individuals realizing the mutual gains from exchange.
15. Another point to consider is that weak financial markets may not prohibit economic
growth if companies are able to reinvest their own profits, see Johnson, McMillan and
Woodruff (2000).
16. There is some empirical literature linking entrepreneurship to economic growth in
the industrial organization context. While these studies do not focus on entrepreneurship
as an omnipresent aspect of human action, they do realize the importance of the forma-
tion of firms as a key element in manifesting entrepreneurial activity and hence, economic
growth. This literature serves as an extension of the underlying Austrian insight regard-
ing entrepreneurship. See Audretsch, Leeuwen, Menkveld and Thurik (2001); Audretsch,
Carree, Stel and Thurik (2002); Reynolds, Miller and Maki (1995); and Reynolds, Storey
and Westhead (1994) for work in this area.
17. For a study of regulation barriers to establishing businesses, see Djankov, La Porta,
Silanes and Shleifer (2000) and Parente and Prescott (1994). See Sautet (2000) for a dis-
cussion of the necessity of firms for the exploitation of discovered profit opportunities.
ACKNOWLEDGMENTS
We acknowledge the financial assistance of the J. M. Kaplan Fund to support our
research. The usual caveat applies.
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of Economic Perspectives, 10, 3–24.
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of Political Economy, 102, 298–321.
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deaths: U.S. 1976–1988. Small Business Economics, 7, 389–407.
Reynolds, P. D., Storey, D. J., & Westhead, P. (1994). Cross national comparison of the variation on
the new firm formation rates. Regional Studies, 28(4), 443–456.
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Logic of Action Two: Applications and Criticism from the Austrian School. UK: Edward Elgar
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Sautet, F. E. (2000). An entrepreneurial theory of the firm. New York: Routledge.
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Schleifer, A., & Vishney, R. W. (1993). Corruption. Quarterly Journal of Economics, 108,
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DIFFERENTIATION AND CONTINUITY
IN THE MARKET ECONOMY
G. B. Richardson
ABSTRACT
The effective working of market economies is dependent, for reasons not
fully recognised, on the existence, and on the relative stability, of differences
in the capabilities of individual firms. General equilibrium theory abstracts
from these circumstances and is therefore unable to explain how economic
adjustment actually takes place; a proper appreciation of the role played by
differentiation and continuity enables to do this and to assess the scope and
limitations of the process.
It is in the tradition of the Austrian School to seek to explain economic phe-

nomena in terms of the consequences of individual actions, and to recognise that
these actions are taken on the basis of subjective beliefs about both technical
possibilities and what other relevant people in the system – consumers, suppliers
and competitors – are likely to do. This being so, it is obviously appropriate to
enquire as to what particular features of a market economy would make it easier or
more difficult for business men to form beliefs which will prove to be justified in
the event.
On the face of it, this is a reasonable question to ask, but one which is ruled out
of consideration by theory which focuses on the pure logic of decision-taking on
the basis of a full specification of the relevant information. It is characteristic of
the Austrian approach, however, to keep the epistemology, as well as the logic, of

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90 G. B. RICHARDSON
decision taking in the foreground – a circumstance of which I first became aware

when I read, as a student, the famous article, Economics and Knowledge, which
Hayek published in Economica in 1937. In addressing the question to which I
have referred, perhaps I could claim to situate myself broadly within the Austrian
tradition.1
In this paper I shall argue that the effective working of market economies is
dependent, for reasons not fully recognised, on the existence, and on the relative
stability, of differences in the capabilities of individual firms. A proper appreciation
of the role of these differences, I shall maintain, enables us to understand the scope
and limitations of the processes that promote an efficient use of resources.
It may be thought that these processes are already well understood, an account
of them having been given in broad terms by Adam Smith over two centuries
ago, and subsequently refined by a succession of writers since that time. Over
one century ago, Walras developed a general equilibrium model, which purported
to identify a configuration of prices and outputs towards which, given perfect
competition, all prices and outputs throughout the economy would tend to move.
Pareto demonstrated its normative properties. Then half a century later, Arrow and
Debreu published a fully developed mathematical theory of general equilibrium
that, by some if not all economists, came to be regarded as a final apotheosis.
Whatever else they may have established, I do not believe that Arrow and Debreu,
any more than Walras, provide an explanation of how economic order in fact does,
or ever could, come about spontaneously in the world we know. Walras sought
to illustrate the attainment of general equilibrium by means of a special kind
of auction in which a process of tentative bidding, on the basis of provisional
prices, caused these prices to be varied until demand and supply came into balance
in all markets. Arrow and Debreu extended this approach by presupposing the
establishment of a complete system of contracts related to an unlimited number
of goods distinguished not only be their physical characteristics, but also by their
place and date of delivery and the state of the world at that time.
Now it is clear beyond any argument that economic order in the real world does
not come about as a result of the complex contracting procedures, the postulation
of which can be justified only as a heuristic device. General equilibrium theory
tells us nothing about the processes of adjustment in the real world; indeed, as
we shall see, it abstracts from circumstances that make such adjustment possible.
Whatever value the theory may have, we are not entitled to draw from it any
conclusions about how economic order could be realised, or about the institutional
arrangements, the market structures, and the distribution of knowledge and skills
that would have to be in place.
General equilibrium theory is associated with a complete set of contracts, which
ensure “clearance” in all markets. In the world as we know it, contracting certainly
Differentiation and Continuity in the Market Economy 91
does play an important role in the process of resource allocation. No economic

activity can be said to be profitable or useful taken by itself, but only within
an appropriate context of related activities. A firm contemplating the production
of a good will therefore want to know that the required inputs will be available
and that a sufficient demand for the good can be depended upon. In order to
ensure this, contracts may be entered into with suppliers and, if possible, orders
for the product sought in advance. In this way cooperation enters into the process
of resource allocation, parties being said to cooperate when each of them does
something on the understanding that the others will likewise do what is expected
of them. Cooperation takes many different forms. A very important one is the
organised cooperation that takes place within a firm, it being distinguished by
contracts according to which all employees undertake, within the limits of their
actual or implied job descriptions, what management asks of them. Cooperation
also takes place among firms, in a wide variety of forms, whenever their differing
capabilities have to be harnessed to a common purpose. Cooperation co-exists and
inter-acts with competition, as the latter regulates the terms on which the parties
to the former come together.
I am inclined to think that, in providing accounts of how resources come to be
allocated, cooperation has not enjoyed its fair share of the limelight. (And also,
perhaps, that the human dispositions favouring cooperation rather than competition
have been undervalued.) Common observation tells us, however, that the role of
cooperation in furthering economic order is nevertheless limited. The limits are
reached when, at the margin, the reduction in uncertainty that is provided by
contracts costs too much in terms of reducing the freedom of action needed to deal
with the uncertainties that will remain. A firm wishing to secure needed inputs,
for example, may be reluctant to enter into a long-term contract for their supply
when it is not sure of its likely future requirements. It will similarly be reluctant
to undertake itself the production of the needed inputs, even if possessing the
capability to do so, in that it will widen the range of its investments associated
with the same risk. Consumers will likewise rarely wish to commit themselves in
advance to a pattern of purchasing when they do not know what future opportunities
may be and how their own needs and preferences may develop. Contracting, in
any case, does not provide perfect assurance as the parties to it, for good or bad
reason, may default.
It is by no means surprising, therefore, that in real world market economies,
contracting does not, as in the general equilibrium models, take over the whole
burden of coordination. A consumer will, without thinking, take the risk of being
able to buy a pair of shoes when he wants them; a producer will enter into long-
term arrangements only for the supply of such inputs as are so specific to his own
needs as to be not readily available on the market.
92 G. B. RICHARDSON
We must conclude, therefore, that although uncertainty about what other people
will do can be reduced by reciprocal undertakings, their effectiveness is limited by
the residual uncertainty, particularly about tastes and technology that inevitably
remains. Nevertheless, the world goes round, as the institutions, structures, laws
and practices of market economies have evolved in adaptation to this circumstance.
In order to understand how market economies work, we have to ask ourselves how
effective business planning is possible despite the fact that reciprocal undertakings
cannot provide full assurance that related activities essential to a contemplated
investment, whether complementary or competitive, will also be undertaken.
General equilibrium models, by presuming that all business decisions are based
on the existence of a complete set of contracts, provide no answer to that question
and may mislead us as to where an answer can be found.
This paper is concerned with two circumstances, familiar to us in real life,
which do not feature in general equilibrium theory, nor indeed in most economic
model building. These circumstances are differentiation and continuity. Individual
people obviously exhibit differences in their ability to perceive and to respond
to particular opportunities, differences attributable to their innate talents, their
situation and their experience. And these differences are relatively persistent; they
usually change only gradually over time.
Systems of organised cooperation, such as firms, likewise exhibit differentiation
and continuity. They have, in other words, particular capabilities which fit them
for some lines of activity better than for others, differences attributable in part, of
course, to differences in the talents and experience of those working within them,
but also to differences in organisation, experience, market connections, goodwill
and reputation. Firms will also differ, as do individuals, in how much expansion
they can safely undertake at any particular time. Again as do individuals, they will
differ also – and importantly – in what may perhaps best, if ponderously, be termed
“the structure of their awareness,” it being upon this that will depend the nature
of the profit opportunities they are likely to perceive.2 And all these capabilities,
although subject to development, will exhibit a degree of continuity. There is likely
to be a relationship, through this continuity of capability, between the changing
activities that a firm undertakes over time; and the rate of change will obviously
also tend to be limited by the durability of fixed equipment.
These two circumstances, differentiation and continuity, will naturally favour
some division of labour both among individuals and among the firms in within
which they are organised. This consideration weighed heavily with Adam Smith
both in his account of the increasing productivity of individuals and in his very
important account of how specialisation among enterprises both brings about,
and is brought about by, increasing total output. “The Division of Labour.” as he
famously put it, “is limited by the Extent of the Market.” Later theorists responsible
for the model of perfect competition, so influential since its development a century
after Smith, in effect rejected this famous principle by assuming the existence of
many firms doing the same thing. There seems little doubt that, in the endeavour
to develop from the contributions of Smith and earlier writers a more accurate and
more formalised theory of the determination of prices and outputs, important ideas
were lost from sight.
It might be argued that neo-classical theory was entitled to abstract from differ-
ences in the comparative advantage between firms on the ground that these were
not relevant to the matter in hand – that of identifying an equilibrium configuration
of prices and outputs towards which they system would move. In fact, however, the
opposite is the case. Differentiation and continuity can be shown to be conditions
necessary for the achievement of economic order. Were all firms to be equally
able to perceive and evaluate a profit opportunity, then it would in effect be open
to none of them; it is differences in firms’ perceptions of an opportunity, in their
evaluation of it and in their ability to respond, that can narrow the field sufficiently
to offer individual firms a chance of success. And just as differentiation reduces the
risk of excessive competitive supply, so continuity reduces the risk that activities
complementary to the investment being considered, whether on the side of demand
or of supply, will not be in place.3
The ability of firms and individual to predict and to plan is assisted by the stability
of their environment, as afforded by the continuity to which we have referred. It is
further assisted by the fact that aggregates commonly show less variation than their
components. It is this circumstance that, in the market for consumer goods, makes
contractual arrangements with individuals, even where practical, rarely resorted to.
I have argued that differentiation and continuity can provide firms with sufficient
assurance to plan their investments, while competition continues to operate on costs
and prices and, through them, the allocation of resources. I have not maintained,
however, that these circumstances will necessarily be able to do so in all markets
and at all times. We have to ask ourselves whether differentiation and continuity
might at some times be too weak to provide the stability needed for enterprise
planning, or too strong for competition to exercise its traditional function. We have
to ask, to put the matter differently, whether market economies may sometimes fail,
either because uncertainty deters some worthwhile private long-term investment
or because competition is too weak to prevent exploitation and inefficiency. These
questions, even if they permit generalised answer, cannot properly be addressed
in the compass of this paper, although I hope that the analysis it contains, together
with further considerations to which I now wish to turn, may be of assistance in
doing so.4
There are some general reasons for expecting that in most markets for most of
the time, there will be sufficient differentiation to offer firms profit opportunities
94 G. B. RICHARDSON
to which they can safely respond. In Adam Smith’s day, transport costs were
frequently high enough for firms to have limited local markets, and as these costs
declined with improved communications, the consequence he envisaged was not an
increase in the number of businesses supplying the same market but a finer division
of labour among them. The differentiation provided by geographical location, in
other words, came to be replaced by that associated with specialisation in the
different stages of a process of production. Firms could enjoy the relative stability
afforded by local monopolies, or “particular markets,” in Marshall’s sense, while
competition on their frontiers maintained a downward pressure on prices and costs.
A firm may have a profit opportunity reserved for itself – at least for a time –
by successfully developing a new product, process or market. Such innovation has
been regarded as providing temporary abnormal profits, but the rate of technolog-
ical development is now so rapid in so many markets that continuous product and
process development is a condition for earning a rate of return sufficient to stay
in business. A firm’s competitive success in these circumstances will depend on
balancing the cost of product development against the prospect, which it provides,
of temporarily “reserved” profit opportunities.
In economic model building, market structure is normally featured as given,
as influencing the behaviour of firms rather than being influenced by it. In reality,
however, these structures evolve in response to circumstances and, should they
preclude informed decision-taking, or cause these decisions to be associated
with an unacceptable degree of risk, they are unlikely to remain unchanged. One
response to over-investment or to under-investment, occasioned by the presence
of a large number of firms with insufficiently differentiated capabilities, may be a
move towards consolidation. The United States oil industry in its early years, when
there were many producers, suffered from endemic over-production until John
D. Rockefeller forced through, by fair means and foul, a consolidation that, for
a time, brought about a closer adjustment of supply to demand. There are indeed
many instances of arrangements, with varying degrees of formality, which firms
have entered into, with the professed aim of achieving this objective. This aim
may not often have been achieved, the result – perhaps the intended result – being
merely to dampen competition, shelter efficiency and obtain monopoly returns.
But it is unreasonable to argue either that competition, if left untrammeled, would
always secure an orderly adjustment of supply to demand or that firms, faced with
the reality of maladjustment, can never be right to seek remedies.
Differentiation and continuity are necessary, I have argued, to enable firms to
take the informed decisions without which there could not be a rational economic
order. They are also necessary, as is more widely perceived, to enable competition
to exercise its selective function, its function, that is, of permitting successful firms
to grow at the expense of their less successful rivals. We should not interpret this
function as promoting only efficiency in a narrow sense. I referred earlier to differ-

ences between firms in the structure of their awareness.5 I used this expression to
convey the idea that firms are more or less specialised in the range of opportunities
they perceive, but it may also help to remind us that firms, like individuals, can
only act on the basis of the pictures or models or representations of reality that
they come to form and that prove, in the event, more or less successful in dealing
with it. Firms whose representations prove successful will be rewarded in the
competitive process, and economic progress will thus be promoted, not directly
through rational calculation about how best to allocate known resources among
known ends, but through a social process of experimentation by which knowledge
is enlarged.6
NOTES
1. I must confess, however, that my knowledge of the relevant literature does not entitle
me to the claim. But see Foss N. J.: The economic doctrines of an Austrian Marshallian;
George Barclay Richardson, The Journal of Economic Studies, 22, 23–44.
2. The notion of capabilities is now well established in the literature. Mrs Penrose makes
extensive use of it in her book: The Theory of the Growth of the Firm, Oxford University
Press, 1959 and 1995. I put it to somewhat different uses in my; Information and Investment,
Oxford University Press, 1960 and 1990, and in an article, now appended to that book, which
is entitled The Organisation of Industry.
3. This argument is presented more fully in my Information and Investment. I have
presented it here somewhat differently, having drawn on thinking carried out since I wrote
that book.
4. I try to deal with the issue somewhat more fully in Information and Investment.
5. It is appropriate here to refer to the work of Israel Kirzner; e.g. his Competition and
Entrepreneurship (1973), The University of Chicago Press. Professor Kirzner proceeds
from the observation that investment opportunities may be neglected, and desirable
economic adjustments consequently impeded, simply because of entrepreneurs’ lack
of sufficient awareness of what is not deemed to be in their interest or, as Professor
Loasby (and I) would rather put it, of what they are not interested in. There is no doubt
that this “subjective” consideration can produce a differentiated response to “objective”
opportunities. My concern in this paper, however, is with the circumstances which facilitate
or impede prediction and thus deny opportunities to those subjectively qualified to perceive
them.
6. I touch in this last paragraph upon evolutionary economics and the process of social
experimentation. I have chosen not to dwell on this theme as the importance of differentiation
and continuity for efficient “selection” and evolutionary development is widely appreciated.
the best known exposition probably being Nelson and Winter (1982), An evolutionary theory
of economic change, Harvard University Press, Cambridge, Mass. Less widely appreciated
is the importance of these circumstances in providing the stability necessary for enterprise
prediction and planning.
ENTREPRENEURSHIP AND THE
GENERATION OF KNOWLEDGE
William N. Butos
ABSTRACT
The received Austrian theory of entrepreneurship is considered in light of the
generation of knowledge. It is suggested that learning involving more than the
discovery of profit opportunities provides a way to endogenize knowledge and
to expand the scope of entrepreneurial activity. The theoretical and applied
aspects for entrepreneurial studies of this approach are discussed.
INTRODUCTION
This paper proposes a market process approach in which entrepreneurs not only
discover existing knowledge but also generate new knowledge, in terms of both
their own understanding of reality and of changes their actions induce in the market.
This focuses attention in directions compatible with an Austrian perspective and
also provides impetus for further theoretical and empirical work in entrepreneurial
studies.
Any Austrian perspective in entrepreneurial studies must proceed from the body
of work that Professor Israel Kirzner has produced. His contributions provide
economists with arguably the most carefully worked out theory of entrepreneurial
activity available. The observation that “Paris gets fed” suggests that something
similar to the coordinating process that Kirzner’s theory analyzes constitutes an
indispensable element to the understanding of how markets work. At the same

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time, Kirzner’s theory of entrepreneurship, which centers on alertness, discovery,

and the elimination of error, abstracts from certain kinds of real world activity
arguably associated with entrepreneurial activity. The point of this paper is to
suggest that recognizing entrepreneurship as knowledge-generating activity can
usefully extend Kirzner’s insights. This approach may be seen as one way to
endogenize the entrepreneurial process, a suggestion Rizzo (1996, p. xxiv) has
recently made.
KIRZNER’S THEORY OF ENTREPRENEURSHIP

Building on the work of Ludwig von Mises,1 Kirzner’s theory of entrepreneurship
elucidates the principal mechanism of the market process. His theory involves
three central components: the costless discovery of profit opportunities, the
subsequent actions that discovery initiates, and the successful exploitation of
opportunities via price arbitrage. For Kirzner “the market process . . . is set in
motion by the results of the initial market-ignorance of the participants” and con-
sists in “the systematic plan changes generated by the flow of market information
released by market participation” (1973, p. 10). Only when no market ignorance is
present (given tastes, technological possibilities, and resource availabilities) will
the market process have eliminated all opportunities for further gains and thereby
have reached an equilibrium in which all decisions and plans dovetail perfectly.
Like Mises who used a stationary model, the evenly rotating economy, only as a
“mental tool for comprehension of entrepreneurial profit and loss” (1966, p. 329),
Kirzner’s principal interest and theoretical analysis concern the process by which
entrepreneurial activity exploits profitable opportunities and not the conditions
stipulated by or consistent with a state of equilibrium. In disequilibrium, the
successful execution of utility-enhancing plans by potential transactors remains
unrealized and thus constitutes a field of opportunity for entrepreneurial activity.
For Kirzner, the initial ignorance of market participants and their consequent
failure to exploit all exchange opportunities does not reflect transactions or search
costs and hence is not categorized as “rational ignorance”; instead, theirs is
“sheer ignorance” (1997a) which can only be rectified by the interdiction of an
entrepreneur alert enough to discover existing opportunities for profit.2
For Kirzner, it is this quality of alertness to previously unnoticed opportunities
that is at the core of his theory of entrepreneurship. Alertness is an “attitude of
receptiveness” (1997a, p. 72) and a disposition to “sniff out opportunities” (1979,
p. 29) that itself involves no opportunity costs to the entrepreneur because it
entails “the discovery of something obtainable for nothing at all” (1973, p. 48).
If alertness refers to the entrepreneur’s mental state of awareness, then discovery
Entrepreneurship and the Generation of Knowledge 99
refers to the identification of something in the external world sufficient to activate

entrepreneurial action. While those actions occur in time, discovery is timeless in
that it constitutes an instantaneous recognition or “moment of realization” of the
existence of a profitable opportunity. At one moment that awareness did not exist
but at the next it does; the proverbial “flash of insight” has occurred. Although
for Kirzner alertness and discovery induce an overhaul in the entrepreneur’s
perception of the field of action, it does not refer to action as such; alertness and
discovery precede action and are a precondition for action.3 The argument that
Kirzner’s theory with its emphasis on discovery precludes a theory of choice, as
Salerno (1993) suggests is, therefore, misplaced.
When alert entrepreneurs discover opportunities for profit (and presumably
choose to thereupon embark on certain courses of action and not others),4 their
actions initiate a market process characterized, as Hayek (1937) emphasized, by
the progressive transmission of relevant knowledge to market participants that
they “are themselves unable to obtain” (Kirzner, 1973, p. 15). For Kirzner this is
achieved by entrepreneurs competing with other entrepreneurs by exploiting price
differentials between inputs and outputs and through those actions inducing move-
ments in market prices that increasingly become consistent with the coordination
of participants’ plans. As envisioned by Kirzner, this process, driven by “competi-
tion between the entrepreneurs as buyers, and again as sellers,” will “communicate
to market participants” useful knowledge enabling each to formulate a “correct
estimate of the other market participants’ eagerness to buy and sell” (p. 15). Prices
move in the correct direction. The process ceases when no further discovery (i.e.
profit opportunity) can be made – there is no relevant knowledge left to discover
because all useful knowledge has, by virtue of the activity of entrepreneurs, already
been utilized, exploited, and otherwise made available to all. The unintended
byproduct of this process is the attainment of equilibrium market prices.5
LEARNING
For Kirzner discovery and the action which follows hinge on an assumed capacity
by entrepreneurs to interpret the current situation and to formulate a view of the
future they imagine will entail profits for them. If the actions of entrepreneurs
are to be characterized as equilibrating, it must be presumed that they have
learned something about the environment that presents a genuine opportunity
for arbitrage profits; that is, entrepreneurs have become aware of some existing
exploitable configuration in prices. In Kirzner’s theory, it is in the course of their
market experience that entrepreneurs will have acquired relevant knowledge that
enables them to uncover or detect discrepancies in the prevailing market data and
100 WILLIAM N. BUTOS
which thereupon provides them with the opportunity to earn profits (1973, p. 71).
Economic analysis enters the picture at the moment of alertness, and it is the
sequence of subsequent actions that such alertness sets into motion that instantiates
the Kirznerian market process. Once that process is underway, Kirzner holds
that decisions made by market participants will be based on knowledge they will
learn in the course of their market activity. In Kirzner’s words: “decision-makers’
alertness to new possibly worthwhile ends and newly available means” suggests
that decisions may be understood as the result of a sequential “learning process
generated by the unfolding experience of the decisions themselves” (p. 36).
As noted earlier, in the course of the market adjustment process all market partic-
ipants in Kirzner’s theory gradually form more correct estimates of others’ plans
through the adjustment of prices made possible by the activity of entrepreneurs.
Entrepreneurial discovery and the subsequent activity it sustains set in motion a
market process that is coordinating: individuals’ plans will more closely dovetail
because entrepreneurial activity has induced, as a byproduct of its actions, the
dissemination of knowledge and the elimination of error (see Kirzner, 1992,
pp. 149–151).
Kirzner argues that economics studies only the implications of alertness. At the
same time, Kirzner holds that the process is driven by learning – discovery – and by
the mechanisms through which those discoveries are dispersed within the market
domain. Learning is central to this process because it opens up the possibility for the
systematic removal of error and hence legitimating the possibility for the process to
be coordinating. Kirzner’s theory, with the pivotal role that learning plays, provides
a non-Walrasian model of market adjustment based on the capacity of purposeful
agents to adapt their behaviors in response to perceived opportunities. If we are to
maintain, along with Kirzner, that the process is in some sense non-random, we
must suppose that learning is also systematic (or at least sufficiently so) if it is to
generate a process that itself is systematic or, in Kirzner’s theory, equilibrating.
But what does discovery and learning refer to in a market setting? Even if we are
content to postulate the entirely sensible notion that learning occurs, that does not
on its own tell us the learning capacities of agents in terms of what (if anything)
is being learned and what learning depends upon. Such questions go to the core
of subjectivism and its theory of agency and hence carry implications for theories
that purport to describe the market process. Boland (1982, Chap. 4) points out
that the way agents are modeled implicitly commits those agents to some position
concerning how they epistemically cope in their environments. In this view, how
a model works and the implications it sustains are not independent of the implicit
theory of learning its agents are presumed to follow. We can imagine, for example,
models generating results very different from each other depending on assumptions
regarding the capacity of agents to learn or the role of knowledge and learning in
the very specification of the model. Thus, Keynes’s bear speculators are assumed
to have little capacity to learn in the sense of revising what they take individually to
be the “safe” rate of interest. On the other hand, agents in perfect foresight models
face no apparent constraints on what they can learn and consequently such models
effectively devolve into models in which knowledge and learning have no role to
play, as in standard Walrasian models of static competitive equilibrium.
Complicating matters, Boland also argues that different theories of learning
and knowledge are not on scientific grounds equally plausible or correct.
Some, he holds, are more correct than others. This suggests that the specific
epistemic practices of agents are relevant to how we depict the market process.6
Entrepreneurs who only look to tea-leaves for guidance would presumably
generate market sequences different from entrepreneurs following more reliable
and grounded approaches. The point here is not directed at subjecting Kirzner’s
(or anyone else’s) implicit epistemics to the pointless exercise of prescriptivist
methodology, but, instead, to suggest that what one means by learning matters
because different conceptions of learning help to shape our theoretical models of
the market process. This is not a question of getting the “right” theory of learning
in hand as the more modest aim of simply developing and making more explicit
what one means by an agent and its capacities.
In Kirzner’s theory, entrepreneurial alertness and learning are confined to the
costless discovery of existing price differentials between input and output prices.
But if we wish to understand more fully how and why entrepreneurial activity is
equilibrating (and the circumstances under which it is likely not to be), we cannot
presume the result, viz., some sort of generic learning will inexorably occur, that we
are seeking to demonstrate. It would be useful, in other words, to make more explicit
what is meant by “alertness” and what it means to claim that entrepreneurs “learn.”
This question and its ramifications for Kirznerian entrepreneurship have
recently been explored by several Austrian economists. Among the more note-
worthy are those by David Harper (1996) and Young Bach Choi (1993). Harper’s
approach, which presents a “cognitive-logical perspective on the rationality
of the entrepreneur, on entrepreneurial learning and on the character of the
market process” (p. 31), uses a Popperian-inspired application of conjectures and
refutations to model entrepreneurial activity. Entrepreneurs formulate and put into
motion plans based on theories – conjectures – they expect will result in profits.
Their actions can be understood as guided by various methodological principles
that they choose to deploy depending on their problem situation and that allow
them to learn from their market experiences in order to correct and modify
plans and to generate new conjectures. In Harper’s treatment, entrepreneurial
learning is thus endogenized. Within this “growth of knowledge” framework,
entrepreneurial activity constitutes the principal mechanism for falsifying theories
about entrepreneurs’ “structural knowledge” pertaining to ends and means and

eliminating those that do not survive market tests. Harper’s treatment provides
a rational reconstruction of the methodological procedures guiding the actions of
entrepreneurs and the implications of those procedures concerning entrepreneurial
learning. Appropriately, Harper refers to the market process as a “learning
mechanism” (p. 290).
Choi’s central concern is the relationship between perceptions (and their
acquisition) and decision making and action under uncertainty. His principal
claim is that individuals cope with uncertainty by searching for and adopting
“paradigms” or models that provide an understanding (or perception) of their
surroundings and the necessary confidence to pursue various actions. Interactions
among paradigm-seeking individuals at the social level tend to generate regimes
of conventions that guide behavior. At the same time, however, the very stability
of conventions promotes endogenous change in the form of opportunities for
profit which go unnoticed and remain unexploited by convention-following
individuals. This provides a window of discovery and for action by entrepreneurs
with new or different paradigms which allow them to see the situation differently
from others. Entrepreneurial learning, “the process by which we come to acquire
paradigms,” provides the impetus for innovation and its acceptance as “com-
monplace knowledge in society” (Choi, 1999, p. 72). In this way, entrepreneurial
discovery of profitable opportunities promotes a process of social learning by
which innovations become installed, at least temporarily, as new conventions.
Other work by Butos and Koppl (1999) looks at Kirzner’s entrepreneurial theory
from a perspective based on a Hayekian theory of expectations. They principally
use Hayek’s The Sensory Order to examine the meaning of subjectivism from
an epistemological and methodological standpoint and, in so doing, provide an
account of how market participants learn in the course of their market activities.7
This forms the basis for a theory of “Hayekian expectations” that they deploy to
give to an account of how market participants come to know relevant aspects (or
what Harper calls “structural knowledge”) of the field of action.
These approaches constitute, however, only a partial rendering of the impli-
cations that a theory of learning (Hayekian or otherwise) holds for Kirzner’s
theory of entrepreneurship. The second part of the story involves the recognition
that any genuine theory of learning must treat not only the discovery of existing
knowledge, but also the generation of knowledge. The theories and conjectures
agents formulate in pursuing their objectives may be described as deriving
from internal models that process and transform signals into expectations (and
behavioral response modes) via complex cognitive processes and multi-layered
adaptive feedback mechanisms. These models serve as “production systems” by
which agents generate interpretations – knowledge – of their environment. This
was only hinted at in Butos and Koppl (1999, pp. 262–263, note 19). There,
learning was identified with the mechanisms that result in the individual’s forming
an interpretation of external reality. On Hayekian “sensory order” grounds, if what
we know about external reality is actually an interpretation, then our subjective
knowledge of reality has somehow been constructed by the brain.
Hayek’s cognitive theory provides an explanation of how this happens.8 In
Hayek’s terminology, the brain produces a classification (interpretation) of external
reality along any number of dimensions according to the perceived attributes the
mind has constructed. In effect, Hayek’s cognitive theory directs our attention
toward a conception of learning in which knowledge is generated. Aside from the
question of how cognitive activity works, a matter better left to cognitive specialists,
what matters is that such activity produces an output that we call knowledge. It
is this point that forms the principal motif of the discussion here. That is, our
interest is not in the psychology of cognitive activity, but in the implications of
such activity. While we often and correctly associate learning with mechanisms
by which existing knowledge is acquired or grasped, as is the case for Kirznerian
entrepreneurs, a Hayekian perspective reminds us that learning also includes the
transformation of existing knowledge and the generation of new knowledge. This
suggests that Kirznerian alertness should encompass the capacity of entrepreneurs
to discover knowledge and to generate new knowledge. In this “sensory order”
sense of what learning means, we can move beyond a conception of entrepreneurial
activity based on discovery of existing knowledge to a more inclusive one that also
highlights the generation of knowledge. What is important here is not the particular
explanation that Hayek offers to account for learning, but simply the recognition
that in looking at learning in this way, our attention is directed toward additional
considerations that may further our understanding of the market process.9
THE GENERATION OF MARKET KNOWLEDGE10

In market theory, the loci for the generation of knowledge are individuals and
the social interactions they participate in. This knowledge is sometimes treated
as “conjectures,” “theories,” “facts,” or “dispositions to act,” but the crucial
point is that however that knowledge is characterized, it is knowledge that is not
simply delivered as such to the individual or acquired in the sense of picking
up pebbles from the beach. Claiming knowledge is something out there, waiting
to be discovered, does not speak to the circumstances and conditions proximate
to its generation (Butos, 1986, p. 851). Claiming that knowledge is analogous to
picking up beach pebbles suggests that discovery simply involves the transference
or communication of data from one realm to another, from the external world to
the cognitive dimension. However, as Hayek (1978, p. 43) notes, knowledge is

something that happens to the mind. If, following Hayek (1952), we view sensory
impulses as the “inputs,” and the apparatus that sorts, organizes, and assembles
them as sets of routines or rules governing their assignment, we have a model that
helps us see the process by which an “output” – knowledge (however contingent
and imperfect it may be) – is produced. Moreover, it is possible to stipulate
that the routines governing the assignment of inputs are themselves mutable,
responding via feedback loops in an obviously complex fashion in ways that may
(or not) be useful for the agent’s successful adaptation to the actual environment.
In Hayek’s theory, the rules governing cognitive mechanisms (including tacit or
“supraconscious” ones) generate a classification over reality; it is a classification
that the mind has produced. Within the constraints imposed by the physiology of
the organism, the particulars of the knowledge individuals generate about reality –
their interpretation and meaning they attach to aspects of the real world, both as is
it and as it might be – is also unique to each individual, as determined by his past
history and the cognitive routines that had been found useful. Yet, for the purpose
at hand, it is not the particulars of Hayek’s cognitive psychology that make it rele-
vant, but its suggestion that the principal characteristic of a particular order (here,
the sensory order) is the generation of knowledge. This broadens what learning
encompasses and thrusts into the mix considerations, such as creativity, that are
at best implicit or treated as exogenous when learning is confined to the discovery
of existing knowledge.
The key claim here, then, is that such processes do not involve the deliverance
of knowledge but a capacity to transform inputs by generating a classification
over those inputs that we would identify as new knowledge. The leads Hayek
provides in this context suggest that the categories of alertness and discovery may
not adequately capture the full dispositional range of entrepreneurial activity.
We also need to take account of the potential for the generation of knowledge
when individuals interact within the framework of the market economy.11 In all
forms of social contexts, individuals enter into interactions with a stock of “public
knowledge,” presumably shared by all, concerning prevailing rules and conven-
tions and other forms of useful knowledge. But individuals also have knowledge
of a more personal sort peculiar and unique to each that could refer to Hayek’s
knowledge of “time and place” as well as to knowledge about their preferences
and plans and, lest we forget, to their capacity to generate knowledge about their
own preferences and plans and form conjectures of the preferences and plans of
others.12 Only in the context of the catallaxy do these interactions generate market
prices as byproducts of the interactions entered into. The constellation of market
prices reflects an outcome of a process that no simple extrapolation, addition,
or summarization of each individual’s knowledge would have been sufficient to
Table 1.
Sensory Order Market Order
Inputs Sensory stimuli Individual knowledge

Mechanisms Rules and routines that connect Rules and routines of interacting
impulses via a classificatory individuals, ie. Institutions within a
apparatus for sorting, organizing, given property rights framework of
relating impulses within a particular exchange
physiological structure
Outputs Individual knowledge (conscious, Market quasi-knowledge (prices,
tacit, predispositions, preferences) quantities, goods’ characteristics)
produce. Instead, the market process involves a transformation of knowledge at

the individual level into a new form of quasi-knowledge that could not have been
inferred beforehand and which is unique to the specific framework in which those
interactions exist, the sequence of those interactions, and to the specific rules and
routines individuals follow. In short, only catallactic interactions can generate
market prices and this particular kind of knowledge cannot be disembodied from
the particular circumstances and conditions associated with its generation. The
same individuals interacting under a different set of (non-catallactic) rules will not
generate market prices nor the same kinds and quantities of goods. And we only
need observe actual market and non-market economies to highlight that, aside from
any comparative welfare comparisons, such systems are unambiguously distinct in
any number of vital ways. One way to understand how and why this should be is to
recognize that the knowledge-generating capacities of individuals and social orders
are not independent of the structure and functioning of the orders themselves.13
We should note that the knowledge produced at the market level most assuredly
does not reflect any “group mind” at work. Unlike individuals, the market order
is neither conscious nor teleological. The argument being drawn here attempts to
highlight the kinds of knowledge that different structures and social arrangements
generate. The knowledge an individual is capable of generating necessarily differs
from that generated by interacting individuals. Nor would it be correct to suggest
that the market is being conceived or treated as a “super consciousness.” The
perspective being advanced here rejects that suggestion. The market economy only
exists because individuals interact within its framework and it has no existence
apart from those individuals. As such, we must recognize that these interactions
involve a degree of complexity that is capable of generating outcomes unique
to those interactions. The subject matter of economics is the analysis of those
interactions; that is, economics has a rationale precisely because its subject matter
is not the product of an omnipotent or super conscious being.
ENTREPRENEURSHIP AND THE GENERATION

OF KNOWLEDGE
The discussion so far has suggested that the problem of the division of knowledge
and the mechanisms for the transmission of knowledge, so famously associated
with Hayek and Kirzner, constitutes one side (albeit a very important one) of
the significance of knowledge for economics. If it is indeed useful to explore the
economics aspects of the generation of knowledge, part of that exploration would
seem to suggest broadening the scope of the role of the entrepreneur in the market
process beyond alertness to price differentials.14
One implication of a knowledge-generating perspective is that the discovery
and elimination of error no longer constitutes the only relevant aspect of
entrepreneurial activity. Instead, the theory of entrepreneurship also refers to the
inherent capacity of individuals to create knowledge – Hayekian interpretations
or Popperian conjectures – about their environment as it was, as it is, and also as it
might be. When we view the market process as one which, through the actions of
entrepreneurs, only removes error, the process itself becomes determinate in that
its path is really an unfolding of the actions implied by the initial conditions.15
As Kirzner puts it, “a theory of process must establish the determinateness of the
course of market events” (1979, p. 17, italics added). This seems a sensible way to
theorize about certain essential aspects of the actual processes of the real world.
At the same time, however, this approach does not consider the dependency of
the generation of knowledge on the market process itself.
This can be seen in Kirzner’s (2000) discussion of the horse-drawn carriage
and automobile industries. Because it is only error that provides the context for
entrepreneurial activity in Kirzner’s theory, any entrepreneurial action (in the
illustration here it is manifested by the appearance of the automobile) only makes
sense if it is stipulated that current economic activity is necessarily riddled with
error. As Kirzner puts it: “we now see with 20–20 hindsight, that the horse-drawn
carriage industry . . . was an industry in grave disequilibrium before the automobile
actually appeared” (p. 250). From this ex post perspective, the introduction of the
automobile simply “revealed the wastefulness and the misallocated character” of
resources in the horse-drawn carriage industry (p. 251). The concentration on error,
including its ex-post construction, suggests a description of the market process
in which every actual decision real economic actors make is defined as an error,
where error is treated as a formal category against the backdrop of full certainty.
In recognizing that the economic analyst and the actual agents would describe
the process and their success (or failures) quite differently, an alternative expla-
nation of the process emerges that does not require us to conclude the decisions
and actions of the carriage builders to have been misallocations or wasteful. This
interpretation can be sustained if the scope of entrepreneurial activity and the
market process instantiating such activity is extended beyond the discovery and
elimination of error. Thus, from the perspective of the carriage builders, their
actions were believed to be maximizing ex-ante. That this did not turn out to
be the case resulted from an innovation that they could not have known about
prior to the fact. Indeed, there was no existing opportunity to be discovered;
rather new knowledge (i.e. as represented by the invention of the automobile)
was generated and once that innovation became available can we then speak of
Kirznerian entrepreneurship springing into action, itself promoting subsequent.
endogenous changes that such activity puts into motion. Thus, the prices that
serve as the (temporary) “givens” for Kirznerian arbitrageurs are also byproducts
of the overall market process and represent, consequently, knowledge which also
has been generated.
In the view suggested here, the market process involves agents who have the
capacity to both discover and generate individual knowledge, their interactions,
and the generation of market level byproducts stemming from those interactions.
The process involves complex feedback loops operating at all levels and learning,
both in the sense of correcting mistakes and of producing new knowledge. In a
process of this kind, “market equilibrium” (in the sense of a description of a process
that has eliminated all error) refers to the logical implications of a particular model
without endogenous knowledge. The knowledge-generating perspective discussed
here provides scope for introducing endogenous knowledge that may allow for a
fuller treatment of the complexities associated with the market process and a basis
to empirically support a more complete range of behaviors ordinarily associated
with entrepreneurial activity.
In considering entrepreneurial activity in terms of a broad array of char-
acteristics, various Schumpeterian propensities might appear to provide a
useful starting point. The dynamic qualities of Schumpeterian entrepreneurs
find empirical expression in the way real-world markets work, suggesting the
desirability of incorporating such behaviors into market process theory.16 While
no disagreement is harbored in recognizing the role of such Schumpeterian
propensities, the discussion here seeks to highlight that the actions through which
these propensities are instantiated reflect a knowledge-generating process of the
entrepreneurs themselves and also of the changes in the market their actions
induce17 be a recognizable for the latter issue.
CONCLUSIONS
This paper has attempted to extend the received Austrian approach to en-
trepreneurship by broadening it to include the entrepreneur and the market as
knowledge-generating entities. Emphasis on the discovery and transmission of
dispersed knowledge, an insight central to the Austrian School since Hayek’s

“knowledge papers,” does not provide a fully endogenous theory of the market
process. Ironically, it is Hayek’s work in another domain that brings into relief
the nature of the problem and a possible solution. I have suggested here that
the theory of entrepreneurship may be productively extended to encompass the
generation of knowledge. This claim and the possible kinds of research it suggests
is, in fact, congenial with the received Austrian view and supportive of attempts
to endogenize knowledge in a theory of the market process.
The scope of the analysis suggested here is, in one sense, very broad. Questions
about the generation of knowledge extend beyond the confines of the market
economy to include the conditions and circumstances of its generation under
alternative institutional frameworks in which markets and their attendant legal
arrangements cannot or do not exist. But in terms of the focus of the present
study, it may be possible to see the entrepreneurial function as including activities
which have the effect, both intended and otherwise, of creating new means-ends
frameworks and fomenting changes in consumer preferences, not simply discov-
ering preferences or price discrepancies in the existing array of goods. Kirzner’s
theory of entrepreneurship provides an account of a crucially important aspect
of the market process; yet, it’s scope is such that while it can explain “how Paris
gets fed each day,” it is less successful in endogenizing the process to explain that
the way Paris gets fed and what it eats each day changes.
In addition, what I have said here should not be construed as advocating
a Schumpeterian approach to entrepreneurial activity. The Schumpetarian
entrepreneur is an innovator who disturbs an existing equilibrium and puts into
motion a process of “creative destruction.” This vision of the market economy
carries great appeal because it corresponds in a casual empirical sense to what is
commonly observed. From the perspective of the present study, however, a central
feature of entrepreneurial activity involves knowledge-generating entrepreneurs,
suggesting that as a theoretical and empirical matter entrepreneurial activity may
express itself in manifold ways and forms, from arbitraging prices to creating
new institutional structures.
More specific research entry points for developing the approach suggested here
have already entered the literature, although not explicitly from the perspective
of the knowledge-generating capacities of different social arrangements and the
scope of entrepreneurial activity in those contexts. It seems, though, that such
considerations could be usefully brought to bear when markets are affected by
“Big Players,” such as central bankers, policymakers, and others more or less
immune to the discipline of the market, as discussed by Koppl and Yeager (1996).
The activities of such players alter the functioning of markets because they have
the capacity to generate knowledge that dominates that of other participants.
Their actions change the resulting configuration of market prices and outputs.
This analysis has a natural extension to situations where only one agent (or Big
Player) operates in a regime of central planning, a scenario which has, of course,
been widely discussed and analyzed in economics as the socialist calculation
debate. In both cases, the issue is not simply the problems faced by Big Players in
acquiring necessary knowledge, but – from the perspective of the argument here –
how differing institutional forms – markets, Big Players in a market setting, and
central planning – affect the generation of knowledge and thereby the stability and
adaptability of the social order.
NOTES
1. Mises (1966) defines the entrepreneurial function in the following way: “The term
entrepreneur as used by catallactic theory means: acting man exclusively seen from the
aspect of the uncertainty inherent in every action” (p. 252). Kirzner (1973) refers to this as a
function which concerns “the very perception of the means-ends framework” (p. 33) and is
distinct from action once that means-end framework has been identified. Also see Salerno
(1993), who argues that Kirzner’s theory is distinct from Mises’.
2. Mises speaks of the “concantenation of the market” as an “outcome of the activities
of entrepreneurs, promoters, speculators, and dealers in futures and in arbitrage” (1966,
p. 327) which conveys a scope of entrepreneurial activity wider than Kirzner’s. See Kirzner
(1973, pp. 86–87) for a discussion of these differences.
3. See, for example, Kirzner (1973, p. 33–34).
4. This sort of “deliberation,” which Kirzner does not highlight, speaks to Mises’ notion
of “appraisement” (1966, pp. 331–333).
5. Kirzner (1973) deployed a single-period model formulation. Later on, Kirzner (1982)
developed a multi-period model to more effectively deal with uncertainty. See Kirzner
(2000, Chap. 13) for his discussion of these developments.
6. For example, following Boland (1982, p. 67), if a particular agent is modeled as a
pure inductivist, the researcher has effectively asserted an incorrect epistemology.
7. Kirzner (1973, p. 71) proposes a hard line separating psychology from economics,
arguing that economics begins with the brute fact of alertness. At the same time, he notes
“it is necessary to build formally into our theory the insight that such a learning process can
be relied upon” (pp. 71–72). Kirzner (1985, p. 26) suggests that “applied entrepreneurial
theorists should look to this research with considerable interest.” Harper’s “growth of
knowledge” approach relies on a methodology that does not encompass the psychology
of discovery, although he suggests that the two are potentially complementary (1996,
pp 30–33). Lachmann (1977, p. 155) equates psychology with motives and argues that
economics is concerned “with plans, not the psychic processes that give rise to them.”
Lachmann’s reservations, like Kirzner’s, are echoed by many economists, including Mises
and Hayek and rightly so. But it is also the case that cognitive theory has gone far beyond
the behaviorist search for motives in attempting to understand and model “the internal
structure and decision processes of agents” (Harper, 1996, p. 35). That economists should
concentrate their energies on economics is not in dispute, but the ideas and concepts that
feed into economists’ understanding of the market process, even when they originate out-
side of economics proper, have a long and valued history in the development of economics.
If the boundary between economics and psychology has blurred, it is mainly due to the
demise of the old psychology and the emergence and flourishing of a new cognitive science
in the late 20th century. Though the domains are separate and distinct, productive links may
exist between them.
8. In Hayek’s account, sensory impulses are sorted out within the hierarchical and
relational structure of the brain. The welter of impulses have no meaning apart from the
transformation they undergo at the cognitive level. It is out of this initial “chaos” that a
particular order, the sensory order, is generated. See especially Weimer (1982). Also see
Agonito (1975), Butos and Koppl (1993). Hayek’s cognitive theory seems compatible at
a suitable level of generality with trends in modern cognitive science, as seen for example
in the work of Edelman (1987), Searle (1984, 1995), and Dennett (1996).
9. On “knowledge-generating orders,” see Butos and McQuade (2002).
10. It is probably useful to maintain a distinction in what follows between knowledge as
it pertains to the interactions in markets as opposed to those in science. Suffice it to say that
the latter, while social and a byproduct of interacting scientists, cannot be assumed to be
analyzable by the same kinds of mechanisms at work in the catallaxy nor to have the same
epistemological status. See McQuade and Butos (2003). Alternatively, Harper’s (1996)
approach, coming out of Popperian philosophy of science, is congenial to the proposition
that both scientific knowledge and entrepreneurial knowledge are similarly analyzable using
an approach based on “conjecture and refutation.” Resolving such matters is not easy, in
part because of the elusiveness of defining what knowledge finally is.
11. Table 1, which emerged out of discussions with Thomas McQuade, summarizes
the analogies between Hayek’s cognitive theory and the generation of market knowledge.
I thank Roger Koppl for suggesting that it is important to also point out the disanalogies
between the sensory and market orders in that the market order is non-teleological and
non-conscious. The reader may question whether it is appropriate to refer to market
outcomes (prices, quantities, goods’ characteristics) as knowledge at all. While this raises
concerns that cannot be fully addressed here, it may be useful to note that “knowledge”
is used here as a generalization of a system’s capacity to produce a classification by some
sort of transformational process performed on inputs. The system, in effect, generates an
adaptive model of the environment dependent on those inputs and on the ways in which
complex feedback loops affect the system’s functioning. In this conception, the generation
of knowledge is not confined only to the human mind, but applies to other complex systems
as well. Different kinds of systems, as defined by their structure, the rules governing their
operation, and functional attributes, will differ in their knowledge-generating capacities.
Pending a fuller explication of these points and their usefulness in applying them to eco-
nomics and social theory, the simple expedient of employing the term “quasi-knowledge”
suggests itself.
12. Such knowledge will generally be expectational, contingent, and revisable, as no
method in such contexts is likely to provide certain and time-invariant knowledge about
one’s own preferences, let alone those of other individuals. The point here is that if an
individual, as discussed earlier, has the capacity to generate new knowledge, then we need to
recognize that so-called “givens” like tastes and preferences are also subject to endogenous
generation.
13. The argument that socialist planners could replicate the results of the market econ-
omy fails utterly to comprehend that the kind of knowledge any social order is capable of
generating cannot be separated from the nature of the order itself. See Butos and McQuade
(2002).
14. Kirzner does not address the idea of entrepreneurial generation of knowledge,
although his following remark may suggest a view different from the one proposed here:
“When one becomes aware of what one has previously overlooked, one has not produced
knowledge in any deliberate sense”(1997a, pp. 71–72).
15. See Rizzo (1996, pp. xvii–xix).
16. Kirzner (2000) suggests incorporating various psychological propensities –
“boldness, self-confidence, creativity, and innovative ability” (p. 248) – to account for how
entrepreneurial activity expresses itself. In this construction, however, the generation of
knowledge and the various modes of its expression, such as creativity and innovation, are
treated as exogenous to the theory of the market process.
17. While Kirzner provides interesting leads about the sorts of changes generated by the
market process, the argument developed here suggests possibly fruitful ways to develop
some of their implications. Thus, in describing the process of market adjustment, Kirzner
(1973) postulates that market participants, in learning of their past mistakes, “can be
expected to develop systematic changes in expectations concerning ends and means that can
generate corresponding alterations in plans” (p. 70). Such changes constitute changes in
knowledge. Yet, they carry no implication in Kirzner’s discussion that the generation of this
new knowledge will induce the market process to follow another path or reach a different
equilibrium price; instead, the adjustment is confined to changes in prices that buyers and
sellers will pay and receive as profitable opportunities are grasped by entrepreneurs. Also
see, for example, Kirzner (1997b, pp. 43–45) on “over-optimism” and “over-pessimism.”
As McQuade (2000) notes, changes in expectations and plans imply changes in reservation
prices by sellers and buyers and hence a change in market price and/or quantity. In the
language of supply and demand analysis, both market schedules would shift.
ACKNOWLEDGMENTS
This paper bears the imprint of discussions over several years with Thomas
McQuade and Roger Koppl. I thank them for comments on an earlier draft of this
paper and Sanford Ikeda for discussions on the theory of entrepreneurship. I also
thank an anonymous referee for suggestions. All remaining errors are mine.
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the Symbolic Processes (Vol. II, pp. 241–285). Hillsdale: Lawrence Erblaum.
THE ENTREPRENEUR AS A
CONSTRUCTOR OF CONNECTIONS
Peter E. Earl
ABSTRACT
This paper attempts to recast the entrepreneur by synthesizing ideas from
personal construct psychology and systems-based evolutionary economics.
It retains an Austrian subjectivist emphasis but focuses on rapid product
innovation rather than arbitrage. Profit opportunities are mental constructs
that link products and revenue streams. Entrepreneurs develop new products
by forming novel connections between existing product elements and
diverse technologies, mindful of the connections between these products
and the complex structures of consumer lifestyles. These linkages are
often formed in the context of large multi-product firms, as well as being
the basis of new enterprises, so entrepreneurship overlaps with strategic
management.
INTRODUCTION
This paper is an attempt to recast the Austrian view of the entrepreneur in the light
of two recent works with which I have had some involvement. The “constructor”
theme comes via a Ph.D. on the nature of entrepreneurship by Christine Woods
(2002), for which I was an external examiner. Woods investigates the topic both the-
oretically and empirically via the Personal Construct Psychology of George Kelly
(1955) that had earlier influenced my own writing on business behaviour (see

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06008-3
113
114 PETER E. EARL
Earl, 1984; Harper & Earl, 1996). The “connections” theme comes via a recent
book by Jason Potts (2000), which shared the 2000 Schumpeter Prize and was
based on a Ph.D. that I had the pleasure of supervising. Central to Potts’ analysis
is the contention that mainstream neoclassical economics differs from heterodox
varieties, Austrian economics included, by taking the mathematical notion of a
“field” as the basis for its perspective on the nature of an economic system. The
key feature of a field is that each element in the system is connected to all the other
elements in the system, and hence the system has no structural architecture of
subsystems and hierarchy. When mainstream economics tries to emulate physics –
rather than, say, chemistry – as a “hard science,” it sets out to emulate the field-based
discipline par excellence. Potts contends that, one way or another, the critics of
mainstream economics are operating from a perspective that sees the operations of
economies as being affected by the failure of their component parts to be linked so
comprehensively.
Instead of viewing the economic system from a field perspective, Potts follows
Koestler (1975a) in seeing the world as a system of systems that are themselves
composed of systems, and so on: economic agents are complex biological
systems operating in complex social and physical environments. From this
standpoint, much of entrepreneurial behaviour entails the construction of new
systems by forming connections that have not previously existed. Since this
connection-constructing process is selective, it is appropriate to consider the
workings of entrepreneurial minds before we consider physical and institutional
areas in which entrepreneurs play a social role by putting new connections in
place. It is here that Woods’ critique of Austrian thinking and her alternative
focus on the mind as something that constructs hypotheses is significant. I
then explore the kinds of connections that entrepreneurs can construct, partic-
ularly given that consumer lifestyles are themselves systems of connections.
This leads to a discussion of what the connectionist view of entrepreneurship
implies about the dividing line between entrepreneurship and management,
followed by a concluding section that reflects on the perspective offered with
particular reference to the theoretical role of the entrepreneur in an age of
globalization.
Throughout the paper, I make copious use of examples, mostly from the music,
publishing and automotive industries, to illustrate the kinds of connections that
entrepreneurs form. We are not dealing here with a simple idealized world of
trade-offs between alternative bundles of apples and oranges, but the real world
of complex systems. Of necessity, therefore, the examples have to be much more
detailed than economists are prone to employ and at times the style consequently
looks more like that in marketing (where the introspective writing of Holbrook,
1995a has been a major inspiration) or management.
The Entrepreneur as a Constructor of Connections 115
THE CONSTRUCTION OF PROFIT OPPORTUNITIES

Kirzner’s (1973) view of the entrepreneur as having a superior capacity for
alertness to profit opportunities is problematic in that it fails to address the issue
of how opportunities come to be perceived. Entrepreneurs may well differ from
the general public in terms of the extent to which they go through life “on the
lookout” for profit opportunities but profit opportunities are not things that lie
around waiting to be found, to which are already attached labels marked “profit
opportunity.” Rather, as Woods (2002) argues, entrepreneurs construct them as
possibilities in their minds. This entails making connections.
Consider the case of an academic publisher as an entrepreneur. In Kirznerian
terms, we might expect enterprise to take the form of the publisher having an idea
for a book and signing up an author or editor to prepare a manuscript. But the idea
for the book does not in itself constitute a profit opportunity until the publisher
has attached to it his/her vision of its potential costs and revenues. Only when that
attachment has been made can the publisher see whether it is worth proceeding
with it. The same applies when the publisher receives an unsolicited book proposal.
In effect, the would-be author is saying, “I construe this a profit opportunity”
but whether or not it becomes one in the eye of the entrepreneur depends on the
prospective net revenue stream that the latter assigns to it. If the publisher sends
it out to academic referees, their constructions of it as a profit opportunity may
be rather different because they lack the publisher’s knowledge of how somewhat
similar books have turned out in terms of costs and revenues. Likewise, different
publishers, with different pools of experience and different ways of forming
conjectures, may differ over whether or not it could be profitable to take on
a particular book. These conjectures sometimes change during the process of
editing a manuscript. In the case of Holbrook (1995a), for example, the author’s
laudable unwillingness to dumb down his manuscript beyond a particular point led
to it eventually being published by a different firm (Sage) from the “Big Textbook
Publisher” (HarperCollins) that had originally asked him to write it (see Holbrook
1995a, p. xii; 1995b, pp. 650–651). In short, although not everyone will have a
particular idea for a product or an arbitrage opportunity, or be informed of it by
someone else, it is not awareness of the possible business activity itself that makes
it a profit opportunity but the awareness of the activity combined with the imagined
net revenue stream they attach to it.
To the extent that entrepreneurs do have original creative thoughts about what
might form the basis of a business project, these too entail making connections.
This is clear from the work of Koestler (1975b) and Shackle (1979), the former
arguing that creativity entails a novel synthesis of existing notions rather than
the construction of something out of nothing, and the latter seeing thoughts as
116 PETER E. EARL
based upon a limited set of elements that are capable of being combined in new
ways, much as letters of the alphabet can be formed into new words. (This kind of
perspective is also found in Adam Smith’s (1795/1980) writings on the history of
astronomy, which Skinner (1979) drew to the attention of economists.) Clearly,
people who can call upon different sets of ingredients will differ in the new ideas
that they can construct, although different sets of ingredients may sometimes be
combined to produce similar novel thoughts.
Entrepreneurs may not only differ from the general public in terms of the
mental ingredients they employ and their tendencies to experiment mentally
with making new combinations. They may also be more willing to take risks
because they do not construe hazards that the rest of the population sees –
either due simply to not thinking in terms of particular dimensions, or because
they have extra thought dimensions in certain areas that lead them to construe
wider opportunities than the general public for gain and for managing problems.
There is much work waiting to be done investigating these kinds of differ-
ences and their implications for policies aimed at promoting entrepreneurial
activity.
LEARNING AS THE RECONFIGURING OF

MENTAL CONNECTIONS
Harper (1996) portrays entrepreneurial learning as Popperian process of hypothe-
sis revision. From the present standpoint, it entails entrepreneurs making changes
in their sets of mental connections. In seeking to come up with more effective
ways of viewing the world, decision makers operate by imposing systems of
thought on a problem that essentially has the format of a field. Whether they
are aware of it or not, they need to avoid being paralyzed by what philosophers
of science know as the Duhem-Quine thesis. This holds that it is impossible
to test any single hypothesis in isolation from a larger set. (It is discussed in
relation to the field issue in Hoover, 1994, pp. 302–303; see also Loasby, 1989,
Chap. 12.) In other words, when evidence at odds with a particular hypothesis
is detected, the problem might lie not with the hypothesis itself but with other
theories being taken for granted during the test. Unexpectedly low profits on a
particular project might reflect mistakenly optimistic cost or revenue projections
on the part of the entrepreneur, but need not do so. Possibly something unexpected
is happening in the distribution chain, or something is amiss with the accounting
information systems that are used, or someone “has their hands in the till.” Or
possibly the answer lies in a combination of these factors and others not yet
imagined.
If absolutely everything is taken as open to question, entrepreneurial activity

becomes impossible. If one cannot have some degree of trust in others with
whom one forms business connections, or some confidence that one has a better
insight into what counts in a particular market or manufacturing process, there
is no firm spot on which to build an enterprise of any particular form. To make
decisions, the entrepreneur takes some things for granted and uses a particular set
of core “do” and “don’t” rules (Earl, 1984; Harper & Earl, 1996) whose efficacy
is taken for granted. When anomalies are encountered, these core elements in
the entrepreneur’s world-view determine how they will be construed, in other
words, which of the more peripheral elements will be adjusted and the form the
adjustment takes. Sometimes, the entrepreneur may sever a particular connection
whilst maintaining core constructs – for example, “I no longer believe it is going to
be possible to make money from selling executive cars that do not carry premium
brand names, but pulling out of this market does not mean we are thinking of
giving up making cars in general.” Sometimes, the entrepreneur will change the
connections between an element and other elements, possibly including new lines
of thinking – for example, “If we are to maintain our share of the liquor market,
we will need to integrate forward into liquor stores and hotels.” Sometimes, the
addition of a particular construct will be associated with a change in the strength
of connection between other constructs – for example, “Given the effect of the
September 11 events in New York on travel and the cost of insurance, our profit
projections from running this event will have to be scaled back somewhat.”
In deciding precisely how to change their minds, entrepreneurs will regard
some kinds of business decisions or projections as unthinkable because they
conflict with core notions. The latter will be preserved, if necessary, by all manner
of twists at the periphery, just as astronomers prior to the Copernican revolution
twisted their explanations to reconcile their earth-centered view with new data (cf.
Smith, 1795/1980). By imposing different systems to deal with the Duhem-Quine
problem, entrepreneurs, and people in general, end up with different views of
what is feasible and differ in their openness to change. Entrepreneurs who think
of themselves in terms of connections with particular activities – for example,
as carmaker, movie producer, beer magnate, media mogul, property developer –
will have particular trouble abandoning such lines of business because doing
so requires them to come up with a new self-image. When their capabilities to
construct viable hypotheses about market opportunities begin to wane in their
core areas, their chances of surviving as entrepreneurs seem likely to be enhanced
if they can concentrate thoughts about their core capabilities at a rather more
abstract, non-product-specific level. They can then try connecting them to new
lines of activity rather than letting their attention become absorbed with anxiety
regarding maintenance of existing activities.
118 PETER E. EARL
CONSUMPTION SYSTEMS
If entrepreneurs are to survive in business, they will need to possess some under-
standing of the thought systems employed by end users of the products with which
they are involved. Sales will not be achieved if the package on offer is deemed in-
admissible by the rules of thought employed by many of those in the target market.
Like entrepreneurs, consumers have their own firm spots on which to stand and their
rules of thought normally operate in a way that is at odds with the field conception
of economics. Consumers typically have lives that “revolve around” linked sets
of activities and products that comprise their “lifestyle” (Earl, 1986; Thompson,
1996) and would not even dream of consuming many of the goods that lie outside
of these sets but which fall within the lifestyles of others. Conversely, they would
find it unthinkable not to consume certain products. Knowing what will appeal
to particular consumers thus requires an appreciation of the contexts in which
choices are being made, which are themselves a reflection of the thought systems
that consumers use.
To understand the fabric of particular people’s lives, the entrepreneur may need
to trade with them repeatedly, itself a connection-forming activity. By cultivating
the goodwill of a regular clientele, the entrepreneur can engage in relationship
marketing, using knowledge acquired from previous transactions to make more
accurate constructions of areas of possible demand (see further, Earl, 1999, pp.
253–257). For example, anyone who has dealt over a number of years with a
good hi-fi store will appreciate this point readily: staff seem to have an uncanny
ability to recall what one’s system consists of, and hence how best to upgrade it on
a piecemeal basis.
The existence of consumer lifestyles means that patterns of substitution between
rival brands of particular kinds of products depend on their complementarities
with other kinds of products. Though already entailed in the comment about
hi-fi retailing, this point frequently applies in a much more subtle manner. For
example, consider the adoption of automatic washing machines in Britain in the
1970s, in favor of twin-tub designs. British suppliers were bemused by the loss
of market share to Italian products. The latter offered inferior drying abilities
compared with more expensive local machines that had been designed to cope
with the inclement British weather. The change in market share arose not because
of the price difference per se but in association with the adoption of central
heating systems that made it far easier to finish the drying process indoors if
necessary (see Hesselman, 1981, p. 24). British manufacturers did not see this
connection and had made their automatic machines so that they offered spin speeds
equivalent to the outgoing twin-tubs, with all that this entailed in terms of extra
production costs.
Due to the complexities of household consumption systems, one change of

lifestyle can have all manner of market implications but may be dependent on a
crucial ingredient. Continuing the previous example, we might also note that the
demand for automatic washing machines itself would have been associated with
the growth in households where both spouses went out to work and hence required
the convenience of machines that could perform the entire wash/spin cycle on their
own, for example, during the night. Dual income households, in turn, were better
able to afford central heating and double-glazing systems. However, they often
could not function without a child-minding infrastructure (children’s television
included!) and convenience foods. Their inability to be available at home to deal
with trades-people during business hours meant that they would often need to
engage in do-it-yourself work at weekends and would demand reliability as a key
requirement of their appliances as well as providing a fertile market for home
security systems – and so on.
The successful entrepreneur may not only need to understand how potential
customers make mental connections, and the connections that make up their
lifestyles. There is money also to be made by construing synergistic marketing
links (cf. Ansoff, 1965) between core products and possible tie-in products
based on a shared brand. Shrewd thinking in terms of connections has led to
the assembly of modern mass-media/entertainment businesses whose magazines
promote television programs and vice versa and both promote particular kinds
of merchandise (such as movies and recorded music) produced elsewhere in the
corporate empire. Failing that, the media contents can be connected to products of
particular advertising sponsors (as with travel and home-improvement programs)
or devised to be ripe for commanding product placement fees. Similarly, a
highly successful children’s novel is no longer merely a book competing in
no particular manner with other books and other ways of spending money.
Nowadays, it is a book to which may be connected a movie (with soundtrack CD
and subsequent video and DVD release), PC and PlayStation games, displays
or rides at theme-parks, a wide range of toys and artifacts, with licensed brand
extensions even to clothing, bedding, food, toothpaste and so on.
In fact, well before the age of Harry Potter and suchlike, children’s books
were sold on the basis of connections: four decades ago Thomas the Tank Engine
may not have had its marketing synergies exploited to the full, but its appeal was
nonetheless increased by the fact that it was part of a series involving a shared set
characters and hence offered scope for readers to spread the set-up costs of getting
to know the characters more effectively and get more out of them. Likewise,
publishers such as Hamish Hamilton used different imprints to signal comparable
books in terms of style or level (even as 10-year-olds, my contemporaries and I
knew what made a “Reindeer Book” different from an “Antelope Book,” much as
120 PETER E. EARL
many adults have particular expectations about books on a “Paladin” or “Picador”

rack compared with those from a more mainstream brand of paperback). If the
competitive arena really were a field in which products were all so transparent that
there were no costs entailed in getting to know (about) them, then there would be
no need for the entrepreneur to construct such connections and we would not see
the remarkably skewed earnings that comes from an ability to capture rents by
doing so.
CONNECTIONS, BROWSING AND SEARCH

As the number of products on offer grows, despite the parallel growth in globally
significant brands, the consumer’s problem remains one of bounded rationality
(Simon, 1982). A corresponding marketing problem is to get one’s brand on the
consumer’s agenda of things to explore and to keep it there. Earl and Potts (2000)
examine this issue in relation to the role and design of shopping malls, but it
clearly also has a counterpart in the world of “virtual” shopping. The rise of the
internet may make it easy for consumers to search for things that they want, such as
information about the latest activities of a particular recording artist and whether
or not they have a new album available, or whether a particular highly specialized
product exists. However, scope for finding information does not guarantee that
consumers will think of trying to find it. An increasingly significant entrepreneurial
skill thus lies in the construction of connections that have corresponding hyperlinks
that will capture the consumer’s attention and lead to particular browsing pathways
being taken. Web-based retailers such as Amazon.com employ precisely such
connection-based techniques to generate sales revenue for themselves and the
firms whose books and music they supply: for example, investigation of a particular
product at their website leads to information coming up about other products bought
by previous purchasers of the product, thereby suggesting possible similarities or
complementarities.
Producers can similarly exploit connections with other producers by swapping
links to each other’s websites, or by trading them if the flow of benefits seems to be
skewed in a particular direction. Thus, whereas I might have thought, without any
provocation, to check via a direct search to see whether long-dormant progressive
rock band Pallas had resumed their activities, my actual route to discovering their
website and new album was from the King Crimson website to the Uriah Heep web-
site (the link being John Wetton, who has played bass with both bands), and thence
to browsing on the latter’s excellent list of other bands’ sites. There, I noticed a link
to Pallas. In providing such a listing, Uriah Heep may not immediately generate
sales of their own recordings but they increase their chances of staying on the
agendas of potential customers: in future, when I want to look up particular bands

or remind myself of bands that I ought to check out, I have a bookmark of their site
ready and waiting. An increasingly important entrepreneurial capacity henceforth
will be that of creating frequently visited website nodes to manage the networks of
search and browsing that potential buyers undertake. Enterprising academics that
seek to ensure a wide readership for their writings can pursue similar strategies
in terms of the links they offer at their websites: Nicolai Foss, for example,
provides useful links not only to fellow economists’ homepages but also to various
organizations and to jazz guitar pages (see http://www.cbs.dk/staff/nicolai-foss/
njflinks.htm).
PRODUCTS AS SYSTEMS
From the Koestler/Shackle perspective, the creation of new products does not entail
creating something from scratch but making new connections between existing
ideas, capabilities and technologies. This happens at both the small business and
corporate level.
As an example of the former, consider the fusion between virtuoso violin
techniques/compositions and the electric guitar, a genre known in rock circles as,
of all things, “neoclassical shred.” The fusion is epitomized in unadulterated form
by the work of Kevin Ferguson, an enterprising but little-known guitarist who
recorded the extraordinary self-released album “From Strad to Strat.” In keeping
with the earlier discussion of website links, I discovered this CD, after years of
hoping someone would come up with just such a fusion, whilst trying to find web
materials regarding well-known electric guitar virtuoso Steve Morse. However,
anyone with a similar vision – be they a would-be consumer or rival supplier –
who thinks of keying “Paganini” and “electric guitar” into a search engine will
discover that Ferguson is by no means the only artist to record violin showpieces
on an electric guitar. Others have made further connections, most notably Julliard
graduate Katherine Thomas, who performs as The Great Kat Guitar Goddess
and seeks to appeal to the darker side of guitar fetishism by blending electric
guitar renditions of classical violin and orchestral music with heavy metal rock
and over-the-top, aggressively sexual Satanic/sadistic/masochistic video imagery.
Whatever next?
At the corporate level, as even an informal examination of the catalogues of
modern consumer electronics firms such as Sony, or automotive firms such as
Toyota, will attest, innovation tends to entail new combinations of a multiplicity of
technologies. Each new product feature, such as a PlayStation II’s capacity to read
DVDs, or electronic stability systems in cars, builds upon existing technologies,
122 PETER E. EARL
and the products of supposedly “different” industries may end up as elements of

each other’s products – as with the incorporation of audiovisual entertainment
systems and GPS/DVD-based navigation systems in cars, or the menus of
digitized cars in PlayStation games such as Gran Turismo. Some technologies,
such as LCD systems, soft touch keypads and memory chips, may be added to
an astonishing variety of products and their growing ubiquity makes it easier to
apply them in yet more applications, as users can employ the same skills in all
manner of different contexts. All it requires is that an entrepreneur dreams up the
possible connections or is prepared to back financially an inventor who sees them
sooner.
As well as being the basis of new types of products, fresh connections provide the
basis for new generations of existing products. In cases of the latter, however, inno-
vation is often deliberately of a restrained nature in order to make the most of knowl-
edge of how customers form mental connections regarding the particular firm’s
products. Successive generations of products as diverse as cars and the music of
particular recording artists may incorporate some stylistic cues – what we might call
“signature” or “trademark” design features – from previous generations, tending
to evolve rather than making revolutionary breaks with the past. For example, over
almost two decades, Volvo moved gradually away from safe but boxy designs
to successively more curvaceous shapes and an emphasis on the combination
of driver appeal and safety. Because of the gradual progression and ever-present
distinctive grill design, current products remain recognizably Volvos: the
Volvo/safety connection has been maintained even though customers may have
taken a long time to adjust their constructs to the idea that structural integrity
did not require cars to look like tanks. By contrast, Ford Europe in the early
1980s had trouble getting customers to switch straight from the conservative
Cortina to the radical-looking Sierra, while the lackluster performance of Fiat in
the lower-medium sector has been associated with an ongoing failure to connect
one generation of its cars to another, even by model name (as if the firm was
conceding that its products stood for nothing in particular).
“PARTS BIN” ENTERPRISE

Firms with a capacity to devise new combinations that fit into buyers’ thought
systems should have greater potential for survival than those that do not, for
the latter will lose market share to them and suffer higher relative costs due to
failures to achieve economies of scope. Just as we can test for the existence of
a market for a particular product by using an internet search engine – as with
the Paganini/electric guitar example – so one might even imagine strategists in
these firms systematically looking at a matrix of all possible combinations of

their products or major components to see what new connections might be made
in theory and what might be the practical objections to them. By raiding the parts
bins of existing models and adding relatively few new parts, the enterprising
firm may be able to occupy lucrative new market niches and gain first-mover
advantages by defining a new genre of product. Toyota, for example, created the
“soft roader” market when it created its RAV4 – essentially a re-bodied, jacked-up
Corolla 4WD wagon with a 4WD Camry’s engine and transmission system.
Subaru countered a few years later by re-bodying its Impreza (itself based on a
shortened Subaru Legacy platform and shared transmission system) as its Forester
model. When, later still, Ford got on to the act – by which time Toyota was
already offering a second-generation RAV4 and maintaining its lead in styling
appeal and premium pricing – it did so with an engine and 4WD transmission
system in its Maverick/Escape model that was closely related to that of its Jaguar
X-Type sedan. In turn, the latter owed quite a bit to the second-generation Ford
Mondeo.
Mere possession of a range of technological capabilities does not guarantee
success in creating new products (see further Pavitt, 1999), for someone must
first notice the potential connections and overcome any barriers to making them
happen. This entrepreneurial role is sometimes played by outsiders rather than by
staff in the organization that seemingly should have been best placed to recognize
the potential and act upon it. For example, the first MGB V8 sports cars were put
together by customizing specialists outside of British Leyland/Austin Rover, using
the latter’s parts, as were the first Range Rovers with larger capacity V8 engines.
(In Australia, this was the resting place for many of the 4.4 liter engines from the
spectacularly unsuccessful 1973–1974 Leyland P76 sedan, a decade before the
manufacturer made the connection and despite the fact that the P76 engine had
originally been developed in the U.K. in the late 1960s for a large Rover sedan
that never made it into production.) Stranger still, the Fender Stratocaster electric
guitar had been in production for over four decades before Fender offered its Big
Apple model featuring twin-coil pickups of the kind that had been privately fitted
by many players who wanted a Stratocaster that had the sound of a Gibson Les
Paul, its main rival. In the meantime, firms such as Ibanez and Yamaha had begun
to produce near-clones of the Stratocaster that offered the best of both worlds:
a mixture of single-coil and twin coil pickups. (Fender’s recent Showmaster
range is a belated attempt to produce something similar for the premium
market.)
Just as the creative insight may rest outside the firm that has the technological
capacity to make new products by making new technological connections, so the
technologies may be bought in from outside suppliers as ready-made components
124 PETER E. EARL
or as capabilities supplied through a corporate alliance. This being so, the

entrepreneur may be someone with an eye for what will fit from other people’s
parts bins – a key feature in the initial success of the Lotus sports car company
was founder Colin Chapman’s legendry skills in this respect – or the capacity to
persuade other suppliers to tailor something that will fit, based on their particular
skills (which may entail relational contracting or other forms of quasi-integration:
see Richardson, 1972), or the capacity formally to stitch together workable
business alliances. Entrepreneurs who have a vision for a product but whose
comparative advantage does not lie in making deals with suppliers can subcontract
this role to entrepreneurs who specialize in doing precisely that. An excellent
example here is the “virtual firm” system that is often employed in major
building products: the property developer has the idea and raises the capital,
but the transforming of it into reality is handled by a construction management
company that hires and oversees an army of specialist subcontractors (see
Earl, 1996).
In some cases, the fact that certain components are outsourced may be some-
thing that can be exploited in marketing terms to appeal to those “in the know”
amongst potential buyers. For example, Mitsubishi reminds potential buyers that
its Lancer EVO VII is equipped with Brembo brakes, OZ wheels, Momo steering
wheel and Recaro seats, just as the pickups on a Big Apple Stratocaster guitar
remained branded as Seymour Duncan products. In other contexts, entrepreneurs
do not shout about their skills in outsourcing; a very notable example being
Rolls-Royce, whose cars prior to the German takeover employed inputs from less
elite brands such as Citroen (adaptive suspension systems) and General Motors
(transmission). To do otherwise might result in customers making all the wrong
connections regarding the quality of the product.
Skills in keeping the customer uninformed of the connections upon which
products are founded look set to become a major entrepreneurial capacity the
more that skills in making additional product lines relatively cheaply from existing
elements are used as part of a strategy of price discrimination. The car market again
illustrates this difficulty. For Jaguar and Volvo to remain premium brands under
Ford’s ownership, their use of Ford components needs to be discrete. Similarly, if
it becomes widely known that one can obtain premium Volkswagen or Audi build-
quality, engines and structural engineering at a budget price by buying a Skoda
or SEAT, then the brand equity of the first two marques will collapse. Whilst the
manufacturers seek to conceal their capacities to make connections, enterprising
consumer magazines can set about trying to make potential buyers aware of them
and in doing so provide the latter with all the ammunition they might need to justify
to their peers their deviant decisions to buy products whose brands have hitherto
lacked cachet.
ENTREPRENEURSHIP AND DESIGN STANDARDS

If entrepreneurship is about making connections, then competitive success may
depend upon setting up systems within which it is more difficult for other
entrepreneurs to make connections that one is capable of making. This process is
obviously at work in some markets, where even though products take the form of
modules that can be combined in different combinations, the interfaces between
them are specific to the brand in question. The specifics of Canon and Minolta
camera and lens relationships provide an example here, as do Apple Macintosh
computers versus PCs. However, there are also many cases – the IBM PC being one
of them – in which entrepreneurial insight takes the form of setting out to create a
set of open standards to enable other entrepreneurs to make money by selling prod-
ucts that hook up with one’s own and in the process generate demand for one’s own
product.
Sometimes the creation of common interfaces between modular products will
be necessary in order to remove technological uncertainty for customers and
thereby promote the growth of the market as a whole, as with the development of
the digital synthesizer market following the adoption of the Musical Instrument
Digital Interface (MIDI) standard that enabled different brands of synthesizers and
peripherals to be wired together. In markets where systems can be assembled in this
way, the role of the entrepreneur may evolve along a variety of connectionist tracks
as the market develops, including the following (see also Langlois & Robertson,
1995):
(1) As a standards promoter, such as by selling licenses to one’s technology or

by promoting cooperative activities at the trade association level or through
strategic alliances;
(2) Trying to become a leading specialist supplier of a particular product that
connects with the output of other suppliers rather than continuing to be a
supplier of an entire system;
(3) Specialization in designing systems tailored to those with particular require-
ments;
(4) Using purchasing skills to package other producers’ elements into low-cost
systems for a mass market; or
(5) Developing new kinds of modules that hook into the technology.
The choice of track to take will depend not merely on being able to envisage
oneself in that role in the first place, but also on assessments of comparative
advantage in terms existing capabilities and capacity to develop what seem to be
pertinent new ones.
126 PETER E. EARL
WHERE ENTREPRENEURSHIP STOPS

AND MANAGEMENT BEGINS
The view of the entrepreneur proposed in this paper needs to be considered in
relation to the roles of strategists and other managers in firms, for clearly it is not
a viewpoint that applies merely to the start-up phase of business. It can be used to
frame decision making in firms of diverse sizes and stages of evolution. It can be
applied to the founding of a business, where the entrepreneur construes that there
is money to be made by making a particular connection, such as between product
elements to form a new product or system, or between potential customers with
a particular unmet need and various presently under-utilized resources that can
be combined to meet that need. It can be applied further, to making sense of the
growth of a business via relationships with customers and/or linkages between
past products and ones subsequently added to the firm’s portfolio. These linkages
may be within the supply chain of what the entrepreneur’s business already
produces, where vertical integration of some kind is seen as necessary to ensure
quality, cost or supply goals are met. Or they may be made horizontally between
any particular activity and others that employ similar production processes and/or
marketing. By successively constructing new connections, the entrepreneur
builds a complex business architecture that often entails both some degree of
vertical integration and horizontal diversification, with new products based on
lateral linkages later being produced with the aid of further forays into vertical
integration.
Such a view of entrepreneurship overlaps to some extent with linkage-based
views of the economics of corporate strategy offered by Moss (1981) and Kay
(1997), but both present business strategists as rather defensive characters who
manage connections between products or activities in order to keep the firm going
in the long run. Moss draws his inspiration from the forward/backward linkages
literature in development planning. Whereas Austrians such as Kirzner tend to
provoke thoughts about the start-up of a business, Moss concentrates on how
additional business opportunities come to be taken on by firms that already exist.
Instead of seeing this as a reflection of an inherent drive of entrepreneurs to strike
forth boldly with the aim of bringing some grand vision to fruition or, more mod-
estly, “to make things happen” (as many of the subjects in Woods’ (2002) study saw
their own motivation), Moss argues that the direction taken by a business as it grows
is a reflection of attempts to solve resource imbalance/capacity under-utilization
problems perceived in what it is doing right now, or which are judged likely to
arise in future due to competitive activities of others. Kay’s analysis of strategy
begins with the connectionist thinking of Ansoff’s writing on synergy but then
sees the development of larger firms as increasingly being concerned to contain
the strategic vulnerability that comes from building too much on too few common
threads.
Each time the structure comprising the firm adds a new connection between
production activities in a vertical or horizontal direction it will be doing something
new, to a greater or lesser extent. Adding twin-coil pickups to an electric guitar
may have had very few manufacturing implications for Fender, beyond cutting
out guitar bodies and scratch-plates differently, and somewhat different wiring.
Dropping a more powerful engine into an existing car may require more challenges
to be addressed, such as re-engineering front chassis members to accommodate
the width of a V8 engine, or learning how to create reliable turbocharger or
supercharger installations and fit them within the confines of an existing body.
Other kinds of diversification, particularly those involving vertical integration,
may entail coping with a whole host of problems that entail totally unfamiliar
technologies (as would attempts by Fender to diversify into digital keyboard
instruments, or a mainstream automotive manufacturer setting out to make an
electric car with a body formed from plastic composites).
In order to judge whether a new line of business represents a profit opportunity,
the entrepreneur needs to have a capacity to judge the implications of such a
move in terms of the competences required, as well as physical resources. From
a connectionist perspective, we might see competence in terms of the ability
to make a particular connection with a particular degree of reliability and for a
particular cost. A useful analogy here is with the playing of a musical instrument,
a matter of matching finger movements to instructions on the sheet music: an
accomplished player may need very little time to be able to perform a particular
piece seamlessly and without error, whereas a novice might require much practice
and still be able barely to offer a tolerable performance. Without an ability to
judge the degree of difficulty the business will experience in implementing a
new connection, the entrepreneur will be unable to size up the costs the new
venture entails and may over-estimate revenue streams in the event that quality
and reliability levels turn out to be harder to achieve than anticipated.
This capability requirement casts the entrepreneur in a role very much like that
of the strategic manager in the recent literature on resource-based approach to the
firm, with its focus on understanding the core competences of the firm and how
its particular set of resources gives it a competitive advantage. (For a compilation
of the key sources, see Foss (Ed.), 1997.) In the context of the large firm, a team
often undertakes this role, though ultimate responsibility for it may rest with
a particular individual, such as a chief executive officer who “signs off” any
significant new venture. The strategic decision makers may not have the task of
making the hypothesized connections come true, but they have to be able to judge
that the new connections are capable of being put into place and, if not assembling
128 PETER E. EARL
the teams who will actually have to implement their decisions, they will need to
be able to make good decisions when assigning to someone else the responsibility
and resources for assembling and running a team to do so. Operations managers
in such teams in turn plan, coordinate activities and deal with surprises as the
need arises, in order to try to make a reality of the connections envisaged by the
entrepreneur.
CONCLUSION: ENTREPRENEURSHIP
IN A GLOBALIZING WORLD
The connectionist perspective on entrepreneurship is sharply at odds with how
mainstream economists are driven to view the theoretical place of entrepreneurs in
the modern world of globalization, a viewpoint that leads them to favor particular
policies aimed at fostering it by making entrepreneurial activity more attractive to
undertake. From the field perspective, the world is increasingly a place in which
competition may come from any quarter, limiting scope for the earning of super-
normal returns. The removal of barriers to parallel importing enables entrepreneurs
who spot opportunities for arbitrage anywhere in the world to constrain the ability
of manufacturers to practice price discrimination between markets. Aided
by internet search engines, consumers can choose in an informed manner with
unprecedented ease and source their purchases from anywhere on the planet that of-
fers the best deal. The same applies to the allocation of investment funds in a world
of electronic share trading. Workers, too, are able to shift to any location where
their services are in demand, aided by increasing standardization of language and
business practices, whilst physical relocation may not even be necessary insofar
as tasks can be performed remotely via modern telecommunications systems. The
rise of the internet and cheap access to high-powered computers means that many
e-commerce businesses can be started up at very low cost (see further, Friedman,
1999). In short, an increasing perfection of markets is eliminating breaks in
chains of substitution.
If globalization really did entail the economic system coming closely to
approximate a field, then little role would remain for the typical Austrian
conception of the entrepreneur as someone whose special capacity of alertness to
arbitrage-based profit opportunities helps to bring the economic system closer to
equilibrium. In the world of globalization, everyone is under pressure to be alert
to potential for doing a better deal in order to prevent others from encroaching on
their standards of living, and the information necessary for doing so is available
to anyone with an internet connection. One conundrum would remain, however,
for mainstream and Austrian views of market coordination alike, namely, the
difficulty that decision makers have in deciding where to invest when they do not
know the plans of others in terms of investment schemes that are competitive with
and complementary to possibilities that they are considering (what is sometimes
known as the Richardson Problem, following Richardson, 1960/1990).
The message of this paper is that if we cast the entrepreneur in the role of
someone with a comparative advantage in making connections between product
elements, products, capabilities and cost/revenue streams, the entrepreneur
emerges as a much more dynamic character than the typical Austrian figure.
Instead of acting to take the economy nearer to some kind of Pareto optimum,
the connection-making entrepreneur is a disequilibrating agent who opens up
opportunity sets in the manner envisaged in Schumpeter’s (1943) work. By making
novel, previously unimagined connections (cf. Shackle, 1979), the entrepreneur
creates new elements from which yet further sets of combinations can be made,
leading to economic growth and the seemingly infinite variety of products
between which modern consumers can choose. Rather than necessarily filling
in gaps in chains of substitution and making the economy better approximated
by the neoclassical “field” perspective, new combinations may provide bases for
rents to be earned – at least for a time – by offering, for example, “unique selling
propositions” and/or providing a niche-market product that appeals to customers
who otherwise would have found themselves choosing between rather different
possibilities none of which really did what they wanted.
Whilst its non-equilibrium aspect may go against the Austrian tradition, the
connectionist approach provides opportunities for building bridges between
economics, marketing, strategic management, and the literature on innovation.
If Austrian writers find it appealing, it may also take them into an interest in
the cognitive process, such as lateral thinking, by which entrepreneurs come to
construct novel connections.
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Ph.D. Thesis, University of Auckland.
MARKET OPPORTUNITY AND
ORGANIZATIONAL GRIND: THE TWO
SIDES OF ENTREPRENEURSHIP
Ulrich Witt
ABSTRACT
In pursuing profit opportunities, entrepreneurs often use multi-person
firms. Since employment contracts leave some discretion to the employees,
organizational coherence requires that they are coordinated on the en-
trepreneurial business conception as their own frame of action. Accordingly,
the entrepreneurial reorganization of production and trade implies two
different coordinating tasks: the exploitation of market opportunities and the
seeing through of the business conception in the firms’ daily organizational
grind. The former has been center stage in the Austrian school of economics.
For the neglected latter task a cognitive theory is suggested which highlights
an Austrian, or entrepreneurial, approach to the firm.
1. INTRODUCTION
Entrepreneurship is the core of the dynamics of modern capitalism. There is no
enhancement in the division of labor and no rise in the degree of specialization
without a reorganization of production and trade conceived of, and carried out by,
entrepreneurs. This fact not withstanding, entrepreneurship only plays a periph-
eral role in economic theorizing (cf. Casson, 1982). In modern microeconomic

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06009-5
131
132 ULRICH WITT
textbooks it is barely mentioned. Their static equilibrium-cum-optimization

perspective means that of course the dynamics of modern capitalism disappear
too. It is not accidental, therefore, that two of the most eminent acknowledgments
of the entrepreneurial role in economics are closely interwoven with an equally
pronounced emphasis on the dynamics of capitalist markets. These acknowledg-
ments come from Schumpeter (1934) on the one hand, and Mises (1949) and
Kirzner (1973) on the other. Different as their interpretations are, entrepreneurship
is the hallmark of both acknowledgements. However, in the way in which they
portray entrepreneurship, they both abstract equally from how entrepreneurs
actually organize production and trade. Given the empirical, organizational
context in which entrepreneurship occurs in most cases, this appears to be
inadequate.
The way entrepreneurs pursue business ventures hinges on how they conceive
of them. They acquire resources to produce and offer products and services to
the markets. But this usually calls for the creation of a multi-person organization
with an internal division of labor. It is based on employment contracts which
leave a certain amount of discretion to the agents who have been hired. This
means that the entrepreneurial goals are attained better, the better the employees
are coordinated on the entrepreneurial business conception, and are motivated to
adopt it for their own productive activities in their respective areas of discretion.
Thus, entrepreneurial reorganization of production and trade usually implies two
quite different coordinating tasks. The first is to help achieve coordination within
the markets by specific and often new productive services (cf. Foss, 1994). The
second is to achieve coordination within the organization created for productive
purposes. Following up some earlier work (Witt, 1999, 2000) it will therefore
be argued here that a full understanding of the entrepreneurial role can only
be gained if two challenges to entrepreneurship are recognized. One is to establish
or seize market opportunities; the other is to master the organizational grind.
The paper proceeds as follows. In Section 2, the theories of entrepreneurship sug-
gested by Schumpeter and Mises/Kirzner are reviewed. They are shown to be two
different versions of the market opportunity centered view. Schumpeter’s version
emphasizes how entrepreneurs establish opportunities, while Mises’ and Kirzner’s
version focuses on how they seize them. Later on Schumpeter (1942) changed his
view and put managers and bureaucracies in the place of entrepreneurs. But he con-
tinued to ignore all organizational issues. They were introduced into his framework
of capitalist development only later by Nelson and Winter (1982). Section 3 briefly
reviews their contribution which – as the late Schumpeter does – neglects the role of
entrepreneurship. In contrast, Mises and Kirzner have stuck to their interpretation,
but they also continued to disregard the organizational aspect of entrepreneurship
and the theory of the firm in general. Section 4 therefore turns to some recent efforts
Market Opportunity and Organizational Grind 133
to address the organizational issues from the point of view of Austrian economics.
The discussion shows that the intra-organizational, entrepreneurial, coordinating
task can best be characterized as one of achieving cognitive coordination. Section 5
therefore analyzes the challenges accruing to entrepreneurship at the cognitive level
in the daily organizational grind in some detail. Section 6 offers conclusions.
2. VIENNA STYLE ENTREPRENEURSHIP:

ENTREPRENEURS WITHOUT FIRMS
In 1908 Schumpeter published his habilitation thesis, accepted the previous
year by the University of Vienna, which qualified him for a professorship in
the Austrian Empire. It was a scholarly, but somewhat uninspired, survey of the
work of contemporary non-German neoclassical writers (Schumpeter, 1908). A
question that Schumpeter seems to have found lacking in those works induced
him to start writing a new book. If, as the neoclassical gospel has it, the economy
is supposed to gravitate back to a state of equilibrium after each disruption,
why and how is the equilibrium state disturbed in the first place? Shouldn’t it
be possible to explain the tremendous industrial transformation of the European
economies which Schumpeter witnessed by focusing on systematic features in
those disruptions? The book with his theory of economic development appeared
in 1912 (revised English edition: Schumpeter, 1934). In the seventh chapter of
that book Schumpeter explicitly recognized the heuristic analogy with gravitating
systems in Newtonian physics as the source of the neoclassical preoccupation with
the equilibrating forces in the economy.1 He argued that using such an analogy
rules out any possibility of development occurring “from within” the economy. A
“developmental method” would be needed to make theoretic progress.
As the core element of that “developmental method,” Schumpeter chose a
theory of entrepreneurship which built on ideas derived from his teacher Wieser
(cf. Streissler, 1983). The unique entrepreneurial achievement, he claimed, is
the “carrying out of new combinations,” more precisely of product innovations,
process innovations, the making of new output markets, the tapping of new input
sources, and the reorganization of markets like, e.g. cartelization (Schumpeter,
1934, p. 66). The uniqueness of the entrepreneurial achievement is, according
to Schumpeter (ibid., pp. 74–94), explained by the entrepreneur’s distinctive
personality characteristics. Being an “entrepreneur” is not an occupation or a
profession, but rather a capacity. It presupposes initiative, authority, imaginative
foresight, leadership (and is entirely independent of capital ownership). The
incarnation of the entrepreneur is the “promotor,” the “captain of industry” – as
long as (s)he is innovative – as opposed to the “plain businessman” who only
134 ULRICH WITT
follows conventional paths. Schumpeter (ibid., p. 88) holds that inventiveness and
creativity are not the key features of entrepreneurship. It is not the entrepreneur
who figures out new possibilities. These are already present in abundance,
are often even common knowledge, and thought up by all sorts of people.
Entrepreneurship according to Schumpeter is the “doing the thing”; the will to
demonstrate that vaguely perceived possibilities can be turned into reality.
Considerable emphasis is given to the problem of explaining the entrepreneur’s
motivation. Typically, it is claimed, an entrepreneur shows little interest in the
“hedonistic satisfaction” that might result from his efforts (ibid., p. 92). He works
relentlessly because of what, in more modern terminology, would be called
achievement motivation (McClelland & Winter, 1969, on this cf. also Khalil,
1997) and a craving for recognition. Dreams and wishes about founding a private
kingdom are mentioned; the sensation of power, leadership and authority, whose
fascination is particularly strong for people who have no other chance of achieving
social distinction; the will to conquer, the impulse to fight, and the satisfaction
from getting great things going.2 Given the exceptional qualities attributed to
the entrepreneur, it stands to reason that, in Schumpeter’s mind, entrepreneurs
are rare – in any case much less numerous than those who, as factory owners,
managers, or administrators, to him personify the “plain businessman.” Indeed,
the distinction drawn between the entrepreneur with rare innovative talents on the
one hand, and the plain businessman on the other, is a reflection of elitist views
quite characteristic of the zeitgeist.3
Schumpeter’s hypotheses about how entrepreneurial innovativeness disrupts and
revolutionizes the production processes, the supply of goods, and the organization
of the economy are significant and help in understanding the role of entrepreneur-
ship (cf. Kirzner, 1999). But they do not give a full account of that role. In order to
realize their ambitious “carrying out of new combinations,” entrepreneurs usually
create firm organizations. Indeed, how else could Schumpeter’s terminology
of “captains of industry” who “found a private kingdom” enjoying “power,
leadership, and authority” be understood? However, the question of how the
entrepreneur acts within the firm’s organizations is not addressed by Schumpeter’s
theory. Authority and leadership – attested in Schumpeter’s psychological portrait
of the entrepreneur – are capabilities which do matter for the pursuit of particular
entrepreneurial tasks, namely those of coordinating the intra-organizational activ-
ities. However, these activities are not dealt with by Schumpeter. Even though the
intra-organizational processes and conditions may by crucial for the success of the
entrepreneurs’ ventures, they are ignored. Schumpeter (1934) confines himself
to the market level and the question of how entrepreneurs eventually succeed in
seeing through profitable new combinations and push forward the reorganization
of the markets.
Schumpeter’s views on entrepreneurship changed significantly after his emigra-

tion to the U.S. in 1932. At Harvard University he got interested in the role of the
large trusts. In the grand view of modern capitalism which he offered in Schumpeter
(1942), trusts are already seen as dominating the industrial dynamics. He argues
that entrepreneurs, as pioneering promoters, are losing out against the professional
teams and trained specialists of the large corporations. Innovative reorganizations
are no longer the exclusive achievement of heroic leaders, but a result of just
another form of bureaucratic office work (ibid., pp. 132–133). However, even the
replacement of the figure of an elitist entrepreneur by a firm organization with
internal specialization in diverse entrepreneurial tasks did not induce Schumpeter
(1942) to address the problem of intra-organizational coordination. In his refer-
ences to the operation of corporate divisions, he did not offer any detailed ideas
about how they work. It is perhaps because of this lack of interest in organizational
coordination that he did not recognize that even anonymous routine-like, industrial
innovativeness is still very much contingent on a coordinating entrepreneurial
influence. What did interest him were the implications for market coordination,
more precisely, for the proper appraisal of market competition (ibid., Chap. 8).
Schumpeter was convinced that the innovative operations of the large trusts were
beneficial for economic growth and for the wealth of the nations. But he also
claimed that they embraced monopolistic practices as a necessary concomitant.
This assessment challenged the static model of perfect competition. It provoked
a debate on the relationships between market structure and innovativeness that
occupied economists for decades (see Baldwin & Scott, 1987, for a survey).
The other distinguished, but significantly different, view on entrepreneurship
to be discussed here is that of Ludwig von Mises, Schumpeter’s contemporary.
Mises received a doctorate from the University of Vienna in 1906. Unlike
Schumpeter, hostile conditions denied him a full-time academic career in Vienna
(cf. Craver, 1986). It was therefore not until he went into exile in Geneva in the
late 1930s that Mises could elaborate in detail his views on homo agens, which
implied his interpretation of entrepreneurship. The work was published in 1940
(revised English edition: Mises, 1949). The background of Mises’ interpretation
of entrepreneurship is his praxeological approach. Mises (1949, Chaps 1 and 2)
portrays economic behavior – or, as he calls it, “human action” – as exclusively
comprised of deliberately considered, purposeful acts.4 As a matter of pure
ratiocination, he argues, human action is an object not of empirical conjectures,
but of a logical reconstruction of means-ends-relationships.
Related to his concept of homo agens (but difficult to reconcile with a purely
logical analysis) is a hypothesis on the motivation to act. Mises submits that
human action is inspired by a man’s endeavor to overcome dissatisfaction with
the conditions given at any particular moment of time:
136 ULRICH WITT
His mind imagines conditions which suit him better, and his action aims at bringing about
this desired state. The incentive that impels a man to act is always some uneasiness. A man
perfectly content with the state of his affairs would have no incentive to change things (ibid.,
pp. 13–14).
This means that human action is not only considered a matter of always choosing
the most suitable among available means for some given ends, but also of looking
out alertly for new possibilities and advantages. Mises (ibid., pp. 252–256)
identifies this alertness, a general feature of homo agens, with entrepreneurship.
This is to say that an entrepreneurial element is supposed to be a part of
human action.
It was Mises’ student Israel Kirzner who later developed some concrete hy-
potheses on what that entrepreneurial element means in daily market operations.
Like Mises, Kirzner (1973, 1982) considers a situation of widespread ignorance of
the actual market conditions as the initial (given) condition for entrepreneurship.
Disorientation, erroneous decisions, and missed chances offer profitable market
opportunities for agents who are alert enough to discover the not yet perceived mis-
matches. Given Mises’ hypothesis about homo agens’ uneasiness and eagerness to
improve her/his situation, Kirzner (1979) claims that there will always be such alert
agents who discover profit opportunities. They can seize them by making offers
that have not yet been made, including relocation (arbitrage), lower prices and/or
higher quality of goods and services. Consequently, Kirzner holds that if arbitrage
opportunities become feasible in the markets, they will always be exploited until
every profitable opportunity has been exhausted in market equilibrium.
The Mises–Kirzner approach to entrepreneurship obviously differs in several
respects from that taken by Schumpeter (1934). Two points of particular interest
here are the following.5 First, by shifting emphasis to a universal entrepreneurial
element in human action Mises avoids Schumpeter’s elitist view of entrepreneurial
personalities. All agents possess, as it were, more or less of an entrepreneurial
trait. Second, and as a consequence of the first point, the entrepreneurial theory
is no longer confined to epochal innovations. On the contrary, particularly in the
interpretation of Kirzner (1979), the focus is now on the low profile profitable
opportunities lurking “just around the corner” in everyday life. They range
from dime-a-dozen innovations to simple price arbitrage which, to Schumpeter,
were the activities of “plain businessmen.” With these modifications, the
Mises–Kirzner approach surely comes closer to what is associated in everyday
language with the notion of “entrepreneurship.” Indeed, allowing the full range
of entrepreneurial possibilities reaching from small scale businesses to large
scale promoters’ ventures, and from short term arbitrage to long term investment
for realizing profitable opportunities, would seem a desideratum of a theory
of entrepreneurship.
However, as far as the intra-organizational aspects of the coordinating en-

trepreneurial actions are concerned, the Mises/Kirzner approach is just as ignorant
as Schumpeter’s interpretation. Whether talking about small-scale entrepreneur
(in Mises/Kirzner) or about a “captain of industry” (in Schumpeter), the fact that
the organizational basis of the entrepreneur’s operations is a multi-person firm is
disregarded in both cases. Kirzner considers entrepreneurship to be entirely un-
related to organizational form (for him this is only a matter of productive services
being sold to an entrepreneur). He abstracts from the fact that entrepreneurial
action in many cases achieves coordination not only via markets, but also in a
most essential way through organizing a firm. To neglect the intra-organizational,
coordinating role that entrepreneurs choose to take when creating a multi-person
firm therefore seems to draw an incomplete picture of entrepreneurship.
In a sense, this neglect corresponds with the praxeological framework of the
Mises–Kirzner approach. Coordinating the members of a firm organization to
achieve the collective production goals is not a matter of minimal behavioral
hypotheses like “seizing opportunities which pop up” or “seeking action because
of some uneasiness.” (In line with Mises’ aprioristic program of economics, such
hypotheses place the burden of explanation on the outcome of the market process.)
Coordinating firm members is, as will be explained below, instead a process of
continued wrestling with rivaling conceptions and agendas within an organization.
To explain the complex coordinating task, detailed notions of the motivational and
cognitive background of the various agents’ behavior are required. It is not simply
“alertness,” but a whole set of personal and social skills and characteristics like
persuasiveness, persistence, authority, trustworthiness, and so on which affect the
entrepreneur’s capacity to master the intra-organizational coordination task. These
necessary theoretical underpinnings can hardly be provided within the framework
of an aprioristic, i.e. non-empirical, conception like Mises’ praxeology. As argued
already in Witt (1989), what is needed is a richer psychological foundation for
human action and its implicit entrepreneurial element.
3. NEO-SCHUMPETERIAN EXTENSIONS: FIRMS

AND ROUTINES WITHOUT ENTREPRENEURS
As explained in the previous section, Schumpeter changed his views on the
entrepreneurial role. In Schumpeter (1942) he concluded that, in the era of large
trusts, it is no longer through the outstanding figure of the promoter-entrepreneur
that new market opportunities are established. This task is done instead by the
bureaucratic work of the specialized divisions of those trusts. However, he did
not explain either how the corporate teams and departments actually operate or
138 ULRICH WITT
how the division of labor internal to the organization is coordinated. Some forty
years later the issue was taken up again in the neo-Schumpeterian revival initiated
by Nelson and Winter (1982). They worked out a synthesis of Schumpeter’s
views with more recent theoretical developments. Their synthesis also fills the
explanatory gap which Schumpeter had left.
One set of ideas entering that synthesis comes from the behavioral theory of the
firm developed by the Carnegie school (Cyert & March, 1963; March & Simon,
1958; Simon, 1949). Following the notion of bounded rationality and its implica-
tions for firm behavior, Nelson and Winter suggest that the internal interactions
of organizations are based on behavioral routines and rules of thumb. Production
planning, calculation, price setting, and even the allocation of R&D funds, all fol-
low rule-bound behavior. The second theory element added to the Schumpeterian
framework in Nelson and Winter’s synthesis is a loose analogy with the concept
of natural selection.6 Nelson and Winter (1982) identify the routines used by
organizations for internal coordination with “genotypes” in the neo-Darwinian
model of natural selection. Correspondingly, they consider specific decisions
that result from the firms’ routines as the analogue of “phenotypes.” The latter
may be more or less favorable for the firm’s overall performance and thus result
in potential differences in profitability. Assuming that profitability differentials
translate into growth differentials, and that routines which successfully enhance
growth will not be changed, Nelson and Winter see firm expansion as an increase
in the relative frequency of the corresponding “genes.” Routines that cause a
firm’s performance to deteriorate are, by contrast, unlikely to disseminate.7
Because of the complexity of the interactive selection dynamics operating on
the routines at the different layers of the firm organization, Nelson and Winter
(1982) derive the implications of their neo-Schumpeterian synthesis by extensive
simulations. The perhaps most significant finding is that their approach supports
what has been called the inverse (rather than the original) Schumpeter hypoth-
esis concerning the relationship between market structure and innovativeness.
According to the inverse hypothesis, the degree of concentration within an industry,
which indicates a potential for monopolistic practices, is a consequence of, rather
than a prerequisite for, a high rate of innovativeness in the industry. Nelson and
Winter thus provide a different rationale for Schumpeter’s notion of a “perennial
gale of creative destruction” and the relationships between market structure and
innovativeness. However, to obtain their results Nelson and Winter specify the
intra-organizational working of the large trusts in a way that does not even mention
entrepreneurship.
The question that can be raised here is whether a full understanding of how
coordination is achieved on the organizational level can indeed be achieved if
the role of the entrepreneur is completely ignored. Can a theory of routines and
selective routine replication succeed which denies entrepreneurship any signifi-

cance? To investigate this question let us subsume “what is regular and predictable
about business behavior . . . under the heading ‘routine’ ” (Nelson & Winter, 1982,
p. 15). This means aiming at a comprehensive interpretation of what is going on
inside firms exclusively in terms of the routines which the firms employ. However,
organizational routines refer to the form of interactions inside the organization,
including the form of communicating information. As such they may constrain the
amount, and perhaps even the quality, of information thus processed, but they do not
determine the meaning or cognitive content of the information. If, as will be claimed
here, the cognitive level is important for understanding what happens inside firm
organizations, then an analysis based exclusively on organizational routines is
not sufficient.
In their actions the members of a firm organization follow their subjective
intentions, conceptions, and conjectures. No less than organizational routines to
which the firm members adhere, their cognitive notions may be a source of regular
and predictable features in business behavior and, as such, a significant and spe-
cific feature of the organization. It is at this cognitive level that entrepreneurship
becomes a crucial input to coordination in the organization. As will be explained
in more detail below, the entrepreneurial input is to conceive, implement, and
enforce a business conception which provides the cognitive orientation through
which the firm members can coordinate. Business conceptions are needed to
create and shape a firm. As such, they may inspire the design of organizational
routines, but they are not themselves organizational routines. In fact, it is only on
the cognitive level that conflicts can be diagnosed between a business conception
and the behavioral inertia resulting from the pursuit of some organizational
routines, or among behavioral inertia. An entrepreneurial task that may be crucial
for the success and survival of the firm – and that is often surprisingly difficult
to achieve (Loasby, 1991, Chap. 3) – may then be to do battle with this inertia
and overcome it.
In addition to the problems on the cognitive level, there are also motivational
or incentive problems. These also relate to entrepreneurship, and they also
tend to be neglected with an exclusive focus on organizational routines. What
an entrepreneur conceives of as desirable, and what is actually realized in the
operation of the firm organization, may be very different. Routines in Nelson and
Winter’s sense imply recurring, multilaterally expected patterns of interactions
between the firm members. Such routines may involve or induce incentive
conflicts. They may, for example, be vulnerable to free riding or to hold up. The
more frequently hold up and free riding crops up, the more likely entrepreneurial
action will be taken to control and fight them. Some of the measures chosen may
consist of new organizational routines intended to keep hold up and free riding
140 ULRICH WITT
in check. The crucial point is, however, that the corresponding organizational
change is an intentionally produced response to the incentive problems diagnosed.
As explained elsewhere (Witt, 2000), such problems depend on the size and
age of an organization. Their systematically changing impact may give rise to
an endogenously caused development of firm organizations which cannot be
explained by relying exclusively on a selection mechanism.
In fact, if the entrepreneurial role is fully acknowledged, the heuristic value of
the selection metaphor itself becomes questionable. A major difficulty is the fact
that, for selection among organizational routines to produce systematic change –
as Nelson and Winter, of course, imply – there must be sufficient inertia both in
the organizations’ environment (the markets) and in their routines which selection
forces are supposed to operate on. In a turbulent, changing market environment
and/or with rapidly mutating routines, selection would have no time to become
a shaping agent. While the pace of change in the market environment is not
necessarily subject to entrepreneurial discretion, the inertia in the organizational
routines clearly is. When they rely on organizational routines, entrepreneurs have
strong incentives to identify low performance routines and to replace or improve
them before being forced out of the market (i.e. falling victim to selection).
Entrepreneurial problem solving of this type amounts to a kind of intentionally
produced mutation and an “internal” rather than an “external” selection process.
Since “internal” selection is likely to depend on hypothesis formation and
learning from insight (relating, to be sure, to the cognitive level), the very notion
of selection is of little help in understanding entrepreneurship. Cognitive processes
are likely to produce adaptations which follow their own regularities. As they
emerge from a limited human information processing capacity – which means
that people are forced to be selective in what they sense, learn, and perceive –
the regularities reflect mental “selection” processes which both in their dynamics
and in their outcomes are not necessarily the same as population-bound, genetic
selection processes.
Nelson and Winter thus do extend Schumpeter’s views on the role of trusts
in economic development. They fill the theoretical gap left by Schumpeter
(1942) with regard to the question of how those large corporate organiza-
tions operate internally. However, perhaps inspired by the late Schumpeter’s
verdict on the declining role of entrepreneurship, they do so in a way that
completely ignores the role of entrepreneurs. Moreover, their heuristic frame,
which is based on organizational routines and the selection metaphor, makes
it difficult to get to the level where subjective cognition and its motivational
implications matter. Yet it is precisely this level which is central to the Austrian
approach to economics and which should therefore be given careful attention in
the analysis.
4. NEW ADAPTATIONS IN AUSTRIAN ECONOMICS:

ENTREPRENEURS AND FIRMS?
Unlike Schumpeter and the neo-Schumpeterian writers, the Austrian school of
economics considers the uncertainty and subjectivity of individual knowledge as
key features of economic action (cf., e.g. O’Driscoll & Rizzo, 1985). Different
agents hold different expectations. The coordination of these expectations is
particularly important if the subjective knowledge underlying the expectations,
and thus the expectations themselves, change (cf. Lachmann, 1977). Coordi-
nation is achieved in different ways in markets and organizations. However,
although in the Mises–Kirzner approach to entrepreneurship coordination within
markets is considered a result of entrepreneurial action, coordination within firm
organizations is not considered at all. Indeed, even the idea of a subjectivist,
entrepreneur-centered approach to organizational economics in general, and the
theory of the firm in particular, has until recently been ignored in the Austrian
camp. Given that the very creation of a firm organization is an entrepreneurial ac-
tion, the neglect of the organizational variant of entrepreneurial coordination does
not seem justified – even less so in view of the total neglect of entrepreneurship in
the various existing theories of the firm. Most recently, however, some reflections
about how to approach the firm organization from the point of view of Austrian
economics (in a wider sense than the Misesian one) have started. These attempts
to adapt the explanatory program of Austrian economics differ significantly in
the extent to which they address the entrepreneurial role for intra-organizational
coordination.
With reference to Kirzner’s theory of entrepreneurial alertness, Ioannides (1999)
tries to make a connection between entrepreneurship and the firm organization.
The question he poses is why an entrepreneur should create a firm organization.
More precisely, why should the discovery of a profit opportunity – Kirzner’s en-
trepreneurial action – result in the emergence of a multi-person organization? The
reason, Ioannides argues, is simply that, in order to realize a profit opportunity, it is
often necessary to employ human assets. They are hired according to the standard
profit maximizing logic, i.e. as long as the profit increase entailed by employing
them for the entrepreneurial idea exceeds the competitive wage rate. (Since, in the
Misesian interpretation, entrepreneurship is a universal element in human action,
the fact that human assets can be hired means that employers and employees
sort themselves according to their differing faculty of discovering and exploiting
profit opportunities.) In the market process perspective, profitable opportunities
that have been discovered of course tend to be competed away. If the firm
organizations which have been created to exploit the specific profit opportunities
do not disappear at the same pace as the profit opportunities do, then the simple
142 ULRICH WITT
explanation offered so far is incomplete. Indeed, the persistence of firm organi-

zations is the key issue in Ioannides’ adaptation of the Mises–Kirzner approach.
Their persistence points to features of firm organizations that go beyond a mere
ad hoc-instrument for pursuing the short-lived entrepreneurial profit opportunity
as they underlie Kirzner’s arbitrage oriented notion of entrepreneurship.
The additional argument which Ionannides proposes is that firm organizations
may persist because, once in existence, they allow further profitable opportunities
to be discovered both by the entrepreneur and by other firm members. Only the
faculties to act in an entrepreneurial way (which are supposed to differ between
employer and employee) need to be suitably coordinated. Ioannides submits that
this is done by implementing proper rules. “It is such rules – organizational forms,
command structures, promotion ladders, recruitment tactics, etc. – that shape
the environment within which the members of the firm act, thus directing their
entrepreneurial behavior towards the attainment of the firm’s goals” (ibid., p. 93).
The question raised by this additional argument is, of course, why the members
of the firm do not pursue their entrepreneurial activities by setting up their own
firm rather than submitting to the given firm’s master entrepreneur. Unless a
satisfactory answer to this question is developed, it seems unclear whether the
two ingredients to Ioannides approach to the firm – the arbitrage-based notion
of (short-lived) entrepreneurship à la Kirzner and the obvious persistence of real
world firms – indeed go together.
An approach which blends Schumpeter’s early notion of innovative en-
trepreneurship and Kirzner’s theory of entrepreneurial arbitrating alertness (along
with many other sources of ideas) in a “praxeological” theory of the firm has been
suggested by Yu (1999). Yu argues that the firm organization is a social world
constructed by the entrepreneur for the purpose of facilitating communication and
coordination. The firm is also endowed with capital that enables it to produce.
The capital structure is shaped in the way the entrepreneur sees it as being most
profitable. As the entrepreneur exploits profit opportunities, the firm’s capital
stock is supposed to grow and to induce more and more complex combinations
of capital. Specialization of, and complementarity in, the firm’s capital structure
eventually lead to vertical disintegration. However, while all these conjectures in
themselves appear plausible, it is not clear why, and in which way, entrepreneur-
ship in either Schumpeter’s or Mises/Kirzner’s senses is indeed necessary for all
this to happen.
The production structure and its relationship to the knowledge problem also
figure prominently in Dulbecco and Garrouste (1999). They focus on the coordina-
tion over time of the firms’ production plans, trying to trace the implications of the
Austrian theory of roundabout production to the level of the firm. On that level, the
specificity or “complementarity over time” (Lachmann, 1977, p. 205) of capital
investments make revisions of the plans a difficult and costly process. A strong
incentive therefore exists to try an ex-ante coordination which acknowledges those
complementarities. The authors argue that the incentive is internalized by the
entrepreneur. The role of the entrepreneur is thus to coordinate production and to
plan the corresponding capital structure according to her/his available subjective
knowledge or guesses of the future. The size of the firm which the entrepreneur
implicitly decides on by carrying out those plans, depends on the extent to which
the complementarity of capital investments needs to be fixed ex-ante.
With their argumentation, Dulbecco and Garrouste add an important element
both to Schumpeter’s early notion of entrepreneurship and to the Mises/Kirzner
approach to entrepreneurship. It is certainly true that production aspects have
been neglected both in the theory of entrepreneurship and the theory of the
firm (cf. Langlois & Foss, 1999). Dulbecco and Garrouste offer a convincing
interpretation of the allocative decision problem involved here. Moreover, their
interpretation accords with the emphasis on uncertainty and the subjective nature
of knowledge in Austrian economics. Yet their focus on the coordination of future
production by means of investment activities addresses only one aspect of the
intra-organizational coordination problem. The question of how the actions of
the agents in a firm organization are coordinated where they are not uniquely
determined by the capital structure is not explored. This is, however, the crucial
question unless the entrepreneurial plans do not need the organizational form
of the firm, because future production structure is contracted via the market. If
investment and future production are realized within a firm, this is a matter of
tasks divided among the employees whose productive actions therefore have
to be coordinated.
The very notion of planning, e.g. of the future production structure, surely relates
to both the firm and the entrepreneur’s role in it (cf. Foss, 1997). It is not entirely
clear, though, what this relationship looks like. Moreover, in the light of the social-
ist calculation debate (on the feasibility of central planning in an economy) and the
strong position taken by the Austrian school in this debate, the relationship does not
seem unproblematic. In fact, the success of the large, multi-division, and often even
multi-national, corporations which seem to rely on planning procedures may ap-
pear to challenge the earlier arguments against central planning. It is not surprising,
therefore, that the role of planning in large firm organizations has attracted some at-
tention in contributions dealing with the theory of the firm from the point of view of
Austrian economics. Sautet (1998) and Sautet and Foss (1998), for example, argue
that large firm organizations face a knowledge problem that in fact prevents them
from engaging in central planning. The managers in these organizations usually
have only incomplete knowledge about their employees’ knowledge and, on top of
that, may be ignorant of their own ignorance. The fact that the large corporations
144 ULRICH WITT
are often very successful is, it is claimed, due to their use of procedures other than
detailed central planning. Among these procedures is the scheduling of rules that
compel the firm members to rule-follow behavior. Sautet and Foss (1998) suggest
that many aspects of the internal organization of firms as, e.g. corporate culture and
some corporate strategy can be understood as rule-following behavior. Rules are
created to induce the firm members to make use of their own subjective, dispersed,
and partly tacit knowledge. The question is, of course, whether such arguments blur
rather than sharpen the contrast to central planning – according to Hayek (1967),
rules and specific commands are mutually exclusive in instructing and guiding
individual behavior.
In a similar vein, Langlois (1995) maintains that firms plan in the sense that
the authority to give directives to (re-)configure the internal system of rules of
conduct is centralized. He explicitly refers to visionary entrepreneurship as a basis
for giving these orders. If this is true, an interesting question arises: how are the
relevant directives communicated by the entrepreneur and how can the employees
be induced to adopt them as rules for their own conduct, particularly if this incurs
opportunity costs for them? The execution of definite orders and commands, or of
the assignments of a quantitative plan in the literal sense, can easily be controlled.
In contrast, the internalization of a specific rule of conduct, namely the one the
entrepreneur prefers, can neither be done by order, nor can it be fully controlled.
Hence, to understand the challenges which entrepreneurship faces within the firm
organization, a closer look at how an entrepreneur is, or is not, able to coordinate
the individual actions of her/his employees seems worthwhile.
5. INTRA-ORGANIZATIONAL COORDINATION
AND ITS COGNITIVE BACKGROUND
A multi-person firm is a way of organizing the division of labor. Much as in the
case of the division of labor via markets, such a firm has to rely on knowledge dis-
persed among several agents (cf. Minkler, 1993). These agents must be motivated
to undertake the physical and mental efforts through which they acquire, improve,
and apply their individual knowledge to contribute to the objectives of the firm – in
short, they must be motivated to contribute to the firm’s goals. Moreover, the indi-
vidual efforts must all be coordinated. Thus, when approached from the cognitive
level, motivational problems and coordination problems are closely intertwined. A
first precondition for coping with these problems is to make sure that all organiza-
tion members are informed about, and have a sufficiently coherent understanding
of, the purpose of their particular activities within the broader frame of the firm’s
goals. The degree of cognitive coherence among the firm members is a non-trivial
problem largely neglected in economics, particularly in agency theory which is

supposed to deal with motivational conflicts. In order to obtain cognitive coherence
among the members of the firm organization, these members must be coordinated
on some basic understanding of what the entire business is all about and what the
role of each member is (for a different, though related, interpretation cf. Koppl &
Langlois, 2001).
Any division of labor, be it market-based or firm-based, has its origin in en-
trepreneurial ventures. These ventures rest on an ideas about how to (re-)organize
work, ideas which initially may not be more than just more or less speculative
imaginings. Such ideas about organizing the division of labor have been called
“business conceptions” (cf. Witt, 1998, 1999). They represent the entrepreneur’s
image of the goals of a firm organization, i.e. of what business to do, and how
to do it with the staff hired. If conveying a business conception were simply a
matter of telling each organization member about the general business and the
particular individual action to be taken, then the intra-organizational coordination
problem would seem easy to solve. Moreover, if assigning tasks to organization
members were to leave no room for the level of effort taken by the members in
pursuing the assigned tasks, then no motivation problem (and no motivational
hazard) would ever put a strain on a business. However, neither of these conditions
is reality – it is simply not feasible to fix everything just by issuing nominal
instructions. In addition, it would not even be possible for the entrepreneur to
issue all necessary instructions, because her/his bounded imaginings prevent
her/him from anticipating all the activities that can become relevant as the
business venture unfolds into the future. All sorts of unforeseen changes and
complications can show up in each and every single task assigned in organizing
the division of labor within a firm. If every such unanticipated deviation from
nominal instructions had to be communicated in every detail to the entrepreneur
in order to determine the proper response, the firm organization would virtually
stifle.
For this reason, organizing the division of labor within a firm organization
always has the connotation of organizing a division of problem solving (Loasby,
1991). Under these circumstances, the entrepreneur is well advised to try to
convey, in a more general form, how unanticipated problems should be framed in
order to solve them. This frame is precisely the business conception in its relevant
parts. If adopted as a cognitive frame by the employees, it will become the
basis for their own problem solving activity. Cognitive frames channel selective
information processing and control the access to memory on an associative basis.
Since the limited mental operating capacity allows only one cognitive frame to
be used at any point in time, this also means that, while in use, such a frame
cannot itself be at the same time made the object of cognitive reflection. The
146 ULRICH WITT
capacity of imagining and reflecting on alternatives for action is constrained and,

hence, selective as well. Some particular courses of action, rather than others
that could in principle be imagined, are conceived and thought through more or
less carefully.8
Since each firm member operates on the basis of an individual cognitive frame,
dispersed knowledge and individual endeavor would be concerted most effectively
if all firm members were to adopt the entrepreneurial business conception as
their own cognitive frame. The rather unspecific nature of the shared business
conception would leave room in the employee’s situational problem solving for
making use of her/his individual knowledge and for accounting for the special
conditions of the individual case. Moreover, it makes a great difference from the
motivational point of view whether or not people see themselves as contributing to
a common goal. If they do, their task perception tends to be framed in a way which
means that their attention is devoted more to solving problems in the interest of the
firm’s goals than to pursuing private short run inclinations and separate interests.
Conversely, it may be concluded that the level of individual effort – which is
particularly difficult to observe in problem solving behavior – may suffer if
rivaling business conceptions are pursued within the firm. It would be even worse
if the firm members perceived no one as contributing to a common goal and instead
saw everyone trying to get an easy benefit from participating in the organization.
Therefore, an entrepreneurial business conception can no longer accomplish an
efficient division of labor within the firm, i.e. organizational coherence, if it is
losing ground within the firm organization beyond a certain threshold.
To communicate the entrepreneur’s business conception and to induce the firm
members to adopt it is not a trivial task. As already explained, no one can be induced
to adopt a cognitive frame simply by being ordered to do so. Consequently, for the
entrepreneur’s business conceptions and suitable social models of behavior to be
adopted by the members of a firm organization, it is not sufficient to give instruc-
tions or to devise organizational and administrative routines. Rather, the social
formation of individual cognitive frames follows its own regularities. Communica-
tion with, and observation of, other agents are a prominent source of information, a
major factor in attracting attention, and an important instance of learning.9 The
more intense and lasting communication and observational learning are, the more
likely the agents involved will tend to develop collectively shared interpretation
patterns as well as common tacit knowledge of facts, hypotheses, practices,
and skills.
Observational learning is also behind the formation of the social models of how
to behave that are characteristic for a group. Certain patterns of behavior tend to
prevail within any group of regularly interacting individuals. Both conformity to,
and deviation from, these patterns can be observed by the group members. Since
the members focus on much the same limited set of behavioral patterns, these tend
to become socially shared models of behavior. If a firm organization forms an
intensely interacting group, there thus may be commonalities in the conceptions
adopted by the firm members and in the alternatives of action that they selectively
recognize as being feasible – and, of course, those that they disregard. Moreover,
as a consequence of intense and lasting communication, the firm members may
share some common standards of conduct exemplified by socially shared models
of behavior. The work motivation of the agents in the firm depends strongly on
the nature of those models.10
Thus, from the motivational point of view, the question of what kind of
social model of behavior or rule of conduct prevails in the firm organization is
consequential. For the entrepreneur it would be desirable to be able to control
the kind of behavior that emerges as a social model. However, this is difficult
to achieve with observational learning being present. Since, in small groups, the
consequences of the other members’ behavior can easily grasped by everyone
without requiring the effort and costs of own experimentation, any attempt to
challenge an established social model for whatever reasons acquires the status of a
vicarious experiment (Bandura, 1986, Chap. 7). If it is observed to be successful,
deviant behavior may pose a serious challenge to a prevailing social model of
behavior. The members of a firm organization may be induced to recognize
previously unconsidered extensions of their choice set.
It should not be taken for granted, therefore, that an entrepreneur can succeed in
making the employees adopt her/his business conception and the social models of
behavior that would be conducive to it. Because of her/his formal power over the
firm organization, the entrepreneur may be able to determine the structure and the
agenda of formal communications, but not the agenda of informal communication
that takes place spontaneously every day. On the informal level, entrepreneurial
conceptions and social models may well be contested by rival cognitive frames
and social models. Failure to prevent these from tacitly taking the lead in the firm’s
informal communication can have far-reaching consequences for organizational
coherence and, hence, for the firm’s performance. In the struggle to maintain “cog-
nitive leadership” (Witt, 1998), particular social skills like communicativeness,
persuasiveness, and persistence, as well as fairness, credibility, appreciativeness
are relevant. But the intrinsic features of business conceptions are also impor-
tant. If a conception is too complex and sophisticated, it lacks soundness and
appeal, not least in terms of expected career options, remuneration, qualification
enhancement, and working conditions for the employees. If it is obviously unsuited
for the imagined business, it is difficult to make employees adopt it. In general,
cognitive frames that do not work well in making sense of information coming
from the environment tend to be modified or replaced if they are adopted at all.
148 ULRICH WITT
6. CONCLUSIONS
In this paper an attempt has been made to show that entrepreneurship manifests
itself in coordinating action on two levels, that of the market and that of the firm or-
ganization. In pursuing profit opportunities which they try to realize in the markets,
entrepreneurs in many cases acquire human resources on the basis of employment
contracts, i.e. within the organizational form of a multi-person firm. Since such
contracts leave a certain amount of discretion to the agents who have been hired,
the coordinative task, and hence the pursuit of a profitable opportunity, in this case
takes a form different from that of ordinary market contracts. To realize a profit
opportunity as perceived in an entrepreneurial business conception, the employees
need to be coordinated on, and motivated to pursue, the entrepreneurial business
conception as their own frame of action. Accordingly, the entrepreneurial reorga-
nization of production and trade implies two different coordinating tasks. The one
focuses on exploiting the market opportunities. It has been extensively discussed
by writers like Schumpeter, Mises and Kirzner. The other coordinating task is
to see through the entrepreneurial business conception in the intra-organizational
interactions of the multi-person firm in the daily organizational grind. This side of
entrepreneurship has been largely ignored in almost all strands of economics. The
cognitive approach to the problem suggested in the present paper provides a fruitful
basis for discussing the theory of the firm from the point of view of the Austrian
school of economics and its core assumptions of uncertainty and subjectivity
of individual knowledge.
NOTES
1. A problem which has been explained in great detail by Mirowski (1989). For unknown
reasons, the seventh chapter was omitted from later editions of Schumpeter’s Theory of
Economics Development and, thus, from the English translation that appeared in 1934. It
has only recently been translated into, and published in, English as Schumpeter (2002).
2. Only later, in the context of a discussion of the surplus, does Schumpeter (1934, pp.
128–156) mention the profit motive. Successfully realizing new combinations promises
“promotors’ profits.”
3. Cf., e.g. Nietzsche (1899) and his influential elitist philosophy.
4. More precisely, Mises suggests to define economics in such a way that any other kind
of behavior is not a subject of economics but rather of psychology.
5. For a discussion about the more frequently made distinction between disruptive
(Schumpeter) and equilibrating (Mises–Kirzner) effects of entrepreneurship cf. Kirzner
(1999).
6. “Economic natural selection,” as Winter (1964) called it, refers to biological analogies
in the theory of the firm discussed in the 1950s. With these analogies, it was claimed that
profit maximization has a selection advantage over other forms of firm behavior – and that
the neoclassical optimization approach can thus be vindicated.
7. Drawing on the satisficing hypothesis (March & Simon, 1958, pp. 47–52), it can be
argued that a deteriorating performance triggers a search for improved routines, i.e. a kind
of induced mutation.
8. For a comprehensive summary see Anderson (1990, Chap. 3). Different cognitive
tasks can, of course, be pursued on the basis of different frames at different times.
9. This aspect has been widely neglected in the literature on bounded rationality. A
notable exception is March (1991). The present approach relies in this point on Albert
Bandura’s social cognitive learning theory (Bandura, 1986).
10. As is well known in social psychology, social models which emphasize task commit-
ment, cooperative problem solving, fairness, and frankness help keep intra group frictions
and individual frustrations down (see, e.g. Paulus, 1989).
ACKNOWLEDGMENTS
I am grateful to Peter Murmann and Klaus Rathe for helpful discussions and to an
anonymous referee for useful comments. The usual disclaimer applies.
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THE BUSINESS FIRM AS A HYBRID
HAYEKIAN ORDER: WHAT IS THE
ROLE OF THE ENTREPRENEUR?
Stavros Ioannides
ABSTRACT
Starting from Hayek’s distinction between spontaneous and man-made
orders, we attempt to analyze the role of the entrepreneur in business organi-
zations. The business firm shares important elements of both categories, thus
we describe it as a hybrid order. We proceed to construct an account of the
entrepreneur that is consistent both with the attributes of the firm that reflect
its affinity with man-made organizations, as well as those that reflect its
affinity with spontaneous orders. We highlight the concept of entrepreneurial
leadership as the major factor for the existence of business organizations
and we discuss why the actual mode in which entrepreneurial leadership is
exercised has important implications for the development of the firm.
1. INTRODUCTION
The rediscovery of Hayek’s thought in the 1970s and 1980s focused largely on the
role of his ideas in the rejuvenation of liberal political philosophy. Hayek was thus
praised by some and condemned by others, as a free market ideologue.1 It is striking
that in this intellectual climate what most students of his thought have not seemed
to ask themselves is, how come this dedicated advocate of free markets, never

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06010-1
153
154 STAVROS IOANNIDES
focused on the concept of the entrepreneur. Indeed, in his most important works
after 1960, the word appears only once in the Index of Hayek (1979). The same
work contains a mere passing reference to Israel Kirzner, the leading proponent
of the theory of entrepreneurship in the modern Austrian school of economics, in
a footnote.
Despite this neglect of the entrepreneur, Hayek’s ideas on knowledge, discovery
processes and learning have provided an invaluable source of inspiration for
students of entrepreneurship, and especially those of the Austrian tradition.2
This was already evident in Kirzner’s (1973) seminal contribution, where the
entrepreneur was described as an agent seeking to discover new knowledge in the
form of profit opportunities. More recently, but in the same vein, Harper (1994,
1996, 1998) has proposed a view of the entrepreneurial role that focuses on the
entrepreneur’s processes of learning, which he likens to the process through which
scientific knowledge develops. Butos and Koppl (1999) also focus on learning
processes and draw insights from Hayek’s (1952) theory of mind. Hayekian
ideas have also figured prominently in a recent stream of work that attempts to
introduce Austrian ideas into the theory of the firm (Dulbecco & Garrouste, 1999;
Foss, Foss, Klein & Klein, 2002; Ioannides, 1999a, 2003; Langlois, 1992, 1995,
2001; Lewin & Phelan, 2000; Sautet, 2000).3
In this paper, we employ Hayekian ideas in order to analyze the role of the
entrepreneur in business organizations, thus linking the theory of entrepreneurship
with the theory of the firm. Our starting point is Hayek’s distinction between
spontaneous and man-made orders. We will argue that the business firm shares
important elements of both categories, and that we can thus describe it as a hybrid
order. Many authors, regardless of the term they have chosen to refer to it, have
pointed out the hybrid character of the firm. What distinguishes our argument is
that we describe the relation between the two sets of elements as one of inherent
tension. This poses a problem for an understanding of the entrepreneurial role
in the context of the business firm. For, on the one hand, the elements of the
firm that reflect its affinity with man-made organization imply a view of the
entrepreneur as the agent who can impose his/her purpose on the workings of
the firm. On the other hand, the elements that reflect the firm’s affinity with
spontaneous order imply that it must be understood as an entity with endogenous
forces of development, which is not possible to be controlled by a central center
of command. But if that is the case, what is the role of the entrepreneur?
Hayek’s ideas allow us to construct an account of the entrepreneur in the context
of the firm that is consistent both with the attributes of the firm that reflect its
affinity with man-made organizations, as well as those that reflect its affinity with
spontaneous orders. Moreover, we argue that these ideas prompt us to understand
the entrepreneur as the agency that constantly resolves the tension we referred
The Business Firm as a Hybrid Hayekian Order 155
to above in a way that allows the firm to grow. Thus, we highlight the concept
of entrepreneurial leadership as the major factor for the existence of business
organizations. We will go on to show that the actual mode in which entrepreneurial
leadership is exercised has important implications for the development of the firm.
In the context of entrepreneurship studies, our analysis thus relates to the 3rd
research question according to the taxonomy of Shane and Venkataraman (2000,
p. 218), the “why, when, and how different modes of action are used to exploit
entrepreneurial opportunities.”4
We begin (Part 2) with a discussion of Hayek’s distinction between spontaneous
orders and organizations. The central concept here is that of the “rules of conduct,”
which are pertinent for social structures of both categories. We then show (Part 3)
that the business firm must be thought of as a hybrid order, as it shares important
features of both spontaneous orders and man-made organizations. Importantly,
both sets of features are related to the character of the rules that govern the
operation of the order. We go on to argue (Part 4) that, as the business firm grows
both in size and in complexity, the nature of the rules that its members have to
follow tends to change from specific to abstract, thus tending to transform the
organization of the firm itself into a spontaneous order. Part 5 argues that for the
firm to be maintained as an organization, entrepreneurial leadership has to be
exercised. In Part 6, we argue that this concept can be divided into two aspects:
leadership-as-authority and cognitive leadership. We go on to discuss how this
idea can be translated in the framework of Hayek’s theory on the relation between
various “layers” of rules. Finally, we conclude (Part 7) by briefly showing
how the two aspects of entrepreneurial leadership relate to different phases of
the firm’s development.
2. THE DISTINCTION BETWEEN SPONTANEOUS

ORDERS AND ORGANIZATIONS5
The distinction between the categories of spontaneous orders and organizations,
which constitutes one of the major building blocks of Hayek’s social theory,
hinges on the role of purposeful agency in the creation of these structures. A
spontaneous order is created unintentionally through the actions of individual
agents. By contrast, organizations are products of a directing intelligence, i.e.
deliberately designed constructs.6
It is important to note that, however, crucial the distinction between the two
categories may be, they are both simply divisions of the same general concept,
that of order.7 It follows that several notions that relate to it are relevant for both
categories. Two such notions, which are crucial for our discussion, are those of
“abstract” and “concrete” orders. According to Hayek (1973, p. 38), the character
of the former cannot be grasped intuitively, thus its explanation requires the social
scientist “mentally to reconstruct it by tracing the relations that exist between
the elements.” By contrast, the orders, which he describes as “concrete,” can be
perceived intuitively by inspection. Hayek (1973, p. 38) maintains “such orders
are relatively simple or at least necessarily confined to such moderate degrees
of complexity as the maker can still survey.” Thus, the concepts of abstractness
and concreteness are directly linked to the complexity that the order – whether
spontaneous or man-made – can achieve. In other words, as the complexity of an
order increases, so does its abstractness.
As Hayek (1973, p. 43) argues, “the formation of spontaneous orders is the result
of their elements following certain rules in their responses to their immediate
environment.” Obviously, the nature of these rules of conduct is of paramount
importance for the character of the order that will result. For a spontaneous order
to emerge, Hayek stresses that the rules must be characterized by three attributes.
First of all they must be largely tacit. Although rules of conduct have to be known
by agents, for only if they are known they can be followed, this knowledge need
not be articulable. Of course, as we will see below, Hayek admits that some part
of the rules governing the behavior of the elements of a spontaneous order may be
formally constituted and thus explicit. However, he insists that there must always
be a sub-stratum of tacit rules for a spontaneous order to emerge.
The second attribute of rules, according to Hayek (1967, p. 56), is that they
must be largely negative rather than positive, as they must mostly determine a
permissible range of behavior rather than specific actions. Precisely because of
their negative character, Hayek describes rules of conduct as abstract, and links
the abstract character of the rules to the abstract nature of the resulting order. A
third attribute of the rules of conduct flows directly from the first two. If rules are
indeed largely tacit and abstract, they must also be general, in the sense that they
must be valid for all individuals and applicable to an infinite number of future
instances.
But how does the following of rules lead to the creation of an order? The key
notion here is that of ignorance. The obedience to rules of conduct helps agents
cope with ignorance, in a double sense: first, by allowing them to draw from
the experience with dealing with specific situations, which is embodied in these
rules; and second, by making the actions – or expected actions – of other agents
intelligible, for the simple reason that themselves they are based on obedience to
the same rules of conduct. Thus, the major advantage of rule-following behavior
stems from the quantity of knowledge that agents can make use of. Therefore,
the character of the rules must have important implications for the quantity of
knowledge that the elements of a spontaneous order can use and produce. The
more abstract and negative the rules are, i.e. the more they do not restrict freedom
of action, the more complex the resulting order.
By contrast to spontaneous orders, Hayek (1973, p. 49) maintains that man-
made orders – i.e. organizations – are created through the specific commands
of a directing authority. Thus, he seems to introduce a very clear criterion for
distinguishing between the two types of order. However, the simple relations:
(spontaneous orders-spontaneous evolved rules), and: (organizations-specific
commands), do not hold unambiguously. In fact, as we will see presently, he intro-
duces two independent criteria for distinguishing between spontaneous orders and
organizations.
Hayek (1973, p. 43) maintains that it is conceivable that a spontaneous order
may rest entirely on rules that have been deliberately designed:
Although undoubtedly an order originally formed itself spontaneously because the individuals
followed rules which had not been deliberately made but had arisen spontaneously, people
gradually learned to improve those rules; and it is at least conceivable that the formation of a
spontaneous order relies entirely on rules that were deliberately made8 [emphasis added].
Note, first of all, that Hayek distinguishes between the spontaneous origins of the
rules on which an order rests and the spontaneous character of the order itself.
The significant point here is that, even if all rules are deliberately designed, a
spontaneous order may still result provided that these rules have all the attributes
that we have discussed above, i.e. abstractness, generality and independence of
purpose. Furthermore, Hayek maintains that a spontaneous order “undoubtedly”
formed itself originally through the obedience of individuals to rules of conduct,
which were themselves spontaneous. Therefore, the first criterion he introduces
for distinguishing between spontaneous orders and organizations relates to the
origins of each type of order: whether the rules that constituted it originally were
spontaneous or deliberately designed.
However, Hayek introduces also a second criterion for distinguishing between
orders and organizations. He observes (1973, p. 49) than an organization run
entirely by commands could only reach a limited degree of complexity, as it
would be unable to make use of the tacit knowledge possessed by its members.
Therefore, he admits that even in organizations, and depending on the degree of
complexity the commanding authority wishes to attain, the latter may also employ
rules rather than merely commands.
However, Hayek (1973, p. 49) adds, “Rules of organization are thus subsidiary
to commands, filling in the gaps left by commands.” Therefore, the rules of
organization are the creation of purposeful authority, and can only develop on
a substratum of authority relations. Thus their nature is essentially different
from that of the rules that lead to the formation of spontaneous orders. On these
grounds, Hayek (1973, p. 48) argues that the rules in the context of organizations
are characterized by three attributes that are exactly the converse of the attributes
of the rules that lead to spontaneous orders.
(1) They are not abstract but concrete, since they must guide the actions of agents
in specific directions.
(2) They are not tacit but explicit, since the commanding authority needs to ensure
that all agents will know and obey them.
(3) They are not general but specific to the particular position of the organization
that an agent occupies.
3. BUSINESS FIRMS AS HYBRID ORDERS

To which of the two categories of order – spontaneous orders or organizations –
do business firms belong? Given Hayek’s discussion on the distinction between
the two, which we only briefly sketched in the previous part, the answer may not
be as straightforward as it may appear at first.
To begin with, a business firm is characterized by some of the most important
attributes that Hayek thought as describing man-made orders. It is obviously
the product of a directing intelligence, rather than the unintended outcome of
individual action. The single act of creating a firm signifies the purpose of an agent
to take advantage of a profit opportunity that may be realized through the joint and
coordinated use of a bundle of resources, which he/she subordinates to his/her au-
thority through the legal person of the firm. As in all man-made orders, commands
constitute the major tool through which the commanding authority directs the
joint operation of its resources. In fact, economic theory has traditionally upheld
one notion of the firm that seems to be entirely compatible with Hayek’s notion of
organization: the firm as a production function. The latter assumes that the com-
manding authority9 is in the position to direct its subordinates unproblematically
to act for the success of the authority’s purpose, i.e. profit maximization.
In the most extreme neoclassical formulations of the logic of the firm as
production function, it is assumed that the commanding authority is omniscient, in
the sense that it knows with complete certainty the technological possibilities, the
input and output prices, as well as whether its inputs – especially the firm’s employ-
ees – perform according to contract. More modern formulations have attempted to
relax especially the latter assumption and have introduced opportunism in various
guises as the behavioral description of the relation between the commanding
authority and its subordinates. Thus, in the modern “contractual” approaches to the
firm, we find analyses of principal-agent relations (Fama, 1980; Fama & Jensen,
1983; Jensen & Meckling, 1976), the monitoring function (Alchian & Demsetz,
1972), and establishment of joint ownership (Grossman & Hart, 1986; Hart,
1995; Williamson, 1975, 1985), as solutions to the problem of opportunism in the
context of economic organization. Although each one of these approaches signifies
a rejection of a major aspect of the commanding authority’s omniscience, they
simultaneously reconfirm the nature of the firm as a man-made organization, as
they reassert the capacity of the commanding authority to design efficient contrac-
tual arrangements that allow it to fully direct the operation of the whole on the basis
of direct commands.
Obviously, this account of the nature of business organization displays some
important attributes of man-made organizations in Hayek’s schema. To begin with,
the fact that the commanding authority fully controls both the emergence of the
organization as well as its operation surely means that a business firm has to be
conceived as a concrete order. Both the emergence and the operation of such an
order can be fully explained, for the simple reason that both are determined by
the will of one single mind. In such a context, there is little difference between an
army and the typical business firm.10
However, this unambiguous identification of the business firm with man-made
organization can be contested. The members of the firm constitute an intensely
interacting social group. Their interactions, although unfolding in the context
of the commands and the rules of organization that are set by the commanding
authority, inevitably lead individuals to learn new things. Richard Langlois (1992,
p. 176) refers to these learning processes and links them directly to Hayek’s
theory: “The . . . personnel of a firm follow, invent, learn and imitate routines that
persist over time. As in Hayek’s theory of culture, the routines are often tacit and
skill-like, followed unconsciously because they produced success in the past.”
These remarks are representative of a recent stream of literature that, explicitly
or implicitly, views the firm as an entity that tends to evolve spontaneously in
directions neither foreseen, nor entirely controllable by the directing authority
(see Ioannides, 1999a, 2003; Langlois, 1992, 1995; Langlois & Robertson, 1995;
Sautet, 2000; Witt, 1998, 2000). This literature links naturally to the competencies
or capabilities perspective (Foss, 1994, 1996), which describes the firm as
spontaneously creating new features that the commanding authority has, first of
all, to discover and, secondly, to coordinate with its strategic vision (Nelson &
Winter, 1982; Penrose, 1959/1995).
Few parts of this literature refer explicitly to Hayek’s schema and more
specifically to his distinction between spontaneous orders and man-made orga-
nizations.11 However, many of the aspects of spontaneous orders that, according
to Hayek, explain their superiority in handling knowledge are also relevant in
the case of the business firm. If that is valid, we should approach the latter
rather as a hybrid order, i.e. an order that displays important elements of both
spontaneous orders and organizations. We will later argue why this is a major
issue in describing the role of entrepreneurship in economic organization.
We have seen that Hayek considers spontaneous order as the social arrange-
ment that has arisen because of its capacity to handle knowledge. However,
the coordination of individual actions and the creation of new knowledge are
important not just for spontaneous orders but also for the business firm. In the
case of spontaneous orders, rule-following behavior makes social interaction
intelligible, for the simple reason that every agent may plan his/her action on the
presumption that he/she understands what the others are doing or how they will
react to his/her action. Thus a “cognitive commonality” is created (Witt, 1998,
2000) among the members of the spontaneous order, in the sense of a volume
of socially shared and largely tacit knowledge, which, although not possessed by
any one in its entirety, still allows the elements of the spontaneous order to act in
a coordinated fashion.
Interestingly, Ulrich Witt has introduced the notion of cognitive commonality
in his discussion of the development of business firms rather than spontaneous
orders. But why is cognitive commonality important for the operation of
the firm? Isn’t the purpose of the commanding authority, expressed through
direct commands, enough to ensure the coordinated actions of firm members?
Following Hayek, we have to look for the answers at the level of rules of
conduct. But how can this be possible, given his insistence on the different nature
of rules of organization and rules that lead to the formation of spontaneous
order?
4. RULES OF ORGANIZATION AND

SPONTANEOUSLY EVOLVING RULES
We have argued so far that the business firm comprises elements of both man-made
organization and spontaneous order and, thus, that we should better think of it as
a hybrid order. However, the important point is that the coexistence of the two
classes of elements and, therefore, the hybrid character of the resulting order must
be perceived as reflecting a constant process of tension between the two souls of
the business firm. But why talk of tension?
Let us begin by asking what these elements are. Obviously, the elements that
reflect the character of the firm as a man-made order are commands and rules
of organization, while those that reflect its character as spontaneous order are
spontaneously evolving rules. It is perfectly thinkable that a business firm may
be run entirely on the basis of direct commands.12 However, we have seen that
Hayek believes that such an organization could only attain a limited degree of
complexity, which explains why the introduction of rules of organization becomes
more important than commands as the firm grows. As in the case of spontaneous
orders,13 rule-following behavior allows agents to make use of knowledge that they
do not possess individually.14 Therefore, in the case of business firms, the reliance
on rules – and not merely on commands – increases the quantity of knowledge
available to the firm.15
However, it is precisely the introduction of rules of organization that leads to
the tension we referred to above. There are three considerations that may explain
this. First, the more complex the organization becomes, the more the rules of
organization that have been set by the directing authority will tend to acquire a
character of generality, thus being gradually transformed into the type of rules
that lead to the formation of spontaneous orders.16 Second, this gradually tends to
transform the character of the organization from a concrete to an abstract order.
Third, according to Hayek, abstract orders tend to rest on abstract rules. Thus, the
fact that business firms tend to acquire the characteristics of abstract orders must
transform also the nature of the rules on which they rest from concrete and specific
to negative and general.
Of course, Hayek maintains that rules of organization are deliberately designed
rather than spontaneous outcomes of human interaction. However, recall that,
according to Hayek (1973, p. 43), spontaneous orders can emerge out of systems
of deliberately designed rules. In fact, we will now argue that, in the context of
the operation of the business firm, there are identifiable tendencies leading to
the transformation of rules towards generality and abstractness and, thus, of the
organization towards spontaneous order.
Note that both commands and rules of organization emanate from one single
center of command, which explains their intimate relation to the notion of man-
made order. However, there is an important difference between the two. In contrast
to commands, rules of organization set the general framework within which the
employees of the business firm can act, thus allowing some freedom of action.
This freedom inevitably entails the possibility to establish ever-new rules for the
coordination of their activities. These rules will now be established spontaneously,
since none of the agents of the organization will have designed them intentionally.
Consequently, their persistence or disappearance must be thought of as taking
place in the same way that Hayek describes for the rules of conduct in the case of
spontaneous orders.17 These spontaneously evolving rules are the routines of the
firm, as defined by Nelson and Winter (1982). They embody a knowledge that
is both tacit and shared by the members of the organization and, therefore, they
allow agents to cope with ignorance and to act in ways that make their actions
mutually consistent.18
Our analysis suggests that the setting of rules of organization by the commanding
authority cannot block the spontaneous and constant creation of routines – or
spontaneously evolving rules, as we described them – through the interaction of
the members of the organization. But this leads towards a transformation in the
nature of the firm, from a typical Hayekian man-made order, to one that tends to
acquire the character of a spontaneous order. We can now see clearly the tension
that we referred to above: the introduction of rules of organization allows the firm
to grow both in size and in complexity; at the same time, however, the spontaneous
growth of routines tends to dissolve the organization, by tending to transform it
into a spontaneous order.
We believe that it is precisely this tension that justifies the application of
Hayekian ideas to the theory of economic organization. We have seen that the view
of the firm as a hybrid order is hardly novel, as we have traced it both in Austrian
contributions to the theory of the firm as well as to the capabilities approach.
However, Hayek’s distinction between spontaneous orders and organizations
prompts us to realize that the coexistence of the two sets of elements is inherently
contradictory rather than merely reflecting a collection of heterogeneous attributes.
We will see below that the manner in which the tension is resolved has important
consequences for the development of the business firm.
In fact, the analysis of this tension is possible through a conceptual schema
that Hayek (1979, p. 159) proposes, when he talks about “layers” of rules that
govern the functioning of spontaneous orders. He describes man-made rules as
“the thin layer of rules, deliberately adopted or modified to serve known purposes.”
Beneath that layer there is the layer of spontaneously evolving rules, which in turn
sits on top of a third layer that comprises the rules that have evolved genetically.
Although Hayek’s discussion refers to spontaneous orders, there is no reason why
this “layered” account of the relations between various types of rules cannot be
extended to business organizations. In the latter, the top layer would include both
commands and rules that are set by the commanding authority. There would still
be, however, a layer of routines or spontaneously evolved rules beneath that layer.
Our line of argument suggests that, inevitably, this middle layer will tend to grow
at the expense of the top layer as the firm grows. So what is it that maintains the
firm as an organization, thus blocking its transformation into a spontaneous order?
It is here, we will argue, that we must seek the role of the entrepreneur.
5. ENTREPRENEURIAL LEADERSHIP
Let us return to the view of the business firm as a hybrid order. A corollary of
the fact that the firm comprises important elements of man-made organization
is that it must also be thought of as being run by a purposeful agency. We saw

in Part 2 that Hayek proposes the concept of purpose as the major distinguishing
characteristic of man-made organizations. Therefore, for the firm to retain the
character of man-made organization rather than slip towards the status of a
spontaneous order, the existence of a purpose must be conceived as an ongoing
process that reproduces these structures as organizations. We define this process
as entrepreneurial leadership. If this process of constantly reaffirming a purpose
for the organization ceases to be effective, the emergence and the evolution
of spontaneously evolving rules that we have already discussed will tend to
transform the firm into a spontaneous order. Therefore, a business firm will
retain its character as an organization for as long as entrepreneurial leadership is
effectively exercised.
But why describe this process as “entrepreneurial leadership” rather than simply
as “entrepreneurship”? We will argue below that the term we propose can better
capture the role of the entrepreneur in maintaining the business firm as a hybrid
order. Note, first of all, that the entrepreneur may be viewed as the agent who “puts
the elements of a set in their places” – to use Hayek’s words again. In other words,
the implementation of a “purpose” through the exercise of entrepreneurship may
be thought of as being conducted solely through the issuing of commands, thus
reducing the business firm to a typical Hayekian man-made order. However, such
an understanding of entrepreneurial action would ignore the implications of the
spontaneous growth of rules and routines within the business firm that we have
already discussed.
Indeed, a view of the firm as an organization run entirely on the basis of
commands and rules of organization would imply a view of the entrepreneurial
role as consisting in the single-minded execution of a preconceived plan, with
the employees of the firm merely and loyally executing the plan. However, Ulrich
Witt (2000, p. 743) provides a different view of the role of the entrepreneur and
maintains that:
The limitations of the human mind prevent the entrepreneur, as much as everyone else, from
imagining all possible moves that unfold into the future. There is always new information
that needs to be classified and assessed with respect to its implications within the existing
interpretative framework. A business conception can furnish such a framework . . . .
In this view, the promotion of the entrepreneur’s business conception requires

the information absorption capacity, the creativity and the problem-solving
capability of firm members. All these capabilities presuppose that the individual
member acts within a framework of sufficiently abstract rules. As we saw in the
previous part, this rule-following behavior will tend to produce spontaneously
ever-new rules and routines. In other words, the firm cannot but, at the same
time, must not operate on the basis of commands and rules of organization
proper. Therefore, we must think of the exercise of entrepreneurship as consisting
primarily in the execution of a plan that unfolds in an uncertain future, thus
making necessary the constant absorption of new knowledge by all team members,
its interpretation, and the implementation of the necessary adjustments to the
firm’s operation.
It is for this reason that Witt (2000, p. 740) maintains that a business conception
has to be “general and unspecific,” so that it can provide orientation to firm members
and, at the same time, encourage them to utilize their problem-solving capabilities.
However, it is precisely the need for the employee’s of the firm to exercise initiative
in the context of the overarching interpretative framework that is provided by the
entrepreneur’s business conception that precludes a view of the firm as a typical
Hayekian organization, i.e. an entity whose operation rests on the commands issued
by the entrepreneurial authority.
6. TWO ASPECTS OF LEADERSHIP

The above reasoning addresses the entrepreneurial component of the concept of
entrepreneurial leadership. Let us now turn to the leadership component. We can
define leadership as the activity of the summit of a hierarchy that aims at keeping the
lower levels operating in a coordinated fashion for the achievement of the leader’s
purpose.19 However, Hayek’s ideas prompt us to recognize the importance of the
mode in which leadership is actually exercised.
A first mode is leadership as authority, i.e. as the power of the leader to
tightly monitor the operation of team members and to coordinate their actions
through the issuing of direct commands. In Hayek’s schema of layers of rules, the
exercise of leadership-as-authority operates at the top layer. It implies that the
locus of entrepreneurship may change the relation between commands and
rules of organization on the one hand, and spontaneously evolving routines,
on the other. For example, it may widen the scope of the former, thus restrict-
ing the scope of the latter. In Hayek’s schema, the top level of deliberately
designed rules would become thicker, at the expense of the middle layer of
spontaneously evolving rules. Alternatively, if the entrepreneur believes that
the spontaneously evolving routines enhance his/her capacity to implement
successfully her/his business conception, she/he may decide to restrict reliance
on commands and centrally imposed rules and thereby encourage the growth and
reproduction of routines.
Obviously, the notion of leadership-as-authority is entirely consistent with a
view of the firm as being run entirely by commands, i.e. as a typical Hayekian
organization. Of course, the exercise of leadership in that mode would entail some
major drawbacks. First, running the firm by commands thwarts the creativity
and the problem-solving capacity of its members, while, at the same time, it
is very costly in terms of the attention the entrepreneur has to devote to even
the simplest operations.20 Second, and related to this, the complexity that the
organization could attain would be limited, because of the inevitable limitations
of the entrepreneur’s ability to effectively monitor all aspects of the firm’s
operations. Thirdly, the exercise of leadership in that mode confronts internal
constraints arising from the past evolution of routines within the firm. Therefore,
both the decision of the commanding authority to act in order to alter the mix of
commands and spontaneously evolved routines, as well as the options for action
that are open to it, will be heavily constrained by the path dependence of the
organization’s development.
However, there is another mode in which leadership can be exercised. Rather
than directing the actions of firm members by fiat – as in the case of leadership-
as-authority – the entrepreneur may attempt to influence informally the cognitive
frameworks of firm members, thus inducing them to behave in accordance with
his/her business conception. Ulrich Witt (2000, p. 746) defines this as cognitive
leadership and maintains that:
. . . conceptions and social models preached and practiced by the entrepreneur . . . may well
be contested by rival cognitive frames and social models both on the level of the individual
employee and on that of subgroups or coalitions. Failure to prevent rivaling frames and mod-
els from tacitly taking the lead in the firm’s informal communication can have far-reaching
consequences for organizational coherence . . . Therefore, for the entrepreneur to succeed in
shaping informal communications in a way that is advantageous to the propagation of her/his
business conception . . . a particular capacity is required. That capacity may be called ‘cognitive
leadership.’
Ensuring that the employees of the firm perceive, interpret and act upon knowledge
on the basis of a cognitive framework that is consistent with the business concep-
tion of the entrepreneur increases the coordination and the effectiveness of their
actions. On the other hand, the effective exercise of cognitive leadership becomes
increasingly difficult as the group of employees whose actions the entrepreneur
strives to coordinate becomes bigger.21 Again, however, the idea of cognitive
leadership can be easily transposed to Hayek’s schema of layers of rules. The
exercise of this form of leadership now aims at shaping developments at the middle
layer of Hayek’s schema, the layer of spontaneously evolving routines. Through
the exercise of cognitive leadership the entrepreneur attempts to influence the
“tacit cognitive commonalities” of firm members, thus shaping their interactions
so that they tend to produce routines that are consistent with the entrepreneurial
conception. In other words, the spontaneous behavior of the members of the
firm will tend to be: (a) coordinated; and (b) consistent with the strategic vision
that the entrepreneur pursues.
7. ENTREPRENEURIAL LEADERSHIP AND

THE DEVELOPMENT OF THE FIRM
Casting the concept of leadership in this Hayekian schema is important because it
allows us to clarify the mode in which the two aspects of the concept – leadership-
as-authority and cognitive leadership – interrelate. Notice, first of all, that they
constitute a genuine trade-off, thus the strengthening of the one inevitably leads
to the weakening of the other. The balance between the two aspects seems to be
theoretically indeterminate; thus every specific business organization will establish
its own mix of the two. But for all organizations, the two aspects will inevitably
operate in opposite directions, thus affecting the complexity that they may achieve.
However, this indeterminateness only relates to a static view of business
organizations, i.e. on the relation between the two aspects of leadership at a point
in time and at a particular stage of their development. When the development of
the firm is the object of inquiry, our analysis suggests that the two aspects may
be shown to be systematically related to different, but very specific, instances of
this development. The reason is that each one of them is better suited for different
instances of the pursuit of an entrepreneurial conception.
Leadership-as-authority is essential for the initial stages of implementation
of an entrepreneurial project or the instances in a firm’s development that the
entrepreneur attempts to effect a major refocusing of his/her conception. These
are instances in which the entrepreneur’s purpose – in the Hayekian sense – has
to be more forcefully asserted, in order to ensure the coordinated operation of the
firm’s members. The importance of leadership-as-authority in the initial founding
of the firm is, of course, self-evident. However, interesting examples can also be
found in instances where the firm’s locus of entrepreneurship opts to pursue a
project outside the existing organization, e.g. through the creation of a spin-off22
or the participation in a joint venture.23 In all these cases what the entrepreneur
attempts to do is to obtain new, potentially profitable, knowledge in ways that are
not constrained by the cognitive commonalities that are already established in the
current organization, i.e. independently of what we have referred to as Hayek’s
“middle layer” of rules.
We have seen, however, that leadership-as-authority inevitably puts upper
bounds to the growth of the firm, as it restricts the capacity of its employee’s to
look for new knowledge, to process it in the context of the entrepreneur’s business
conception and take decentralized action accordingly. Therefore, it is cognitive
leadership that is much more important for the growth of the firm and especially
for its development to ever-higher degrees of complexity. The reason is that
through cognitive leadership the entrepreneur can ensure the coordinated action
of the firm’s members and, especially, their coordinated and, at the same time,
creative response to the new contingencies that the organization’s development
confronts. Unlike leadership-as-authority, the exercise of cognitive leadership is
much more difficult to discern empirically, since, as we have seen, it refers to the
ability of the entrepreneur to influence informally the cognitive commonalities of
team members. However, interesting examples may be sought in instances where
cognitive leadership is evidently ineffective or even totally lacking, e.g. clashes –
or, more generally, incompatibilities – of “corporate cultures”24 in recently
merged organizations.
In Hayek’s schema of layers of rules, our analysis suggests that, although
the top layer, which consists of commands and rules of organization, is indeed
essential for the emergence of the firm, it is the middle layer of routines and
spontaneously evolved rules that determines the growth and development of the
firm. It is the maintenance of cognitive leadership by the entrepreneur at that
layer, i.e. his/her ability to ensure that the cognitive commonality shared by
all employees is consistent with the entrepreneurial business conception, that
allows the firm to develop, thus blocking its dissolution and, consequently, its
transformation from an organization into a spontaneous order.
The interesting line of empirical research that this analysis leads to is the
investigation of the relation between the use of direct commands and rules of
organization for the running of specific business firms – i.e. the exercise of
leadership-as-authority – to the unplanned evolution of routines within the same
organization. Most research on this issue is conducted in the context of inves-
tigations into the role of “corporate culture” and focuses on static comparisons
between monitoring costs and the “thickness” of the corporate culture of a specific
organization. Camerer and Vepsalainen (1988, p. 122), for example, maintain that
“since cultural rules are substitutes for communication and explicit monitoring, if
the costs of communication and monitoring fall then cultures will get thinner. That
is, the number of written rules will grow and the number of agreed-upon unwritten
rules will shrink.” Obviously, we see here the trade off to which we referred above,
as well as the idea that when the top layer of rules in Hayek’s schema grows, the
middle layer inevitably shrinks. However, what this static account of the problem
misses is the relevance of corporate culture, i.e. Hayek’s middle layer of rules,
for the growth of the firm. In contrast to such a static approach, therefore, the
interesting line of research that our Hayekian schema opens up is the study of the
manner in which the exercise of cognitive leadership by the entrepreneur relates to
the development of the firm.
NOTES
1. The 1990s have been more sober in that respect, as academic interest has increasingly
focused on the analytical value of his social theory, quite independently of the political
vision, which he had constructed it to serve. Fleetwood (1995) is an excellent example of
this shift.
2. See Koppl and Minniti (2003) for a survey.
3. A major source of inspiration for this stream of literature is Loasby (1991), who
described the firm as an institution specializing in problem-solving.
4. The first two questions that they propose are “(1) why, when, and how opportunities
for the creation of goods and services come into existence, and (2) why, when and how
some people and not others discover and exploit these opportunities.”
5. This part draws from Ioannides (1999b).
6. Hayek (1973, p. 37) maintains that: “The distinction of this kind of order (i.e. spon-
taneous) from one which has been made by somebody putting the elements of a set in their
places or directing their movements is indispensable for any understanding of the processes
of society as well as for social policy.”
7. Which Hayek (1973, p. 36) defines: “. . . as a state of affairs in which a multiplicity
of elements of various kinds are so related to each other that we may learn from the
acquaintance with some spatial or temporal part of the whole to form correct expectations
concerning the rest.”
8. And he adds: “The spontaneous character of the resulting order must therefore be
distinguished from the spontaneous origin of the rules on which it rests, and it is possible
that an order which would still have to be described as spontaneous rests on rules which are
entirely the result of deliberate design.”
9. Loosely referred to as the “entrepreneur.” See, for example, Henderson and Quandt
(1958/1971, p. 52).
10. Arguably, the most important differences would be, first, the severity of the sanctions
that the commanding authority can impose on the lower levels of the hierarchy in order to
curb opportunism and, second, the unavailability of the exit option to dissenters.
11. There are two notable exceptions in that respect. First, Langlois (1992, p. 169)
discusses the need to study what he describes as “organic organizations,” i.e. organizations
that display important elements of both spontaneous orders and organizations. Second,
Sautet (2000, p. 99) introduces the concept of the “complex” firm, which he defines as an
organization in which the commanding authority faces a “Hayekian knowledge problem”:
i.e. “the entrepreneur-promoter can be ignorant of his/her ignorance with respect to the
knowledge possessed by some of his/her employees.” Thus, both authors seem to approach
the firm as a “hybrid order,” according the terminology we are adopting here.
12. Sautet’s (2000, p. 85) concept of the “simple” firm is relevant here.
13. See Langlois (1992, 1995) and Vanberg (1994, p. 114).
14. A kind of knowledge, in other words, which is uncentralisable because of its very
character. See Hayek (1967, p. 61).
15. See Minkler (1993) for a similar argument on the role of knowledge in business
firms.
16. See Vanberg (1994, p. 114) for a similar point.
17. The interaction among firm members tends to create ever-novel mutations of the
rules. The ones that will be selected will be those that prove to have greater capacity to
coordinate the actions of agents.
18. Routines effect coordination not only contemporaneously but also in the inter-
temporal sense of allowing action to take into account past experience. This aspect of
routines implies that any attempt to redesign them may involve a great cost, which may
not be immediately obvious to the reforming agency. For even if successful in bringing
about a more effective coordination of contemporaneous acting, it may destroy the ability
of agents to tap the accumulated knowledge that is embodied in them.
19. This general definition has been put forth in Ioannides (1999b, p. 880).
20. See Witt (2000, p. 748): “However, a high price has to be paid for running an
organization on the basis of a monitoring regime . . . Monitoring curbs individual creativity
and the intrinsic motivation in problem-solving . . . . Furthermore, coordination through
detailed directions, regulations, authorization, and tight control causes frictions and is slow
and costly in terms of time resources. The larger the firm, the more these negative effects
tend to lower its efficiency.” See also Witt (1998, p. 167).
21. This relates in an interesting way to Penrose’s (1959/1995, p. xii) theory of the
growth of the firm. In her view, one of the major obstacles to this growth is the acquisition
of managerial services that can be easily “absorbed” by the existing managerial team:
“. . . managerial resources with experience within the firm are necessary for the efficient
absorption of managers from outside the firm. Thus, the availability of ‘inherited managers’
with such experience limits the amount of expansion that can be planned and undertaken in
any period of time.” Obviously, the “absorptive capacity” of the existing management team
is intimately related to the effectiveness with which it can establish what we have described
as “cognitive commonality,” especially with respect to the managerial resources obtained
from outside the firm.
22. See the account in Langlois (1992) of the organizational mode – i.e. through the
creation of a spin-off-that the management of IBM chose in order to develop and market
the first PC.
23. For a view of joint ventures as “hybrid” forms of organization, see Williamson
(1996). See also Caloghirou et al. (2003) for a survey of the theoretical and empirical
literature of a very interesting type of joint venture (Research Joint Venture) that involves
cooperative R&D.
24. For the concept of corporate or business culture see Casson (1991) and Camerer and
Vepsalainen (1988).
ACKNOWLEDGMENTS
A first version of this paper was presented in Jena, at the seminar of the Max Planck
Institute for Research into Economic Systems, Evolutionary Economics Unit, in
December 2001. The author wishes to thank the participants and especially Ulrich
Witt for helpful comments. The usual disclaimer applies.
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INFORMATION, ENTREPRENEURSHIP,
AND ECONOMIC PROGRESS
Randall G. Holcombe
ABSTRACT
Recognition of a profit opportunity requires a framework of knowledge
to place information about a profit opportunity in a context where it can
be recognized. The same information about a profit opportunity could be
revealed to many people, yet only a few with the appropriate knowledge
will be able to place this information into a context that suggests to them a
profit opportunity. This paper discusses how entrepreneurs gain knowledge
to enable them to be more entrepreneurial, and shows how an economy gen-
erates information about entrepreneurial opportunities. Entrepreneurship
adds to an economy’s knowledge base, making it easier to recognize profit
opportunities when they arise.
INTRODUCTION
Entrepreneurship is the act of discovering and acting upon a previously unnoticed
profit opportunity. Kirzner (1973, 1979, 1985) has analyzed at length the role
of entrepreneurs in the economy and their impact on the market, but has paid
less attention to the origins of the previously unnoticed profit opportunities that
give rise to entrepreneurship. They must come from somewhere, and Holcombe
(1998) argues that the most common source of profit opportunities is from the
entrepreneurial actions of other entrepreneurs. New entrepreneurial ideas arise

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06011-3
173
174 RANDALL G. HOLCOMBE
when an entrepreneur sees the results of the actions of earlier entrepreneurs

who have created previously unavailable profit opportunities. Entrepreneurial
opportunities tend to appear within the context of a specific time and place,
following Hayek (1945), so entrepreneurial opportunities are more likely to
reveal themselves to people who are at the right “time and place” to make the
discovery. Everyone is not equally likely to notice an entrepreneurial opportunity:
many people may be at the same location at the same time, but one person may
notice it while it remains unseen by others. This paper considers some factors that
determine how individuals come to recognize these previously unnoticed profit
opportunities, and what factors give individuals that specific knowledge of time
and place that allows them to make entrepreneurial discoveries.
As Kirzner (1973) describes it, entrepreneurs happen to notice what nobody
has noticed before. Whether an entrepreneurial opportunity actually is noticed
depends on many factors, but those factors can be divided into two general
categories: factors specific to the individual, and factors related to the individual’s
economic environment. Many individuals might observe the same information
revealing an entrepreneurial opportunity, yet only a few may have the wisdom
to actually act on it. One focus of this paper is on how individuals transform the
economic data they observe into a systematic body of knowledge that allows them
to spot entrepreneurial opportunities. A second focus of this paper is on the role
the economic environment plays in signaling that certain data actually represent
a profit opportunity. A growing economy is more conducive to revealing profit
opportunities to potential entrepreneurs, for reasons that will be discussed in detail
below, and within an economy, those areas that are growing more rapidly will
offer more profit opportunities. Entrepreneurial activity in an economy creates
data about profit opportunities that potential entrepreneurs add to their knowledge
base, which then makes it easier for them to recognize other unexploited profit
opportunities. This paper discusses how entrepreneurs acquire information about
entrepreneurial opportunities, and how entrepreneurial activity itself generates
information that fosters additional entrepreneurial activity.
INFORMATION, KNOWLEDGE, AND WISDOM

Boettke (2002) notes that economists are inconsistent in their use of the terms infor-
mation and knowledge. For present purposes, and consistent with Boettke’s use of
the terminology, information refers to data that an individual can collect. Individ-
uals can search for information, and may be aware of information they are lacking
that, if attained, could help them achieve their goals. For example, people might
read newspaper ads looking for information about prices for goods they intend to
Information, Entrepreneurship, and Economic Progress 175
buy. They may be unaware of other information that would help them if they had
it. Knowledge refers to the incorporation of information into a framework where
it can be used for decision making. Information about the price someone charges
will be of little use unless the person with the information can place it in context.
For example, what do other sellers charge for the same or similar goods? Is this
price likely to fluctuate, so that next week’s price might be considerably higher or
lower? Do some sellers offer non-price advantages that might make it desirable to
look at other information besides prices before deciding whether to buy? These are
the types of factors that enable an individual to place information in a context that
makes that information a component of the individual’s knowledge. Wisdom refers
to the use of knowledge to make good decisions. Because many factors must be
weighed to arrive at a decision, and because some of those factors may be difficult
to articulate or weight in a mathematical sense, many people may have the same
knowledge, but even with identical knowledge, some will make better decisions
than others.
Boettke (2002, p. 268) notes that “information is a flow concept, while
knowledge is a stock notion.” By extension, Boettke (2002, p. 269) observes,
“Knowledge is ever changing and is multifaceted, while information is something
fixed.” The flow of information adds to the stock of an individual’s knowledge,
but new information may also change the context within which old information is
interpreted. Knowledge is more than just the sum of all information possessed by
an individual. If one pictures a pitcher of water, and an individual adding a flow
of water to the stock of water already in the pitcher, this analogy inadequately
describes the relationship of flow information to the stock of knowledge. Instead,
picture someone adding flour, water, yeast, and the right amount of heat, to
produce bread. In the kitchen, the flow of ingredients yields a stock of food that is
qualitatively different from the flow of ingredients that produced it. Just as bread
is not some flour, some water, and so forth, a person’s knowledge is not just all
the information the person possesses. And just as some chefs are more successful
than others at producing meals even with the same stock of ingredients, many
individuals might have similar stocks of knowledge, yet some have the wisdom
to make better economic decisions with their knowledge.
Kirzner (1973, p. 67) makes a similar distinction between knowledge and
entrepreneurship. “But as closely as the element of knowledge is tied to the
possibility of winning pure profits, the elusive notion of entrepreneurship is, as
we have seen, not encapsulated in the mere possession of greater knowledge
of market opportunities. The aspect of knowledge which is crucially relevant
to entrepreneurship is not so much the substantive knowledge of market data as
alertness, the ‘knowledge’ of where to find market data” (emphasis in original).
Kirzner means by data what this section refers to as information. But knowledge as
Kirzner describes it in this passage is knowledge about where to find information.

One must put that information in context to have knowledge, and must be able to
use that knowledge productively to have wisdom.
In most instances, acting on an entrepreneurial insight is a risky undertaking.
The well-known fact is that most new businesses fail within their first five years,
illustrating that in many cases, what appears to some as an unexploited profit
opportunity turns out not to be profitable after all. When Kirzner talks about
someone noticing a previously unexploited profit opportunity, what the potential
entrepreneur notices is information. The entrepreneur must be in a position to turn
that information into knowledge, and to turn that knowledge into wisdom. The set-
ting within which the information reveals itself plays an important role in whether
the information about a profit opportunity ultimately is transformed into knowl-
edge, and then wisdom, leading to action to exploit the opportunity on the part of the
entrepreneur.
Consider a simple example of an individual who notices that apples can
be bought for $0.25 in city A and sold for $0.50 in city B. These prices are
information. The individual can place this information into a framework that can
lead to an entrepreneurial insight: a profit opportunity may exist by buying apples
in A and selling them in B. More must be known than just the prices, however. The
potential entrepreneur would have to factor in transportation costs, and for a true
profit opportunity to exist, not only would the entrepreneur need this information
on prices, but also a reasonable expectation that the price differential would
continue to exist long enough for the entrepreneur to complete a transaction. If an
apple can be shipped from city A to city B for $0.10, there is still the possibility
for a profit, if after buying apples for $0.25 in city A and shipping them to B,
the price in B has not fallen below $0.36. The entrepreneur may have information
about the propensity for apple prices to fluctuate in the short run, or may be able to
avoid the risk of fluctuations in the spot market by contracting ahead of time with
a buyer in city B. Prices by themselves provide information, but as this simple
example shows, information by itself does a potential entrepreneur little good.
The entrepreneur must be in a position to place that information in a framework
that yields knowledge before a profit opportunity can be spotted.
In this sense, Hayek (1945) was discussing the use of knowledge in society,
as his title says, not the use of information. Wisdom goes a step further, and is
the ability to use knowledge to make good decisions. The fact that most new
businesses fail within the first five years suggests that many people incorrectly
believe they have discovered profit opportunities. For example, the apparent
profit opportunity above might be undone if too many apples are spoiled or
damaged in transit, or if the entrepreneur failed to account for the possibility that
transportation costs might fluctuate even while taking account of price fluctuations
for the apples themselves, or any number of other complications. Wisdom lowers
the probability that one is wrong when making a decision based on knowledge.
With hindsight, one can separate good decisions from bad decisions on the
basis that good decisions yield profits while bad decisions produce losses. One
can never know whether a decision was “optimal,” in the sense that it was better
than other available alternatives, because as Buchanan (1969) notes, one can never
know what would have been the outcome of a foregone alternative. Information
is relatively easy to evaluate, in the sense that one can check on its validity,
despite the fact that people can obtain information that is wrong, incomplete, or
faulty in some other way. Knowledge is more difficult to evaluate, because one
must be aware of the context within which information is used, and it is easy to
envision how someone’s knowledge could be faulty because the person is lacking
some information the person does not even realize would be useful. Wisdom is
more difficult to evaluate than knowledge, because even in hindsight one cannot
compare the outcomes of decisions people make with what would have been the
outcomes if they had chosen differently.
If one views entrepreneurship as seeing and acting upon a previously unnoticed
profit opportunity, it is apparent that two people could observe the same informa-
tion, and one would see it as an unexploited profit opportunity while the other might
not, either because the second person did not have the knowledge to place that in-
formation in context, or did not have the wisdom to see that the information does,
in fact, reveal the opportunity to make a profit. Ray Kroc, who built the McDonalds
restaurant chain, sold restaurant equipment before he took over McDonalds. He had
an order for a large number of milkshake makers, and went to the restaurant started
by the McDonald brothers to see personally how a restaurant could be selling so
many milkshakes. What he saw was an innovation in restaurant operation. Before
McDonalds, restaurants got customers’ food orders and then prepared the food, but
McDonalds had the entrepreneurial insight that they could prepare the food before
it was ordered so customers could get their food right away. This system required
that management be good at predicting the number of customers and food orders
so the right amount of food would be on-hand, and hindsight shows that they had a
good system. Ray Kroc did not develop this system himself, but he recognized it as
a profit opportunity. He had the information from seeing the operation of McDon-
alds, he had the knowledge from years of experience in the restaurant industry,
observing many different types of operations, and he had the wisdom (moreso
than the original innovators) to see this as a profit opportunity. So he bought the
restaurant from the innovators and established it as a world-wide chain.
Perhaps Kroc was just lucky. It is difficult for an outside observer to separate
out luck from wisdom, because there is no formula for identifying how individuals
can use knowledge to make good decisions. It is easier to see how knowledge
can prevent people from making bad decisions, by identifying potential problems
before they arise, but how did Ray Kroc have the insight to see what a profit
opportunity McDonalds presented when the innovators who started the restaurant
were (using their sale as evidence) less optimistic. Part of the answer likely
lies in the different knowledge bases of Kroc and the McDonald brothers. The
McDonalds may have had the knowledge to start and operate a restaurant, and
the brilliant insight to prepare the food before the customers ordered it, but Kroc,
as a vendor selling to many restaurants, had a broader knowledge of the industry.
Regardless of whether this speculation on the differences in knowledge between
the McDonalds and Kroc is true, this is an example of how two people could have
the same information about a profit opportunity, and yet because the two individ-
uals had different knowledge bases, one saw it as a more profitable opportunity
than another.
Perhaps Kroc was lucky, but there’s an old slogan, “Luck is when preparation
meets opportunity,” and it seems to apply here.1 Kroc was prepared because
of his background in the restaurant industry, and had the opportunity when the
McDonald brothers were willing to sell him their restaurant. But many people
believe they have spotted profit opportunities that result instead in losses. Perhaps
their knowledge was faulty, but consider companies like IBM on the brink of
bankruptcy in 1991, or Xerox and Polaroid on the brink of bankruptcy in 2001.
Surely the management in those companies had ample knowledge of the computer,
photocopying, and photography industries, respectively, but that knowledge did
not translate into the wisdom that led to profitable decisions. In the real world
(unlike the neoclassical model of the firm), profitability is a moving target, and
activities that were profitable a decade ago – or even a year ago in rapidly-evolving
industries – may not be profitable today. As Christensen (1997) notes, decision
makers can be misled by their past successes into thinking that strategies that
brought them profits in the past can continue to do so in the future. As the IBM,
Xerox, and Polaroid cases show, more than knowledge is required to spot profit
opportunities. Entrepreneurship is built on a foundation of knowledge, but also
requires the wisdom (or luck) to be able to sort the good strategies from the bad.
CAN ENTREPRENEURSHIP BE PRODUCED?

As Kirzner defines entrepreneurship, the entrepreneurial act itself is costless,
and uses no resources. It is simply the act of noticing what nobody has noticed
before. But people can invest resources into activities to make it more likely
that they will make an entrepreneurial discovery. Research and development
activities are not entrepreneurship, but R&D creates an environment within which
entrepreneurial opportunities are more likely to present themselves. Research

and development generates information, which can add to knowledge. Within
a neoclassical framework, where things are produced by combining inputs in a
production function, research and development is undertaken by combining land,
labor, and capital, to produce technological change. The successes attributable to
investment in research and development are indisputable, but R&D expenditures
cannot be the whole story, because once the research is done, the results need to
be applied to make production less costly, or even more mysteriously, to produce
goods and services that have never been produced before.
Schumpeter (1934) distinguishes invention from innovation. Invention is a pos-
sible product of R&D, but inventions do not necessarily lead to economic im-
provements. The innovation is taking the invention and applying it to produce new
products, or to produce existing ones more efficiently. The taking of inventions
and making them into innovations is the role of entrepreneurship. Fifteen hundred
years ago China was the most technologically advanced nation in the world, but did
not turn its inventions into innovations, whereas during the industrial revolution,
Europe did. Similarly, Xerox invented the computer interface used on the Apple
Macintosh and in Microsoft Windows, including the use of windows to show dif-
ferent tasks, and the use of the mouse to navigate the operating system and its
applications, but Xerox did not turn its invention into an innovation. Steve Jobs of
Apple, and Bill Gates of Microsoft, saw what Xerox had done, incorporated that in-
formation into their stock of knowledge, and with that knowledge had the wisdom
to see that the commercialization of that interface was an unexploited profit oppor-
tunity. The information was revealed to those at Xerox first, but those who saw the
information first failed to see that it revealed an entrepreneurial opportunity. The
story of the development of the graphical user interface for the computer parallels
the story of the development of fast food restaurants told in the preceding section.
While entrepreneurship may involve that flash of recognition that a profit
opportunity exists, entrepreneurship can be produced, in the sense that individ-
uals and firms can create an environment that is conducive to entrepreneurial
discovery. People can search for information about market conditions, about
production processes, and about possible innovations and new goods. Research
and development can be viewed as the creation of an environment that produces
information that could reveal entrepreneurial opportunities. Some information
about an entrepreneurial opportunity is available to everybody. Price discrepancies
and arbitrage opportunities fall in this category, and those most alert will notice
them. Some information is available only to a few, and the object of commercial
research and development is to generate information that nobody else has. This
gives the researcher a substantial advantage in transforming the proprietary
information into a profit, but as the Xerox example above shows, it is not an
insurmountable advantage. Despite the fact that Xerox developed the information
to produce the graphical user interface for the computer, the company did not
have the wisdom to recognize it as a profit opportunity, so those profits from the
information Xerox generated ended up going to Apple Computer and Microsoft.
Information about entrepreneurial opportunities can be produced, and firms
actively undertake activities to produce that information. The knowledge to place
the information in context can also be produced. Businesses go to great lengths to
try to understand not only the engineering aspects of the products they produce, but
also the nature of the market within which their products are sold. As Christensen
(1997) notes, firms always run the risk of misunderstanding their markets, even
when they are market leaders, and sometimes past successes lead firms to overlook
the future direction of the market. But firms do try to understand their markets so
that they can remain successful. Understanding the market means taking available
information and placing it in context so that the firm can make successful decisions.
To that end, firms undertake marketing research, engineering research, and other
information-gathering activities, and consolidate that information to try to acquire
the knowledge to make managerial decisions. This knowledge is necessary for
entrepreneurship.
Information about entrepreneurial opportunities can be produced, and that in-
formation can be aggregated into knowledge about entrepreneurial opportunities.
In that sense, entrepreneurship can be produced. But the wisdom to use one’s
knowledge effectively is more problematic. It can be produced by experience, but
some people seem more adept at making wise decisions than others. As Boudreaux
and Holcombe (1989) note, it is more than just good management – finding ways
of minimizing costs and combining inputs efficiently. Entrepreneurship means
finding a better way of doing something, and there is no benchmark for compar-
ison. Can entrepreneurship be produced? Information that can help people act
entrepreneurially can be produced, and the knowledge to place that information in
context can be produced, but there is no clear-cut way to produce the wisdom that
leads to entrepreneurial discoveries. Entrepreneurship is more than just noticing
something, as the record of business failures suggests. It involves having the
wisdom to separate actual profit opportunities from tempting options that will not
generate profits.
THE ORIGINS OF
ENTREPRENEURIAL OPPORTUNITIES
How readily an unexploited profit opportunity is recognized is related to the
ways in which entrepreneurial opportunities arise. Some profit opportunities
are easier to spot than others. Holcombe (2003) argues that entrepreneurial
opportunities arise from three different sources: factors that disequilibrate the
market, factors that enhance production possibilities, and as the by-product of
previous entrepreneurial actions. Within a neoclassical framework, and within
Kirzner’s (1973) framework, factors that disequilibrate the market provide the
most obvious source of entrepreneurial opportunities. If some trades are being
made at disequilibrium prices, then an entrepreneurial opportunity exists, and the
act of entrepreneurship pushes the market toward equilibrium.
Factors that Disequilibrate the Market
Kirzner (1973, pp. 72–75) contrasts his equilibrating view of entrepreneurship with
Schumpeter’s (1934), which Kirzner characterizes as disequilibrating. “Schum-
peter’s entrepreneur acts to disturb an existing equilibrium situation . . . . The
entrepreneur is pictured as initiating change and generating new opportunities” (pp.
72–73, emphasis in original). Kirzner then quotes Schumpeter as concluding that
entrepreneurship is at odds with equilibrating activity. Kirzner, in contrast, argues
that the entrepreneur “. . . brings into mutual adjustment those discordant elements
which resulted from prior market ignorance” (p. 73, emphasis in original). Kirzner
raises the issue because he believes Schumpeter’s discussion of entrepreneurship
is “. . . likely to generate the utterly mistaken view that the state of equilibrium
can establish itself without any social device to deploy and marshal the scattered
pieces of information which are the only source of such a state” (pp. 73–74).2
A key point here is seen in Kirzner’s reference to the scattered pieces of infor-
mation required to equilibrate the market. The necessary information is readily
available in the form of market prices, but for entrepreneurship to equilibrate the
market, there must be somebody with the knowledge required to take advantage of
the information. If the market is disequilibrated through a shift in supply or demand,
the change in the status quo should provide a relatively obvious signal of an en-
trepreneurial opportunity, and provides the most likely case that an entrepreneurial
opportunity would be recognized. People who already trade in a market are likely to
spot opportunities that are created by factors that disequilibrate the market as a by-
product of their routine economic activity, so many people will have the required
knowledge, and relatively little wisdom is required to spot such a profit opportunity.
Factors that Enhance Production Possibilities
The second source of entrepreneurial opportunities, factors that enhance produc-

tion possibilities, create entrepreneurial opportunities in several different ways.
Most obviously, more production means people have higher incomes, so there is a
profit opportunity to produce more output for them to purchase. More significantly,
higher incomes will lead to changes in the mix of goods demanded. As income rises,
people tend to demand more automobiles relative to bicycles, and may shift from
auto or train travel to travelling by air. People may demand more steak relative to
hamburger, and may demand more restaurant meals relative to home-cooked meals.
Changes in the composition of demands for various types of output creates profit
opportunities. Perhaps more significant as a source of profit opportunities, a more
productive economy has a greater role for the division of labor, as Smith (1776)
noted, so even if the output of all goods did increase proportionally, there would
still be the opportunity to change production methods to produce more efficiently
with a finer division of labor. As Richardson (1975, p. 351) notes, in Smith’s view
“the division of labor is at once both a cause and an effect of economic progress.”
Young (1928) and Kaldor (1972) also emphasize Smith’s principle of the division
of labor as an important and underappreciated engine of economic progress.
In this case, the exact nature of an entrepreneurial opportunity will not be as
obvious as in the previous case (for factors that disequilibrate the market). If there
is an opportunity to produce new goods to sell to a broader market, it is not always
obvious what new goods it would be profitable to produce. Likewise, if there is an
opportunity to profit from increased specialization in production, or by any other
change in the production process, it is not always obvious how this could be done.
Consider Henry Ford’s insight that because of a growing market, automobiles
could be mass-produced on assembly lines to lower the cost and bring the oppor-
tunity of automobile ownership to the masses. Many people had the same market
information as Ford, but he had the wisdom to seize that profit opportunity. While
it looks obvious in hindsight, many automobile companies led by people with less
wisdom than Ford failed in the early 20th century. For a similar example, consider
the success of Palm Pilots – small hand-held computers. Do readers recall the Ap-
ple Newton, which was Apple Computer’s entry into that market only a few years
before the Palm Pilot? Apple spotted the information signaling a profit opportunity
in that market before Palm,3 Apple had the knowledge to see that there was a profit
opportunity (the evidence is Palm’s profit in that market), but Apple was unable
to profit from it.
Profit opportunities created by enhanced production possibilities probably
take more wisdom to turn into actual profits than those created by the other two
categories. The process by which profit opportunities are generated is more evo-
lutionary and continuous than in the other cases, the knowledge required to make
a profit is typically substantial, and the wisdom necessary to make good decisions
is substantial, as the Newton-Palm example illustrates. One interpretation of this
example is that the failure of the Newton in this market provided information
to Palm which helped them to succeed. These opportunities are considerably

more complex than spotting a $20 bill lying on the sidewalk, or seeing that
something can be bought for less in one location than it can be sold for in another,
and the failure of the Newton to capitalize on the same profit opportunity later
exploited by Palm illustrates the difficulty of seeing the exact nature of a profit
opportunity.
Entrepreneurial Opportunities Produced by Entrepreneurship
The third and most significant source of entrepreneurial opportunities arises

from entrepreneurial actions that have taken place in the recent past. As Kirzner
(1973) depicts it, entrepreneurial opportunities lie unnoticed until entrepreneurs
see and act on them. If this was all there was to it, entrepreneurial opportunities
would be used up as entrepreneurs exploited them. Once the market reached
equilibrium, no more opportunities would appear – unless, as noted above, factors
disequilibrated the market, or production possibilities were enhanced. However,
entrepreneurial actions themselves produce new entrepreneurial opportunities,
as Holcombe (1998), Minniti (1999), and Minniti and Bygrave (2000) note.
Consider, for example, the cordless computer mouse. Some entrepreneur had
the idea that computer users would prefer a mouse that was not tethered to the
computer by a cord, so created a battery-operated mouse that would communicate
with the computer through radio waves or infrared light (there are at least these
two types of cordless mice). That entrepreneurial insight would not have been
possible had Steve Jobs and Bill Gates not had the entrepreneurial insight to
adapt Xerox’s graphical user interface to the PC. And in turn, the graphical
user interface would not have been an entrepreneurial opportunity had not
the PC been commercialized. And the opportunity to create the PC would not have
been available had the microprocessor not been developed, and there would have
been no opportunity to develop the microprocessor without the invention of the
transistor. The point is that entrepreneurial actions do not use up entrepreneurial
opportunities: on net they create more entrepreneurial opportunities. The main
source of entrepreneurial opportunities is from the act of entrepreneurship itself.
To see entrepreneurship in this way adds to Kirzner’s (1973) model of
entrepreneurship in an important way. As Kirzner describes it, entrepreneurial
opportunities lie unnoticed until entrepreneurs seize them, but Kirzner does not
describe where they come from, and leaves the impression that entrepreneurs use
up entrepreneurial opportunities as they act on them. Seen in the broader way
described here, entrepreneurs create new entrepreneurial opportunities as they act
on existing ones, so entrepreneurial actions create more opportunities and more
entrepreneurship. One might picture, following Kirzner, profit opportunities lying

unnoticed until the spark of recognition hits an entrepreneur, but in fact, most
entrepreneurial opportunities do not lie unnoticed for long. The opposite is true:
most profit opportunities get noticed by entrepreneurs because they are new. This
is true whether the entrepreneurial successes are spectacular or more mundane.
This effect of entrepreneurship suggests Schumpeter’s vision of economic
progress as a spontaneous, revolutionary, and discontinuous process.4 Surely
the seizing of an entrepreneurial opportunity can upset people’s expectations,
because almost by definition (Kirzner’s definition, at least), entrepreneurial
actions must come as a surprise to everyone but the entrepreneur, because nobody
noticed the opportunity before. But once the entrepreneur acts, information on the
entrepreneurial activity becomes widely available as market data, alerting others
to the potential of profit opportunities.
Consider some great American fortunes. Andrew Carnegie was able to build
the foundations of U.S. Steel by capitalizing on the newly developed Bessemer
process. John D. Rockefeller’s Standard Oil Company developed because he was
able to control the distribution network, which at the time relied on the recently-
constructed railroad infrastructure. Henry Ford’s assembly lines were feasible
only when there was enough of a mass market for automobiles, and the fortunes
of Bill Gates rose along with the fledgling personal computer industry. None of
these individuals invented the technology that made them wealthy, but they had
the insight to take advantage of an entrepreneurial opportunity. Note, however,
that in each case the opportunity was newly developed, and the entrepreneurial
opportunity did not go unnoticed for long. Entrepreneurial opportunities are not
just lying around waiting for someone to notice them. Rather, they appear and
then entrepreneurs rapidly move to take advantage of them.
Consider again the innovation of the cordless computer mouse. It is a small
development, to be sure, but is a good example of an entrepreneurial insight and the
capitalization of a previously unnoticed profit opportunity. The profit opportunity
arose solely because of a previously non-existent market niche, and once that
market niche appeared, it did not take very long for an entrepreneur to seize on the
idea. Notice that this entrepreneurial insight did not arise for either of the first two
reasons discussed earlier. It did not arise because of a profit opportunity created
by a temporary disequilibrium in the market. Before personal computers used
mice (which also is an example of an entrepreneurial insight), there would have
been no possibility for the insight, regardless of how far the market was out of
equilibrium. It did not arise because of the second reason either, which is a bigger
market. The division of labor has nothing to do with the insight that a mouse could
communicate with a computer through infrared or radio technology (although it
might have something to do with what type of firm produces the technology). An
increase in wealth could not create the demand for infrared mice without the inno-
vation of mice as a computer input device. This entrepreneurial insight capitalized
on a new opportunity, which was created by other entrepreneurial insights.
In each of the above examples, the entrepreneur had some specific knowledge of
time and place as a context for new information revealed through the market about
profit opportunities produced by recent entrepreneurial acts. The entrepreneurial
act of seizing those opportunities that produces the engine for economic progress,
and lays the foundation for more entrepreneurial discoveries.
Where do entrepreneurial opportunities come from? Many of them come
from the actions of other entrepreneurs. Henry Ford could not have succeeded in
mass-producing automobiles until there was a substantial market, including in-
frastructure such as roads, gasoline stations, and repair facilities. Bill Gates could
not have made his fortune had not Steve Jobs seen the opportunity to build and
sell personal computers, and Steve Jobs could not have built a personal computer
had Robert Noice not invented the microprocessor. When entrepreneurs take
advantage of profit opportunities, they create new entrepreneurial opportunities
that others can act upon. Entrepreneurship creates an environment that makes
more entrepreneurship possible.
INFORMATION, WISDOM, AND THE PROCESS

OF ENTREPRENEURSHIP
Entrepreneurship creates new entrepreneurial opportunities, but how do en-
trepreneurs gain the knowledge to spot those opportunities once they are created?
In a static setting, because there is little change, there will be relatively little in
the way of entrepreneurial opportunities. Those that might be lying in wait must
be relatively obscure to have remained unnoticed, and the static environment
precludes the creation of new opportunities. Schumpeter (1934, p. 154), discussing
a framework in which all profit is competed away in equilibrium, and in which
profit is the return to entrepreneurship, observed, “Without development there
is no profit, without profit no development.” Economic progress relies on an
economy that is not in neoclassical general equilibrium to generate the profit
opportunities necessary for development to occur. Schumpeter’s argument attacks
the very foundation of equilibrium growth theories built on Solow (1956).
A key question is, where do potential entrepreneurs get the knowledge to
utilize information about entrepreneurial opportunities? As Holcombe (1999)
discusses, one view of equilibrium, shared by Stiglitz (1987) and Kirzner, is
that equilibrium implies that there are no unexploited profit opportunities. By
definition, entrepreneurship is ruled out in equilibrium, and a Solow-type growth
model is inconsistent with entrepreneurship. Another view of equilibrium, shared

by Hayek (1937), Hahn (1984), and Lewin (1997), defines economic equilibrium
as a condition in which the plans of all individuals in the economy are mutually
compatible.5 If this latter definition of equilibrium is taken, entrepreneurial
opportunities can exist in an economy and lie unnoticed for an indefinite period
of time as individuals continue making mutually consistent plans, oblivious to
the existence of profit opportunities. The potential for entrepreneurship exists, but
how would opportunities be observed?
Consider a traditional economy described by Heilbroner (1962) in which hered-
ity and institutions assign people their economic roles. Institutional constraints
prevent entrepreneurial activity. The same would be true in a centrally-planned
economy, where profits are institutionally ruled out. Now consider an economy
in general equilibrium. Period after period, economic agents undertake the
same activities, earning a normal rate of return for their efforts. There are no
economic profits, and much like the traditional economy, nothing in the economic
environment changes period after period. In such a setting, individuals must be
suspicious of any potential opportunity that would appear to be profitable. An old
joke goes, Economist 1: “Look, there’s a $20 bill on the sidewalk!” Economist
2: “Couldn’t be. If there was, somebody would have picked it up.” The punchline
exactly applies to profit opportunities in general equilibrium. If there really was a
profit opportunity, why had nobody seized it before?6 Most businesses fail within
their first five years because what appeared to the business’s founder as a profit
opportunity turned out not to be. In general equilibrium, market participants have
the knowledge that apparent profit opportunities are likely to be illusory, and the
most profitable course of action would likely be to ignore them.
Consider again the hypothetical example where one discovers the information
that something is selling for $0.25 in one location while buyers are paying $0.50
for the same good in another location. Now consider two different scenarios in
which that information is revealed. First, imagine a setting of general equilibrium,
or as Mises (1966) and Rothbard (1962) call it, an evenly rotating economy.
The same economic activities happen period after period, leading the potential
entrepreneur to think that if this really was a profit opportunity, someone would
have already acted on it.7 If one were to factor in transportation costs, shipping
damage, possible price fluctuations, and a host of other factors, the apparent profit
would probably disappear. When the information about prices is incorporated
into a body of knowledge, that body of knowledge weighs against acting on
what initially appears to be a profit opportunity. Now, consider another setting
where entrepreneurship is rampant: perhaps the microelectronics industry at
the end of the 20th century. The innovations of entrepreneurs are creating
new entrepreneurial opportunities, and the observer’s body of knowledge now
incorporates that environment. Many people have spotted and acted on en-
trepreneurial opportunities, and profited from their actions. In this setting, the
same information leads to a different sort of knowledge, and makes it more likely
that the apparent profit opportunity really would lead to a profit.
An entrepreneurial environment changes the knowledge base of potential
entrepreneurs, and makes it more likely that information about an entrepreneurial
opportunity will actually be spotted and acted upon. If the same information
about a potential profit opportunity surfaces in an economy stagnating in
general equilibrium versus an entrepreneurial economy characterized by constant
change, it will be more likely to be an actual profit opportunity in the dynamic
entrepreneurial economy, so the information will be more likely to be acted on
by an entrepreneur. The environment within which information presents itself
affects the observer’s knowledge base, and an entrepreneurial environment is
more likely to develop the knowledge that leads people to act entrepreneurially.
Entrepreneurship creates more entrepreneurial opportunities, but it also creates
a base of knowledge that makes it more likely that entrepreneurial opportunities
will be spotted and acted upon. Knowledge is more than just the sum of the flow
of information that creates it. The market economy itself creates knowledge that
would be unavailable in a different institutional setting.
WISDOM AND ENTREPRENEURSHIP

A view that opportunities for entrepreneurial insights are produced exogenously
and lie in wait for entrepreneurs to notice them would be fundamentally mis-
leading. Furthermore, it would be misleading to think that at any point in time
there is an abundance of entrepreneurial opportunities that are unnoticed, waiting
to be discovered. Entrepreneurial opportunities constantly arise in a growing
economy, and when they do they are, except in rare circumstances, rapidly
acted upon. Entrepreneurial insights are produced in the process of economic
advancement. More rapid advancement brings more entrepreneurial opportunities,
and more entrepreneurial opportunities produce greater incentives for potential
entrepreneurs to become more alert to them. The actions of entrepreneurs add
to the knowledge base of potential entrepreneurs, so entrepreneurship generates
more entrepreneurship. In contrast, a stagnant economy blunts the incentives
for entrepreneurial activity, and can remain stagnant because it is more difficult
to spot those entrepreneurial opportunities that actually exist.8 Even if the
information about a profit opportunity is revealed, a stagnant economy may not
generate the knowledge sufficient to prompt an entrepreneur to act. The idea that
entrepreneurial activities create more entrepreneurial opportunities endogenizes
the creation of entrepreneurial opportunities, expanding Kirzner’s model of

entrepreneurship to explain the origin of entrepreneurial opportunities as well as
the competitive process that results from their existence.
Equilibrium economics offers little insight into entrepreneurship, precisely
because of its equilibrium character. Twentieth century equilibrium economics in
all of its variants has viewed production in a Ricardian production function setting
(Holcombe, 1999). In contrast, Bohm-Bawerk (1959) depicted a structure of
production that would become more roundabout as more indirect methods of pro-
duction were used. Bohm-Bawerk’s approach more closely follows Smith (1776),
who emphasizes increases in the division of labor as the engine of economic
progress. Smith’s division of labor finds a parallel in the Bohm-Bawerkian con-
cept of extending the structure of production. Within the neoclassical-Ricardian
framework, the new production processes imply changing the functional form of
the production function, which means changing the way that inputs are combined
into outputs. In the neoclassical framework, this could happen in any way – it is
more general than Bohm-Bawerk’s approach – but because of its generality does
not focus on the nature of changes (such as increasing the division of labor, or
lengthening the structure of production).
The Smithian view of economic progress is based on the concept of increasing
returns, and 20th century contributors to the Smithian idea, like Young (1928) and
Kaldor (1972) have explicitly acknowledged that they were building on Adam
Smith’s insights. Yet increasing returns is a problematic concept in an economic
framework because it implies that average cost continually declines. Kaldor (1972)
notes the problems for general equilibrium models when firms are characterized
by increasing returns, but another possibility is that the production functions of
firms do not exhibit increasing returns. Rather, firms generate network externalities
that lower the costs of production for other firms in close proximity.9 Individual
firms do not exhibit increasing returns, but the entire economy does. This is easy
to visualize as a Smithian idea. The division of labor is limited by the extent of the
market, so additional firms in an area enlarge the market and allow all firms to be
more productive by becoming increasingly specialized. Increased specialization is
but one way in which firms can become more innovative, so a more general way
to envision this idea is that the knowledge created by firms benefits other firms in
close proximity. When one firm innovates, other nearby firms find themselves in
a better position to innovate also.
Romer (1986, 1990) depicts the process as a knowledge spillover. Knowledge,
embodied in human capital, is the factor with increasing returns, meaning that
investments in human capital make future investments in human capital more
productive. Because human capital must be combined with other factors of pro-
duction, there will be a tendency for productivity increases to be geographically
concentrated, which result in some areas manifesting more economic growth than
others. Along these lines, Krugman (1991) and Audretsch and Feldman (1996)
develop models in which increasing returns occur in geographically concentrated
areas. Desrochers (2001) presents an excellent discussion about the way that
tacit knowledge, as described by Hayek (1945), is transmitted more effectively
by people in close proximity to one another. Some things can be observed more
effectively than they can be described, so industries that are more entrepreneurial
are more likely to reveal entrepreneurial opportunities to those in their own
industry, and geographical areas that are more entrepreneurial are more likely to
reveal entrepreneurial opportunities to those in their own area.
The wisdom to undertake effective entrepreneurship is not equally available to
everyone, and entrepreneurial opportunities that may be easily obtainable for some
will be out of reach for others. Much information is readily available to all, but as
noted above, people also generate their own private information with the intention
of using it entrepreneurially. Information is valuable only within a broader
context of knowledge, and information that would have no meaning to some
might suggest an entrepreneurial opportunity to others who are able to put that
information in the context of their knowledge. Wisdom comes from the effective
use of knowledge, and part of this is collecting sufficient knowledge to avoid
making bad decisions. This section has suggested the important role of proximity
in making wise decisions. Some information is difficult to communicate without
first-hand knowledge. Those in a particular industry will have more wisdom about
entrepreneurial opportunities in that industry, and following the arguments of a
substantial literature discussed in this section, geographical proximity generates
a substantial amount of this type of knowledge. Desrochers (2001) gives a superb
description of knowledge transmission through geographic proximity.
Earlier, the paper showed that people can take actions that will increase the
likelihood of their discovering entrepreneurial opportunities by, for example, un-
dertaking research or studying industry trends and activities to build a knowledge
base. But holding individual action constant, some economic environments gener-
ate information for all individuals in the environment that make it more likely that
they will recognize entrepreneurial opportunities. An environment where there is
a substantial amount of entrepreneurship creates a knowledge base that increases
the probability that when people are exposed to information about entrepreneurial
opportunities, they will recognize it as such and act on it. The market process
itself generates information. Entrepreneurship creates more entrepreneurial
opportunities, as Holcombe (1998, 2003) argues, but entrepreneurship also
generates information that adds to the knowledge base of potential entrepreneurs,
making them more entrepreneurial. The same profit opportunity is more likely
to be recognized in an entrepreneurial economic environment than in a stagnant
one, or in an equilibrium setting. Entrepreneurship requires knowledge, but en-

trepreneurship also generates information that adds to knowledge, leading to more
entrepreneurship.
CONCLUSION
Entrepreneurship, following Kirzner (1973), is the recognition of a previously
unnoticed profit opportunity, but Kirzner does not consider how profit opportuni-
ties are created in an economy. Holcombe (1998, 2003) extends Kirzner’s model
of entrepreneurship by showing that entrepreneurship creates new entrepreneurial
opportunities. While at first it might appear that when an entrepreneur acts on
a previously unnoticed profit opportunity, there are fewer profit opportunities
left as a result, the opposite is true. An entrepreneurial act creates additional
profit opportunities, so entrepreneurship generates the opportunity for more
entrepreneurship.
Entrepreneurial opportunities may not be easy to spot, even if they are lying
in plain sight. The information may be available to everyone, but recognizing
a profit opportunity will typically require a framework of knowledge to place
information about a profit opportunity in a context where the profit opportunity
can be recognized. As Hayek (1945) notes, everyone has some specialized
knowledge of time and place that enables them to make use of market information
in ways not available to others without that specialized knowledge. The same
information about a profit opportunity could be revealed to many people, yet only
a few with the appropriate knowledge will be able to place this information into
a context so that the information suggests to them a profit opportunity.
The distinctions among information, knowledge, and wisdom help illuminate
the nature of entrepreneurial discovery. Information includes much of the data
of the market, but may also include other data not visible to everyone, such as
production techniques, or even market data generated by surveys or statistical
analysis. In order to yield any insight, information must be placed in the context
of other information, and this aggregation of information that an individual
possesses is knowledge. Entrepreneurial opportunities, as Kirzner describes them,
are information, but Hayek (1945) was talking about how people use knowledge,
which requires them to place information they receive in a broader context.
Knowledge is insufficient to produce entrepreneurship. The individual must be
able to evaluate that knowledge in subjective ways to determine whether an
entrepreneurial opportunity actually exists. Wisdom is the product of knowledge,
intelligence, and experience. This paper cited several examples showing that
when different people have the same information and knowledge, some may
recognize the information as signaling an entrepreneurial opportunity while

others may not.
People may gather information themselves to generate a base of knowledge
that can enhance their opportunities for making entrepreneurial discoveries.
Independent of any individual’s actions, the market environment has a large
impact on people’s stocks of knowledge that can contribute to entrepreneurship.
Entrepreneurial activity in an economy produces information that creates
knowledge of time and place that helps to reveal entrepreneurial opportunities.
Entrepreneurship produces information about entrepreneurial opportunities in
several ways. An economy with little entrepreneurship, simply because of the lack
of entrepreneurship, provides information that few entrepreneurial opportunities
are available. In an economy in general equilibrium, all profit opportunities have
been competed away, so what appears to be a profit opportunity may actually
generate losses if acted upon. Few profit opportunities present themselves as
sure things, and a potential entrepreneur will be less likely to take a risk on an
apparent profit opportunity if it appears that most apparent profit opportunities
are illusory. If entrepreneurship produces more entrepreneurial opportunities,
then an extension of this argument is that an entrepreneurial economy will
have more profit opportunities than a stagnant economy (or one in equilib-
rium). If this information is in the entrepreneur’s stock of knowledge, then
entrepreneurship itself produces knowledge that leads to more entrepreneurship.
Entrepreneurial activity generates more entrepreneurship because opportunities
are created, and because knowledge about those entrepreneurial opportunities
are created.
The knowledge that is created is more than just information. It is a context
within which information can be evaluated, and entrepreneurial activity adds
to knowledge in several ways. First, it reveals that others have found profitable
opportunities, encouraging potential entrepreneurs to be more alert. Second, it
provides information on how previous entrepreneurs have seized profit opportuni-
ties, and this information generates knowledge for other potential entrepreneurs.
For example, an entrepreneur could observe someone else’s entrepreneurial
activity and have the insight that if that person did something a little differently,
the activity would be more profitable. The new entrepreneur could copy much
of the predecessor’s actions, changing only those things that the entrepreneur
thought would warrant improvement. Or, an entrepreneur might observe certain
changes in one industry and see that they could be adapted to generate profits
in another. The point is that entrepreneurship does more than just generate ad-
ditional entrepreneurial opportunities. It also generates the knowledge that leads
people to better be able to take advantage of those entrepreneurial opportunities
that exist.
Hayek noted that knowledge is often not easily transmitted from person to per-
son. A person can have knowledge about a particular industry, process, or market,
and yet not be able to articulate that knowledge to pass it along to others. It is at
this point that knowledge becomes wisdom, and enables people to make better de-
cisions than others who have all of the same information available to them. People
can pick up wisdom from others by observing their actions and by collaborating
with them, but this requires that interactions take place in close proximity. This
is why areas that become entrepreneurial tend to generate more entrepreneurship
This is the knowledge of time and place that Hayek discussed, and place can be an
industry, or a geographic area. More entrepreneurship occurs when both industry
and geographic location coincide. This explains, for example, the concentration
of entrepreneurship in semiconductors in silicon valley, in financing in New York,
and in automobile development in Detroit. As Desrochers (2001) describes, people
are able to get ideas from others who have specialized knowledge in the same area
in a way that would not be possible without the geographic proximity. Because
of the geographic proximity, knowledge that is difficult to articulate can still
be shared.10
Entrepreneurship creates more entrepreneurial opportunities, as Holcombe
(1998, 2003) notes, and this paper extends that argument by showing that
entrepreneurship also adds to the knowledge base, providing the knowledge that
makes it easier to recognize profit opportunities when they arise. Kirzner depicts
entrepreneurs as noticing profit opportunities that nobody has noticed before,
which raises the question of why one person notices what others have missed.
Hayek emphasizes the importance of individual knowledge of time and place, and
this paper shows that entrepreneurship in an economy produces knowledge for
individuals that enhances their ability to recognize entrepreneurial opportunities.
Entrepreneurial activity generates information that aids future entrepreneurial
discovery.
NOTES
1. I do not know the origin of this slogan, but first saw it painted on the wall of the football
locker room at my high school. At the time, it appeared to apply to winning sports contests,
and with each passing decade it seems to me more generally applicable to all aspects of life.
2. Kirzner (1979, Chap. 7) argues that there are important differences between his and
Schumpeter’s ideas. Elsewhere, however, Kirzner (1985, Chap. 4) develops the idea of
entrepreneurship in a manner that encompasses the spirit of Schumpeter’s ideas, and their
ideas on entrepreneurship clearly can be reconciled.
3. Actually, the Palm Pilot was developed by the 3Com Corporation, which later spun
Palm off into a separate company.
4. Schumpeter (1934, p. 63) discusses the revolutionary nature of economic growth, and
later (1934, p. 65) describes the motive forces as “spontaneous and discontinuous.”
5. Hayek (1949, p. 41) says equilibrium is the condition where “. . . the different plans
which . . . individuals . . . have made for action in time are mutually compatible.” Hahn
(1984, p. 44) says equilibrium exists when “. . . the intended actions of rational economic
agents are mutually consistent and can, therefore, be implemented.” Lewin (1997, p. 245)
says “equilibrium is understood to be the consistency of actions and the plans on which
they are based.”
6. See Olson (1996) for an interesting analysis of this example.
7. Whether such an unexploited profit opportunity could exist in general equilibrium
depends on the view one takes of equilibrium. The Kirznerian view would be that an
economy with unexploited profit opportunities would not be in equilibrium, but following
Hayek’s view that equilibrium simply means that everyone’s plans are mutually consistent,
one could imagine such an unexploited profit opportunity existing unnoticed period after
period. See Holcombe (1999) for a further discussion and elaboration.
8. Young (1993) develops a model along these lines. Mokyr (1990) classifies technolog-
ical advances as “macroinventions” and “microinventions.” The idea is that major inven-
tions like the steam engine and the microprocessor create entrepreneurial opportunities for
microinventions that further drive economic growth.
9. Arthur (1989) presents a model showing how increasing returns can lock an economy
into an inferior technology. Perhaps the most famous (but questionable) example is related by
David (1985). See also David (1975) for a clear recognition of the importance of increasing
returns to economic progress.
10. An interesting extension of this idea would be to consider how one’s specific “place,”
in Hayek’s (1945) sense, is enlarged by the development of transportation and communica-
tion technology. People can see more, and broaden their knowledge bases further, by being
in close proximity to others who may actually be physically distant most of the time. In the
same way that Smith (1776) noted that the extent of the market can grow, allowing a greater
division of labor, a person’s place in the market system can be enlarged, giving that person
greater knowledge about entrepreneurial opportunities.
REFERENCES
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Economic Journal, 99, 116–131.
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Wilson (Eds), Essays on Adam Smith (pp. 350–360). Oxford: Clarendon Press.
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S71–S102.
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443–472.
SCHUMPETER SYMPOSIUM
197
THE ENTREPRENEUR AT A CRUCIAL
JUNCTURE IN SCHUMPETER’S WORK:
SCHUMPETER’S 1928 HANDBOOK
ENTRY ENTREPRENEUR夽
Markus C. Becker and Thorbjørn Knudsen
ABSTRACT
This essay introduces the first translation of Schumpeter’s article
Entrepreneur, originally published in 1928. We describe the background
of Entrepreneur and use new archival sources to situate the article in time.
Entrepreneur marks a transition of Schumpeter’s conception of entrepreneur-
ship that took place between 1911 and 1926. Entrepreneur also contains
Schumpeter’s most profound vision on economic selection, a vision that
Schumpeter never elaborated further. We consider the most important impli-
cations of the new material in Entrepreneur and the reasons for the apparent
shift in Schumpeter’s thought.
夽 First published 1928 as Unternehmer in Handwörterbuch der Staatswissenschchaften by G. Fischer
Verlag. The English translation of the title “Unternehmer” is “Entrepreneur.” We use the English title
throughout the text.

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06012-5
199
200 MARKUS C. BECKER AND THORBJØRN KNUDSEN
INTRODUCTION
Schumpeter was one of the first to succeed in assigning a role of prominence to
the entrepreneur in economic theory, a role that associates the entrepreneur with a
dynamic vision of an evolving economy (Baumol, 1968). Following Schumpeter’s
lead, it is now commonplace to consider entrepreneurship when we are interested
in understanding how the economy evolves over long periods of time, including
a never-ending development of institutional arrangements and technological
possibilities (Baumol, 1968). Over the last decades, the increasing speed of
technological change, the complex interaction among an increasing number of
economic agents, and the alleged importance of vision- and knowledge-driven
competition have brought home the significance of entrepreneurship. A number of
important approaches that all view Schumpeter’s entrepreneur as their patron saint
have emerged, including Nelson and Winter’s (1982) foundational work on evolu-
tionary economics, the emerging theory of economic sociology (Swedberg, 2000)
as well as numerous frameworks and theories emerging in the study of strategic
management, business organisations, marketing and internationalisation, to
mention a few.
Even if Schumpeter’s theory of entrepreneurship has overwhelmingly influ-
enced the ascendance of entrepreneurship in the social sciences (Swedberg,
2000), most people refer exclusively to Schumpeter’s famous second chapter of
the translated version (1934) of the Theory of Economic Development (hereafter
abbreviated to Theory) that was based on the thoroughly revised second German
edition of 1926. The reason is simply that this chapter presents Schumpeter’s most
profound statements about entrepreneurship available so far to the English reader.
Schumpeter’s essay Entrepreneur to be presented here in English translation
for the first time, presents additional rich material that significantly adds to the
statements of the second chapter.
Today, most people think of Schumpeterian entrepreneurship in terms of the
function associated with the production of new combinations, innovations that
alter the routine flow of the economy and therefore introduce discontinuities.
This view of entrepreneurship, however, represents a revision on Schumpeter’s
part. From 1926 and onwards Schumpeter no longer viewed entrepreneurship
as the personalisation of the almost superhuman powers of energetic will he had
presented in the 1911 edition of Theory (Becker & Knudsen, 2002). After a radical
revision of his earlier statements, Schumpeter now presented entrepreneurship
as a depersonalised1 function that was present only at the particular occasion
when some person was engaged in innovative activities. This revised conception
of entrepreneurship as a depersonalised function was first published in the 2nd
revised edition of Theory and in the essay Entrepreneur.
The Entrepreneur at a Crucial Juncture in Schumpeter’s Work 201
Since Schumpeter remained faithful to his altered conception of entrepreneur-

ship throughout the writings produced in 1926 and onwards, the English speaking
reader has not been able to witness the transition of Schumpeter’s entrepreneur.2
The English translation of Entrepreneur presented here thus provides a unique
perspective on the birth of the depersonalised Schumpeterian entrepreneur known
to the English reader. A glimpse of the earlier entrepreneur can be seen in the
translation of Theory 1911 (Becker & Knudsen, 2002).
In the following, we will briefly describe the background of Entrepreneur
in terms of the context of Schumpeter’s private and intellectual life and use
previously unknown correspondence from Schumpeter’s hand to situate the article
in time. We further identify the dramatic transition of Schumpeter’s conception
of entrepreneurship that took place between 1911 and 1926, single out the most
important implications of these changes, and finally, leave the reader with some
thoughts of the possible reasons for these changes.
THE BACKGROUND OF ENTREPRENEUR3

In mid-November 1925 Joseph Schumpeter arrived at the University of Bonn,
Germany, to take up a chair in Public Finance. Entering the University of Bonn
marked his “rebirth” as a scholar after a seven-year period in which he was engaged
in politics and business.4 While Schumpeter continued to write and publish during
these ventures, he wrote no serious academic articles, and nothing of significance
for his intellectual life came from his practical experiences. Schumpeter later
referred to this period as his “gran rifiuto,” or great waste,5 not only because of his
failures both as a politician and a businessman, but also because he had lost time6
in research. On top of this, Schumpeter had almost “sacrificed his career in eco-
nomics, having done almost no serious writing since 1917” (Allen, 1991, p. 189).
When Schumpeter entered into his duties in Bonn, he was an extremely happy
man, and people who knew Schumpeter at the time describe his mood as buoyant
at the end of 1925 and in early 1926.7 No wonder, as Schumpeter had just married
his great love, Annie Reisinger, on 5 November 1925,8 and looked forward to
plunge into what he did best, namely research, teaching and university life. With
a newfound optimism he now turned back to revitalising the personal research
program he had outlined before he left academia. Where did Schumpeter pick
up the threads that he had left seven years ago? Which topics did he concentrate
on in his second academic life? How did he further develop the core ideas of his
early years?
Swedberg (1991a) reports that three scientific topics especially fascinated
Schumpeter during his time at the University of Bonn (1925–1932): the theory of
money, the theory of economic change, and the general structure of a broad-based
economic science, or Sozialökonomik.9 While Schumpeter successfully continued
to pursue his earlier writings in economic sociology during the late 1920s and
published a sociological essay that he would consider later as one of the two
articles deserving to be included in “his most important works,”10 the work on
money did not go well. Even if Schumpeter worked furiously to develop his ideas
on the theory of money and continued to work on this topic also in his later years,
nothing ever came of it.11 With regard to economic change, Schumpeter was
interested in the business cycle and changes in the economic system per se,12 but
he also pursued a more narrow focus as he set his mind on a particularly important
aspect of economic development: the entrepreneur.
His teaching and administrative duties apart, Schumpeter had to establish
his standing within the community of German economists, all belonging to
the dominant German Historical School. This may explain why Schumpeter
immediately in one of his first articles (Schumpeter, 1926b) addressed topics
that were important to the German Historical School and further chose to side
with Schmoller, one of its most powerful members. Also in Entrepreneur, written
soon after Schumpeter arrived in Bonn, it is apparent that Schumpeter, although
critical, sides with Schmoller against Sombart and also cautiously against
Weber.13 Another early endeavour in his new position was the revision of Theory,
which had been out of print for some years.14 This revision still kept him busy
at the end of May 1926 and was a nuisance to Schumpeter for reasons that we
can only speculate about.15 A matter of fact remains that Schumpeter signed the
foreword to the second edition of Theory in October 1926.
In parallel to the revision of Theory, Schumpeter had begun to focus more nar-
rowly on entrepreneurship, a line of research he would continue to pursue during
the late 1920s. He himself stated, on 22 May 1929, that he had lectured on the topic
of the entrepreneur repeatedly over the preceding two years (Schumpeter, 1929b,
p. 195). We further know that on 31 March 1927, Schumpeter held a lecture on the
topic, The entrepreneurial function and workers’ interests (Unternehmerfunktion
und Arbeiterinteresse) and gave a number of lectures on entrepreneurship in
Germany during 1927 until he left for a research stay in the USA at the end of
September 1927.16 In any case, the overall picture is clear: Schumpeter revised
Theory, which covers many aspects of economic development, and also turned
his attention to a very detailed examination of entrepreneurship, elaborating
on what he had said on this topic in Theory. Schumpeter’s renewed focus on
entrepreneurship produced a string of four pieces that were published in the years
1927–1929.17 Of these four, Entrepreneur, the handbook article, stands out as
the most “high-profile” one. And Entrepreneur is not only outstanding among
these four articles. In all of Schumpeter’s writing it is only in the second chapter
of Theory one finds a treatment of entrepreneurship that parallels the scope and
detail of the material contained in Entrepreneur.18
When one compares Schumpeter’s description of the entrepreneur in the late
1920s,19 i.e. the above-mentioned four articles plus the revised 2nd edition of
Theory, to his earlier conception of the entrepreneur before 1918 (notably, as
expressed in the 1st edition of Theory), it is evident that he had changed his
mind. Schumpeter’s conception of the entrepreneur was “in transit,” and the
major change took place during Schumpeter’s first year in Bonn. Because it was
the first work on entrepreneurship Schumpeter finished in Bonn, Entrepreneur
deserves special attention since it is the single piece that best carves Schumpeter’s
re-conceptualisation of the entrepreneur at its joints.
Not only had Schumpeter’s entrepreneur undergone a major transition during his
first year in Bonn, he also experienced a triple blow of fate that dramatically ended
his happiness and forever altered his personality. The first blow was the death of his
mother, 22 June 1926. Schumpeter had always been greatly attached to his mother,
and her death left him devastated. The shock of his mother’s death also influenced
Schumpeter’s relation to his now pregnant wife, Annie, and a controversy broke
out over a letter from his first wife (whom he never divorced) threatening to take
legal action because of bigamy. Then came the second blow as Annie, nearing
the full term of her pregnancy, suddenly died in childbirth on 3 August 1926 at
the age of twenty-three. Also the child died within hours, and Schumpeter turned
from a man of immense vitality into a mentally and emotionally broken man. One
way in which Schumpeter reacted to his grief was by burying himself in work, and
one of the first tasks he worked on must have been the completion of the revision
of Theory. Another was the finishing of the article Entrepreneur.
THE WRITING OF ENTREPRENEUR

Entrepreneur was published in 1928. However, it has not been known that
Schumpeter wrote it some time before 1928 – namely in 1926. We have been
able to retrieve Schumpeter’s correspondence with the publisher, G. Fischer in
Jena, which allows a very precise dating of the origin of this article. The dating
is important, because in the small cluster of articles on entrepreneurship that
Schumpeter wrote in the years 1926–1929, the sequence of events obviously
matters for reconstructing how the entrepreneur evolved in that critical period
when Schumpeter put his mind to this topic a second time.20
The correspondence shows that Schumpeter submitted the final version of
Entrepreneur to the publisher on 7 September 1926. This date makes clear that the
article was written extremely close in time to the revision of Theory (the preface
to which Schumpeter signed in October 1926) – maybe Schumpeter even wrote

them, or at least put the finishing touches, in parallel. The date is further significant
for the reason that it shows Schumpeter finished the work on Entrepreneur during
the most difficult moments of his life. Pushed for the deadline, Schumpeter
intended to deliver the article in the week following 1 August 1926 – that is, the
very week his wife and child died. He then finished the article during the five
weeks following their death. According to himself and people close to him at the
time, Schumpeter was left in a state of boundless despair and depression (Allen,
1991). This state of mind is also clearly present in Schumpeter’s correspondence
with the publisher of Entrepreneur. While it is conceivable that his belief in
the strong leader (as of Theory 1911) must have already been shattered by his
failures as minister and bank president (Becker & Knudsen, 2002), this last blow
of fate might very well also have left its mark on Entrepreneur in particular, and
subsequently on the Schumpeterian entrepreneur in general. Therefore, we think
it is likely that the disappointments and personal tragedies had a cumulative effect
on Schumpeter’s previous conceptualisation of the strong leader as a personalised
aspect of human nature. To appreciate the precariousness of the moment when the
article was finished, we have reproduced excerpts of the correspondence below.
In a letter dated 28 July 1926, the publisher asks Schumpeter to deliver his
essay Entrepreneur by 1 August 1926. The tone of the letter is insisting, and the
publisher emphasizes it is urgent that Schumpeter delivers by 1 August since his
article alone is delaying the further processing of the encyclopaedia. Several delays
had already occurred (most likely in connection with the death of his mother, on
22 June 1926), and the publisher seems to have run out of patience.
Four days later, on 1 August 1926, Schumpeter responds that he will not schedule
any other work, use every free hour to work on Entrepreneur and submit within a
week’s time. He also indicates that the article is finished already, and that “if needs
be, I will leave the article as it is” (Letter to G. Fischer Verlag, 1 August 1926).
Two days later, his wife and the newborn child die in childbirth.
One week after that tragic day, on 10 August 1926, Schumpeter writes a postcard
to the publisher, which we quote in full:21
Unfortunately I have to inform you that due to a bereavement that occurred on the 3rd of the
month, and which momentarily shut down my capacity to work, it was not possible for me to
submit the article “Unternehmer.” I will neither do anything else, nor leave Bonn, before I have
finished it, but I first have to see about my state of mind before I can give you a definite date. I
hope to be in a condition to start in some days, however, and to then be able to finish the article
within another week’s time (Letter to G. Fischer Verlag, 10 August 1926).
The publisher replies the next day with condolences, but is quick to emphasize
his gratefulness for keeping an eye on finishing the article (Letter by G. Fischer
Verlag to Schumpeter, 11 August 1926).
A reminder of 21 August 1926, much firmer in the tone of voice, presses the
message that Schumpeter is holding up the production process of the encyclopae-
dia. The next day, 23 August 1926, Schumpeter answers the publisher’s letter and
the question when he will be ready to submit:
I hope to be able to answer: one of these days. In any case, you will receive the article as soon
as I can, and muster the necessary energy to work. I know how unpleasant this new delay is
for you, and how embarrassing for myself; no reminder can be more impressive than what I
feel about it. Should you wish to find out more on the reason please ask Spiethoff. But, yes, I
believe that it will be possible now (Letter to G. Fischer Verlag, 23 August 1926).
This day-by-day tracing of Schumpeter’s work on Entrepreneur allows us to draw

the conclusion that he had something important to integrate or refine – after all,
according to his own words, Schumpeter already had a finished version at the end of
July that he had considered to submit in case problems arose. If he had not done so in
this kind of catastrophy, some important new idea must have been on his mind that
he wanted to include in the article. He desperately struggled to make that happen –
against his emotional wrestling with the bereavements and their aftermath, against
the staunch reminders of the publisher and the fact that his article was holding up
the production process of the whole volume, and against his inability to concentrate
properly. If we take the two conclusions together, it is likely that he had come across
something that he very much wanted to integrate into his notion of the entrepreneur,
but that he probably did not succeed to integrate very well in Entrepreneur because
of the limited time and his handicaps at that precarious point of time.22 And indeed,
there is support for such an interpretation in the letter that accompanied the article
when Schumpeter finally submitted it on 7 September 1926. He writes:
Work on the art. has, however, been broken off prematurely and much material has not been
considered. The execution, too, is lacking, and no one can regret that as much as I do, as I
would have very much liked to put the various new vantage points on the topic, which I have to
present, in more perfect terms. At any rate, the essential of what has to be stated in the HWB
[Handwörterbuch] has been said – for the many defects in form I ask you and GHR [Geheimrat]
Elster to excuse me (Letter to G. Fischer Verlag, 7 September 1926).
Here we have then, Schumpeter describing how he struggled with perfecting the
expression of “the various new vantage points” that he had to report on the topic,
which was the entrepreneur. Most commentators have noticed a radical shift in
Schumpeter’s conception of entrepreneurship between the 1911 edition of Theory
and the English translation of his early work. Yet this observation has never before
been supported by Schumpeter’s own words. Three obvious questions arise at
this point: What are the new “vantage points” on Schumpeter’s entrepreneur?
What are the implications of these new “vantage points” for Schumpeter’s theory
of entrepreneurship and economic development? What are the possible sources
of the shift in Schumpeter’s thinking? The next section will deal with the first
question, and the following sections will turn to the second question. In these
sections, we will further address the third question by briefly pointing out that
the shift in Schumpeter’s thinking is best viewed in terms of his own description
of innovation, as an instance of a new combination of a number of intellectual
sources that had influenced him.
SCHUMPETER’S NEW PERSPECTIVES ON

ENTREPRENEURSHIP OUTLINED
IN ENTREPRENEUR
Since Schumpeter did not elaborate on the “various new vantage points” he had
in mind, we are left with the inference that transpires from a comparative reading
of Entrepreneur and Schumpeter’s earlier statements on entrepreneurship. We
singled out the 1911 edition of Theory as the obvious source representing his early
views on the entrepreneur and then traced the shifts in Schumpeter’s conception
of entrepreneurship between this text and Entrepreneur. It is clear from these find-
ings, reported below, that the most profound change in Schumpeter’s conception
of entrepreneurship is the depersonalisation of his earlier entrepreneur, the strong
individual of almost superhuman powers of energetic will. This represents a radical
revision of Schumpeter’s conceptualisation of entrepreneurship. Shifting focus
away from the person of the entrepreneur, Schumpeter now talks of entrepreneur-
ship as a completely depersonalised function that is not associated with any person
in particular.23 That Entrepreneur is the work in which Schumpeter first uses
the expression “entrepreneurial function” is further significant as an indication
that this article marks the shift in his reconceptualisation of entrepreneurship.24 It
may come as a surprise, however, that Schumpeter, as reported in the following,
chose to root his entrepreneurial function in a collective level situated in historical
epochs.
We now proceed to add the details harvested in our comparative reading. One of
the most significant changes in Schumpeter’s conceptualisation of entrepreneur-
ship is associated with a new perspective on his part, according to which social
interaction cannot be viewed as an instance of causality. In the 1st edition of
Theory, Schumpeter explicitly conceives of the entrepreneur as the main cause and
hence the explanation of development, not only in the economic sphere, but also in
politics, arts, and science (see Becker & Knudsen, 2002). While he would attempt
to conceive social interaction and interdependencies as an instance of causality
in 1911, Schumpeter had abandoned this approach in 1926 and would now insist
that “we do not speak of cause and effect where there is an interdependency
between two groups of facts.”25 Both in Entrepreneur and Theory of 1926,
economic change is brought about by the entrepreneurial function whose essence
lies in recognising and carrying out new possibilities in the economic sphere.
Yet, Schumpeter now portrays the entrepreneur as “the middleman” between
producers and consumers.26 Since the entrepreneurial function now operates in
terms of social interaction, Schumpeter would mainly conceptualise this function
as an instance of interdependence, but not causality (as he previously did in 1911),
a viewpoint that is expressed in Entrepreneur as well as in Theory of 1926. And
throughout his writings from 1926 and onwards, Schumpeter would consistently
rely on his newfound conception of entrepreneurship as an instance of social
interaction that generally evades conceptualisation in terms of cause and effect.27
Here it should be noted that Schumpeter’s distinction between causality and social
interaction arises because of deep difficulties in conceiving social interaction in
terms of causality, difficulties that continue to plague evolutionary explanations of
economic change.
The shift in Schumpeter’s thinking, from viewing entrepreneurship as an
instance of causality to the much weaker idea of interdependence, is associated
with the depersonalisation of the entrepreneurial function in terms of viewing
the entrepreneur as “the middleman”28 between producers and consumers.
Although the idea of the middleman function is implicit in Theory of 1911, it is
in Entrepreneur that Schumpeter first presents an explicit and detailed account
of this idea. And, as two of the other articles from the years 1926 to 1929
show (Schumpeter, 1927, 1929a),29 this idea represents a systematic shift in
Schumpeter’s conceptualisation of the entrepreneur. This view of the entrepreneur
as “the middleman” is also associated with a significant downplay of the almost
superhuman powers of leadership that were imputed to the entrepreneur in
1911. For example, Schumpeter had explained in 1911 that the entrepreneur is
characterised by “the disposition to act” in terms of “the ability to subjugate
others and to utilize them for his purposes, to order and to prevail, which leads
to successful deeds – even without particularly brilliant intelligence.”30 In the
seventh chapter of Theory 1911, omitted in the revision of 1926, Schumpeter
further explained that “inventions do arise when the entrepreneur needs them, and
if the personality of the entrepreneur is not in place in order to make use of every
new invention, the inventions will never turn into practice.”31
In Entrepreneur and in Theory of 1926, the entrepreneur had lost much of
these previous characteristics, or rather entrepreneurship had become a function
that personifies no one in particular, and anyone on some occasions. Starting
with Entrepreneur and the first revision of Theory, both submitted for publication
in 1926, Schumpeter would forever abandon his previous views expressed in
Theory of 1911 that economic relations emanated from two distinct types of
human nature, the static type and the dynamic type (the entrepreneur). Thus, en-
trepreneurship had become a depersonalised function. Note here that Schumpeter
retains the explanatory structure of Theory 1911. In Entrepreneur and his later
works, entrepreneurship is still defined in terms of particular economic relations
among human actors, but these economic relations are no longer an expression of
differences in types of human nature, as in the static and the dynamic type defined
in 1911.
While only a select few could possibly personify Schumpeter’s early en-
trepreneur of 1911, anyone could, on some occasions, serve as the middleman of
Entrepreneur or Theory of 1926. Nevertheless, Schumpeter retains that leadership
is an integral aspect of entrepreneurship. This becomes clear in Entrepreneur
when he makes the distinction between leadership, management, and adminis-
trative functions. In Entrepreneur, Schumpeter explains that entrepreneurship is
associated with the will to dominate or win, a somewhat weaker characterisation
of leadership than expressed in his earlier statements in 1911. Schumpeter further
asserts that it is the exception for a leader to actually engage in leadership. Most
of the time the leader would be occupied by administration and maintaining the
daily routine of business. Only on rare occasions would he be engaged in what
Schumpeter refers to as the essential function of leadership, the carrying out of
new combinations. Leadership and the carrying out of new combinations are
inextricably intertwined for Schumpeter. Keeping this in mind, we can explain
how his new notion of entrepreneurship – with a somewhat weaker leadership
component – is consistent with his earlier notion.
What has happened is that in Entrepreneur Schumpeter has shifted emphasis
from the leadership aspect to the combinations aspect. The important implication
for the conceptualisation of the entrepreneur is that while in Theory of 1911 there
was a strong contrast between new combinations (instances of entrepreneurship)
and the recurrent use of old combinations (the circular flow), these two cases
now become part of one continuum. As pointed out in the following, this move is
nicely related to Schumpeter’s abandoning of the contrast between the dynamic
type who was capable of carrying out new combinations and the static type who
was not. Rather, the entrepreneur becomes a middleman that, on some occasions,
may introduce new combinations provided he is capable of leadership and the
circumstances are favourable.
Thus, a further move associated with the depersonalisation of the entrepreneurial
function is Schumpeter’s downplay of psychological factors as an explanation for
the behaviour of the entrepreneur. In 1911, Schumpeter explained that the possible
new combinations existed in the psyche of a small group of economic subjects
and characterised “the act and the energy to act” in terms of a particular “mental
constitution.”32 In 1911, Schumpeter viewed entrepreneurship as an expression

of a rare dynamic type of human nature, a particular gift bestowed upon a select
few individuals. Whereas Schumpeter retained the idea of entrepreneurship as a
personal attribute (as can be seen from footnote 20 in Theory of 1926, pp. 119–121),
in Entrepreneur he lets go of the idea that differences in economic relations spring
from two distinct types of human nature. In Entrepreneur, there is no longer a pure
type of entrepreneurship (as in 1911), now there are shades of entrepreneurship.
This conceptualisation is crucial in enabling Schumpeter to usher the dichotomy
between the “static-hedonic” and the “energetic” types of Theory 1911 into a
continuum: anyone can be an entrepreneur at some occasion – but no one will be
so all the time.
Thus, one of the most important changes in Schumpeter’s previous theoretical
construction of Theory (1911) is that he abandoned the typological thinking
according to which economic relations emanated from two distinct types of human
nature, the static and the dynamic type. It is likely that Schumpeter’s previous
typological view was inspired by the thinking of some members of the German
Historical School, e.g. Friedrich von Wieser and Karl Bücher,33 according to
which economic ordering was an expression of types of human nature.34 Thus,
Schumpeter’s new depersonalised view of the entrepreneurial function marks a
break with the typological thinking of the Historical School. The significance
of this break is to associate entrepreneurship with the indeterminate emergence
of economic relations rather than the pre-determined appearance of particular
relations as an expression of either the static or the dynamic type. In Entrepreneur
and Theory of 1926, Schumpeter thus had abandoned the idea of entrepreneurship
as a particular gift bestowed upon a select few individuals, and now evaded
individual-level psychological explanations of entrepreneurial behaviour. It is
somewhat surprising to notice, however, that Schumpeter refers to social-level
mentalities in Entrepreneur. In Entrepreneur Schumpeter introduces the concept
of “mentality” as an aspect of private ownership. He explains that private
ownership is associated with physical means of production and is “a correlate of
the existence of a mentality prone to economic activity, whose most important
derivates are an experimentally developed technique of production, a mode of
economic calculation geared towards being useful for private enterprising, and a
corresponding design of trade law and economic policy.” Later in the text Schum-
peter expands on this point in describing how “public administration” and “the
competitive economy” would lead to the development of a mentality that detaches
the economic agent from emotional and interest-led relations to individual enter-
prises, changes the motivation, deprives work of its personal character, introduces
professionalization and reduces private ownership of production factors to majority
ownership. That is, in Entrepreneur “mentality” is a social level concept situated
in a particular historical situation, and the “mentalities” associated with “public

administration” and “the competitive economy” lead to a process that it is common
to characterize as “rationalisation.”
When we consider Schumpeter’s use of the term mentality in Entrepreneur it
is difficult not to think of Max Weber. Yet it is curious that Schumpeter refrains
from using the term “rationalisation.” After all, in his essay, The Sociology of
Imperialisms, published 1918–1919, Schumpeter had described how competitive
capitalism “inevitably democratised, individualised, and rationalised”35 the
economic agent. The quoted passage from Imperialisms is one of the few places
in his earlier works that Schumpeter provides a reference when he writes about
rationalisation.36 The reference, however, is to an article by Lederer,37 not to
Weber’s work. Therefore, to draw the immediate conclusion that Schumpeter was
merely influenced by, or perhaps even was copying Weber is probably unfounded.
By writing about the rationalizing effect of competitive capitalism, Schumpeter
rather attempted to develop his own views on a topic that had been widely
discussed owing to Weber’s work, and because of now long-forgotten contributors
to this debate.38 This is not said to belittle Weber’s stature, but merely a caution
against drawing too hasty conclusions. And when we consider that Schumpeter
in Entrepreneur argued that certain “mentalities” associated with competitive
capitalism had a rationalizing effect, the emphasis is shifted so that it is Marx rather
than Weber that comes to mind. Whatever its source, it is clear that Schumpeter in
Entrepreneur associated entrepreneurship with the social-level concept of “men-
talities,” whereas he earlier had emphasised individual-level psychological factors
to explain the behaviour of the entrepreneur. It is further the case that this move
from an individual- to a social-level explanation for entrepreneurial behaviour is
associated with the depersonalisation, or de-personification, of entrepreneurship.
It is not the point that Schumpeter generally shifted his emphasis from the
individual to the social level, however. Such a conclusion is unwarranted. But his
re-conceptualisation of the entrepreneurial function clearly led to a shift in this
particular unit of analysis, from the individual to the social level. In Entrepreneur,
Schumpeter went a step further when he argued that besides a few questions
belonging to theoretical economics, “it is advisable at all times . . . to interpret the
action of the group as primary and essential, and to understand the autonomy of the
economic unit as a derivate that has to be explained in each particular instance.”
Even if Schumpeter maintained that the private economic subject was the carrier
of the entrepreneurial function, he also insisted that leadership, the most important
aspect of this function, “is never purely embodied in concrete persons.” Thus,
Entrepreneur presents Schumpeter’s depersonalised entrepreneurial function as
representing an underlying collective level, which is expressed through the actual
behaviour of the economic units. Moreover, it is clear that Schumpeter views the
underlying collective level as situated in historical epochs encompassing long

periods of time. Theory of 1926 conveys a similar but somewhat downplayed
view. Since Schumpeter must have finished revising Theory immediately after he
had submitted Entrepreneur, it is conceivable that he chose to modify some of the
statements of Entrepreneur.
As we have emphasised, the important new contribution was the introduction
of the entrepreneurial function – or rather, a new way to conceptualise this
function and thereby highlight what in Schumpeter’s opinion was the essence of
entrepreneurship. In Entrepreneur, the function of entrepreneurship consists of
two aspects that are closely connected. First, Schumpeter distilled the essence
of his earlier conceptualisation of entrepreneurship in stating that “[t]he basic
function of the entrepreneur is to combine the production factors into the
product.”39 This firmly places the entrepreneur at the very centre of the collective
production process. Note also that this definition of entrepreneurship, in contrast
to the previous conceptualisation as it appeared in Theory (1911), does not
rely on psychology and is firmly set in economics. It is the entrepreneur who
purchases the production factors, combines them into a product, and sells them
to the consumers. The conclusion Schumpeter draws of this conceptualisation is
to define the essence of the market economy in terms of the combining function
performed by a “private economic subject,” i.e. an independent economic unit.
A further analysis of how the combination-process actually takes place leads
Schumpeter to characterise the entrepreneur as a “middleman”40 between the
consumers and the owners of the means of production (and productive services).41
The entrepreneur acts as the buyer on the market of means of production and as
the supplier on the market for consumption goods. In this sense, he is at the very
core of the market-economy, and to Schumpeter the entrepreneur is indeed the
defining criterion of the market-economy. A number of important implications
that follow from Schumpeter’s depersonalised conception of entrepreneurship, to
be considered in the next section, are then further developed in Entrepreneur.
IMPLICATIONS OF SCHUMPETER’S DEPERSONALISED

CONCEPTION OF ENTREPRENEURSHIP
Immediately after defining entrepreneurship in terms of the function of the
middleman, Schumpeter emphasises that this function of mediation between
producers and consumers is an “extraordinarily important aspect for the theory of
the market economy.” The reason is that Schumpeter defines “the essence of the
market-economy” as the fulfilment of the entrepreneurial function by a private
economic subject, i.e. any independent economic unit, including the individual.
In the market-economy, the middleman serves the crucial function of connecting

the independent economic units, whereas the central agency would take care of
this function in a planned economy. Much later in the text Schumpeter alludes to
various forms of economic leadership, of which he only describes one in detail: the
market-economic form of economic leadership. He says that the market-economic
form of economic leadership is the entrepreneurial function. And, as we already
know, the essence of the entrepreneurial function is “to combine the production
factors into the product.” But what makes this function the market-economic form
of leadership? What distinguishes it from other types of economic leadership?
According to Schumpeter, one characteristic of the market-economy is “the way
in which the leader, who in such an organisational form does not have any authority,
acquires the necessary means of production – namely, by purchasing them on the
market for means of production”42 (emphasis in original). In a planned economy
he would acquire them by order. What we see here is how Schumpeter has fitted
the entrepreneur neatly to the very heart of the economy, but also to the very
heart of a specific historical period, namely the period of the market economic
system. At the same time, he has done so in a way that yields a typology of
entrepreneurial functions, with clear characteristics defining each type. It is of
interest to note that we have only mentioned one characteristic so far. Schumpeter
names three characteristics that distinguish types of economic leadership: there are
also the focus of self-interest, and the mode of selection of leaders. With regard
to the first point, Schumpeter notes (elsewhere in the text) that the self-interest of
the leader does not have to be related to profit. Schumpeter does not elaborate on
the second point in Entrepreneur, but develops this idea in two other works of his
second period, Unternehmerfunktion und Arbeiterinteresse (Schumpeter, 1927)
and Der Unternehmer in der Volkswirtschaft von heute (Schumpeter, 1929a).
One important implication of changing his earlier conception of entrepreneur-
ship to a depersonalised function is, as we have seen, that Schumpeter is able to
centre the entrepreneur at the heart of the economy and make entrepreneurship
the defining criterion of the market-economy. This conceptualisation also opens
the possibility that entrepreneurship may eventually lead to the demise of the
market-economy, a point Schumpeter briefly considers at the end of Entrepreneur
and further develops in his later works.43
A further implication is that the conceptualisation of entrepreneurship as a
depersonalised function allows Schumpeter to both capture the case of the static
and the dynamic economy or, in other words, to formulate the entrepreneurial
function in such a way that it fits both cases. The elegant way in which he does this
is precisely to afford the entrepreneur the central place in between the owners of
means of production and consumers and by emphasizing the financial flows and
the flows of productive services between them, which may be depicted graphically
as a circle. What matters here is that the entrepreneur is always involved. He
literally is at the heart of the collective production process. Now, is this true both
for the static and the dynamic case? In order to find out, we have to answer the
question: What is the difference between the static and the dynamic economy?
In the present text, Schumpeter characterises the static case as follows: a “static”
economy is an economy that is in a balanced state of equilibrium, repeating its
life cycle year in, year out. This means that every economic period is similar
to the previous one, an incessant repetition with two aspects: on a macro-level
the continuous circular flow of production and consumption recreates the same
objective situation; on a micro-level, it means that the economic subjects always
approach the economic possibilities with the same mentality, knowledge and
experience, openness of horizon, production methods, business habits, tastes, and
relations to customers, suppliers, and competitors; “[a]s a rule, under the pressure
of the necessities of everyday life, the economic subjects have to approach the
opportunities in this way.” In other words, everything remains the same. “The
mass of economic activities each move in well-trodden and familiar tracks.” This
explains the smooth, almost automatic, course of the normal economic period.
Schumpeter’s formulations are very clear: “As if it were happening by itself . . . the
means of production offers itself to the producer, the desired consumer good to
the consumer” – the entrepreneur, although still at his place in the circular flow,
becomes invisible, insubstantial. There is very little left to do for him, and the little
that remains is more in the character of administrative and management tasks than
carrying out new combinations. Although the entrepreneur as an economic actor is
still in place, in a static economy, he does not have any entrepreneurial functions to
carry out but will busy himself with administrative and managerial functions. Yet,
since the entrepreneurial function remains in place, even in the static economy,
this also carries the potential that some day the circumstances will inspire the
economic subjects to carry out new combinations, and thereby induce change
in the economic system. Whether this happens depends on the motivations that
drive the economic subjects, which in turn depends on the underlying collective
mentality associated with specific historical periods. In the following section, this
lead further invites consideration of “mentalities” as one of the key elements in the
much-strengthened conception of selection that Entrepreneur presented vis-à-vis
his earlier writings.
THE STRENGTHENING OF SCHUMPETER’S

ECONOMIC SELECTION THEORY
A further implication relates to a shift in Schumpeter’s emphasis on what we
today refer to as the principles of selection and retention. Elsewhere (Becker &
Knudsen, 2002), we have argued that Schumpeter in the 1911 edition of Theory
defined a principle of retention in terms of the actual new combinations that

happen to be realized by the entrepreneur, who in 1911 was the decisive element
in a causal chain explaining how a new combination is carried out. Compared to
Entrepreneur, only a very rudimentary selection principle was outlined in Theory
of 1911, whereas Schumpeter’s earlier concept of entrepreneurship represented a
possible but unsatisfying retention principle (see Becker & Knudsen, 2002).
The way in which the entrepreneur is situated in Entrepreneur and Theory of
1926 makes it easier to see how entrepreneurship is associated with a principle
of selection, but at the same time it also becomes clear that the depersonalised
entrepreneurial function can never serve as a retention mechanism. It seems
that Schumpeter has traded retention for selection. That is, he assumes new
combinations will somehow be retained, which allows him to focus on how the
entrepreneur may both create and winnow new variation. The middleman function
allocated to the entrepreneur in Theory of 1926 and Entrepreneur serves both
purposes. By being at the very heart of the collective production process, being
the “carrier of exchange acts, through which the economic process is realising
itself,” every exchange act that so to speak makes the economic process live for
another period, makes the economy breathe and move through another economic
period, every single such act involves, or “goes through,” the entrepreneur.
The entrepreneur is almost like a filter that decides which exchange acts to
facilitate and which to block, for instance by demanding a too high price for a
consumer-good. It is precisely because all exchange acts, or transactions, run
“through” the entrepreneur, that he has such a strong influence on the decision of
which combinations may be carried out and thus “selected,” and which ones not.
In order to carry out a new combination, however, the entrepreneur must
further be able to assert leadership. That is, he must not only perceive the
possibility, but also be able to carry it out. In 1911 this condition was fulfilled by
Schumpeter’s conceptualisation of the entrepreneur as an energetic and powerful
leader. In Entrepreneur it is still the case that entrepreneurship is represented as
a particular form of leadership in the economic sphere. It must be remembered,
however, that Schumpeter in Entrepreneur explains that the periods in which
the leader actually performs leadership make an exception. That is, the new
depersonalised entrepreneurial function cannot be viewed as a description of a
retention mechanism, but it may well serve as a principle of selection and as the
source of new variation. How well this leadership-function is fulfilled depends
on individual competencies, and it is the competencies associated with practical
initiative that counts (taking decisions and carrying them through), like strength
of will and the ability to dominate and win.
There is a subtle change in the character of the entrepreneur as a strong leader,
however, that comes to the fore only when drawing on an analysis of the changes
in Theory. When revising Theory in 1926, Schumpeter deletes a passage that

reads: “The entrepreneur acquires productive services, thus withdraws them
from their static uses, uses them without asking their proprietors, and thereby
forces the economy into new channels.”44 The deletion of this passage is but one
example of a number of changes between the 1911- and 1926-edition of Theory
that systematically shifts emphasis from the “pushy” aspect of the entrepreneur’s
acquisition of factors, to his role in combining the factors of production. This is
in line with a clarification from Schumpeter’s hand that emphasises the role of
the new depersonalised entrepreneur as a carrier of the mechanism of change,
rather than the direct source of change. This passage, added by Schumpeter in
the revised edition of Theory (1926) reads: “my description . . . is not at all about
factors of change, but about the way in which these have an effect, about the
mechanism of change. Here, the ‘entrepreneur’ is neither a factor of change, but
the carrier of the mechanism of change.”45
As we have seen, Schumpeter’s new depersonalised principle of entrepreneur-
ship, appearing simultaneously in Entrepreneur and Theory of 1926, not only
placed the entrepreneurial function at the centre of the economy, it also opened
the possibility of a strengthened conceptualisation of selection to complement the
principle of variation he had earlier devised. But Schumpeter went further in
the endeavour to strengthen his concept of selection. In the following section,
we will point out that Entrepreneur and a few other articles written in the late
1920s, contain a selection principle that was completely absent in his earlier
writings and went well beyond what he would write ever since. For some reason,
Schumpeter’s conceptualisation of selection and adaptation, at this time, was
particularly ripe, perhaps even foreshadowing some of the essential components
of the selection model that would later be associated with neo-Darwinian theory.
SCHUMPETER’S VISION OF ECONOMIC

SELECTION AND ADAPTATION
In Entrepreneur and a few forgotten articles, all written during the late 1920s,
Schumpeter presented his most profound vision of economic selection. Although
Schumpeter never followed through on these themes they merit attention for a
number of reasons. First, it is not widely known that Schumpeter developed a
conceptualisation of economic selection at this level of detail, and the material has
never been translated into English. Second, it is interesting to note that Schumpeter
explicitly disavowed the Darwinism of his day (Schumpeter, 1926a, Chap. 2),
but in Entrepreneur approaches a selection argument that bears remarkable
resemblance with key elements of the neo-Darwinism that was not yet developed
at the time. Third, in the light of the material contained in Entrepreneur, a number
of the issues that were raised in recent debates whether Schumpeter’s theory is
Darwinian or not (Hodgson, 1997; Kelm, 1997) must be revised. Fourth, even at
the present day, conceptualisations of economic selection are unclear and need
further development. Here Schumpeter’s considerations of selection mechanisms
may illustrate important aspects of the difficulties that still need to be addressed
in order to develop a unifying concept of economic selection. Fifth, at the time
Entrepreneur was written, it was common to conceptualise economic and social
evolution as proceeding through a number of distinct stages, a perspective that
was closely associated with the German Historical School (Krabbe, 1996). It is
remarkable that Schumpeter in Entrepreneur outlines a selection argument that
goes well beyond this view. It is therefore important to highlight the ingenuity
of the selection argument presented in Entrepreneur and to identify the possible
sources of this argument. Putting aside the question of the possible sources for
this rather surprising finding for a moment, we begin by briefly reiterating the
material contained in Entrepreneur.
Schumpeter introduces his argument by rejecting the theories of “economic
stages” that were commonly used to conceptualise economic change. Schumpeter
argues that previous attempts of situating economic entities in history on the basis
of theories of stages are inadequate because they ignore “important similarities in
essence” that transgress historical periods. For this reason, Schumpeter argues that
any division of history into distinct periods is problematic. Schumpeter further
implies that theories of economic stages ignore “the unfolding inner logic” of
the invariant essence of particular forms of economic organisation. In particular,
Schumpeter focuses on the emergence of the enterprise as a form of production
and explains “the enterprise exists in all observable historical states . . . and in its
economic essence it always manifests itself in the same way.”46 The “essence”
Schumpeter speaks about is characterised as an invariant component of economic
life that unfolds into the enterprising form of production. It is described as an
“ideologically grounded mentality” situated in history, and Schumpeter further
explains that once a mentality exists there are “cultural expressions flowing from
it.” Having emphasized the invariance of the essence of the enterprise, Schumpeter
immediately adds, “[t]he enterprise changes so much in the course of history that
the outer characteristics of the enterprise of our time, one after another, slip through
our fingers while we are observing it . . .” And emphasizing that he views the
essence of the enterprise and its expressions as ontologically distinct, Schumpeter
continues: “while the enterprise changes incessantly, there is no change at all in its
underlying principles . . .” If one views Schumpeter’s conceptualisation through
the lens of neo-Darwinism, the “essence” would be Schumpeter’s genotype and the
actual manifest outer characteristics of the Enterprise would be the phenotype. It
is clear, however, that it is not Darwin that inspired Schumpeter. The description of
the essence of the enterprise as an ideologically grounded mentality rather points
to Marx.47 Nonetheless, Schumpeter’s description of the relation between the eco-
nomic core – the essence – and the unfolding of this core in terms of particular
outer characteristics shaped by particular circumstances has some resemblance
with the neo-Darwinian model.
Even if Schumpeter views the modern enterprise as the unfolded expression
of an ideologically rooted mentality, he further argues that the particular circum-
stances of the enterprise introduce a “determining pressure.” This pressure, in turn,
leads to a profound variation in the outer characteristics of the enterprise, across
time and across place, and for that reason, Schumpeter argues, the “economic
essence” of the enterprise cannot exhaustively explain why the economic organi-
sation of the enterprise changes through history. To uphold the similarity with the
neo-Darwinian model, the determining pressure of social facts should, however,
adjust the frequency of the particular “essence” of the enterprise within a set of
“essences.” Note that we are not keen to enrol Schumpeter as a neo-Darwinian,
merely pointing out where the analogy breaks down. Moreover, a blind spot
in Schumpeter’s explanation is the source of further disanalogy. At no point in
Entrepreneur does Schumpeter attempt to explain the evolution of the mentalities
that constitute the essence of the enterprise, or any other distinct form of economic
organisation for that matter. The whole point of the neo-Darwinian explanation
would be to establish a causal relation between the change in the “outer characteris-
tics” and the change in the distribution of “essences.” Because of this missing causal
link, it appears we have merely established a weak analogy, but as pointed out in
the following, Schumpeter provides a remarkable selection argument that much
strengthens the analogy.48
In arguing why the private enterprise is superior to the public one, he argues
that “the private industry is mainly directed by a circle of persons that still today,
even when they have not personally gone through the school of the competitive
struggle, hold on to its tradition and represents the result of its selection.” Note that
Schumpeter in this passage describes the personal qualities of a particular group of
people as the outcome of selection associated with the competitive struggle. And
Schumpeter adds “[f]or this reason, the one-man-enterprise of the competitive era
is a unique method to provide a complete freedom of choice, and at the same time,
the strongest assurance against a lack of a sense of responsibility.” Remarkably
Schumpeter hints at the missing causal link. And in the next sentence, Schumpeter
leaves no doubt that he is explaining some aspect of the essence of the enterprise
as a result of selection: “much of the principles of the competitive struggle are
still preserved in the modern large enterprise, while the leading man of the public
enterprise is paralysed.” So it seems that Schumpeter was after all trying to develop
a conception of selection that can be reconstructed to bear resemblance with the

neo-Darwinian model. This becomes even clearer in the following passage, “[t]he
competitive economy meant a complete, and incessantly revived, reorganisation of
the productive organism towards what is appropriate for the private enterprise – and
in many cases also socially – by the method of competitive ejection of those that
were neither adapted from the private enterprise perspective – nor in many cases
adapted from a social perspective.” The term “adapted” is not a coincidence. In
the preceding passages Schumpeter provided a detailed account of the adaptations
that followed in the wake of the emerging private enterprise. At this point we will
leave further scrutiny of Schumpeter’s conception of selection to the reader. It
is remarkable, however, that apart from a few other articles written within a few
years after Entrepreneur, Schumpeter never further developed these thoughts.49
Perhaps, Schumpeter’s reluctance in submitting Entrepreneur was partly motivated
by his difficulty in developing the selection argument? We do not know if this is
the case, but the selection argument is certainly a “new vantage point” compared
to Schumpeter’s earlier writing.
Before concluding the essay, we will briefly consider the possible sources
for Schumpeter’s passing conceptualisation of selection in terms of competitive
ejection of the less adapted. Considering the alternative texts in economics and
sociology available at the time when Schumpeter wrote Entrepreneur, there is
one description of selection that stands out as a particularly likely source. This is
a section in Max Weber’s Economy and Society50 titled “Conflict, Competition,
Selection” in which Weber provides a remarkable description of the contrasts and
similarities between “social selection” and “biological selection.” Not only is it one
of the clearest texts that existed on competitive selection in the social sciences when
Schumpeter wrote Entrepreneur, it is also highly likely that Schumpeter had read
it.51 After all, we know from Schumpeter’s obituary of Max Weber that Schumpeter
was aware of Weber’s work on selection and adaptation: “His memorandum . . . on
a survey dealing with adaptation and selection, the occupational choice, and the
occupational fate of workers in large-scale industrial enterprises . . . opened up a
comprehensive field of fruitful empirical research. However, Weber himself did
no further work in this area.”52 This passage refers to an early essay on selection
and adaptation that Weber published in 1908,53 and the last sentence sounds as if
Schumpeter would have an interest in developing this line of work. Later, when
Schumpeter wrote Entrepreneur it is therefore likely that he would also have
studied the section on “Conflict, Competition, Selection” in Economy and Society.
In Economy and Society, Weber (1978, p. 38) provides a definition of biological
selection that is valid even by modern standards as well as a definition of social
selection that presents exactly the solution to Schumpeter’s problem that any
kind of evolutionary explanation stemming from biology would be discredited.
Having defined selection, Weber points out that the correspondence between
behaviour and personal qualities introduces a “differential advantage in selection
for social success” that matters in social selection, but not in biological selection.
In Entrepreneur, Schumpeter’s description of selection is very much in line with
this thinking, probing whether the personal qualities of the leader matter for
the success of his behaviour – and that of the enterprise led by him. And when
Schumpeter argues that the personal qualities of a circle of persons directing the
private industry are the result of the selection associated with the competitive
struggle, there is a very close similarity to Weber’s thoughts. A further parallel be-
tween Entrepreneur and Weber’s section “Conflict, Competition, Selection” is the
remarkable combination of selection and adaptation forces. According to Weber
(1978, p. 39), even if all competition were completely eliminated, “conditions
would still lead to a latent process of selection, biological or social, which would
favour the types best adapted to the conditions, whether their relevant qualities
were mainly determined by heredity or by environment.” Recalling Schumpeter’s
conceptualisation of selection in terms of competitive ejection of the less adapted,
one is struck by the similarity. Returning to the requirement of neo-Darwinian the-
ory, that selection must be defined in terms of a causal relation between the change
in the “outer characteristics” and the change in the distribution of “essences,” it
appears that Schumpeter was indeed trying to achieve this in Entrepreneur.54 And
as far as we know, Weber is the only source providing a comparable definition of
selection in the social sciences at the time Entrepreneur was written.
Even though further similarities can be identified between Weber and Schum-
peter, such as the concept of “routine” that crept into Schumpeter’s writings during
the 1920s, there are also crucial differences.55 The most important is perhaps that
Schumpeter in his theory of social classes, which can be viewed as a selection
theory, defined the family as the elementary unit of social classes (see e.g. Stolper
& Seidl, 1985, p. 170). It is clear that Schumpeter also in Entrepreneur retained
this view that the family can be a unit of selection, which is a negation of Weber’s
definition of “social selection”:
The struggle, often latent, which takes place between human individuals or social types, for
advantages and for survival, but without a meaningful mutual orientation in terms of conflict,
will be called ‘selection.’ Insofar as it is a matter of the relative opportunities of individuals
during their own lifetime, it is ‘social selection’; insofar as it concerns differential chances for
the survival of hereditary characteristics, ‘biological selection.’
Weber (1978, p. 38), emphasis added.
Even if Schumpeter, as opposed to Weber, included social groups, such as the

family, as the unit of selection, the argument here is that Schumpeter’s construc-
tion of the selection argument in Entrepreneur bears remarkable resemblance to
Weber’s.56
When considering the sources of Schumpeter’s selection argument presented in

Entrepreneur, it also interesting to note why he would engage in this thinking at this
point in time. A possible reason is that Schumpeter, as he arrived in Bonn in 1926,
needed to position himself within the community of German economists. Since
also Schmoller cautiously linked up with Darwin’s ideas on selection (Krabbe,
1996), Schumpeter’s views on selection may be viewed as a further instance of
his siding with Schmoller against Sombart and Weber, as previously mentioned.
Therefore, we should once more caution against drawing too hasty conclusions
that Lederer, Marx, Weber, Sombart or any other single source can be seen as
the main inspiration for Schumpeter’s work on entrepreneurship.57 As mentioned
above, we are of the opinion that the shift in Schumpeter’s thinking is best viewed
in terms of his own description of innovation, as an instance of a new combination
of a number of intellectual sources that had influenced him.
CONCLUSIONS
Each scientific discipline has a set of defining reference books, a small collection
of timeless volumes that establish the rough contours of the intellectual landscape.
Schumpeter’s most famous work in economics, Theory of Economic Development,
is one of these select beacons of economics, or perhaps an economics yet to
come. It got excellent reviews when it appeared in English in 1934, and it is
widely recognised as the founding work, perhaps not of the current mainstream,
but certainly of the literature on entrepreneurship and economic evolution. As
Swedberg (2000, p. 12) notes, Schumpeter is the main figure in the literature on
entrepreneurship, and we might add, the second chapter of Theory is the main
text on entrepreneurship from Schumpeter’s hand.
Theory was first available for the English reader in 1934 about two years after
Schumpeter had emigrated to the USA to take up the position at Harvard that
would be his end-station. Yet again Schumpeter would embrace a new position,
a new country, new colleagues and friends, and eventually, a new wife. But the
optimism from his first new beginning in Bonn would never return. Schumpeter’s
personal tragedy in 1926 would forever leave a shadow on his personal life. In 1926
Schumpeter had finished revising Theory just a few months after the tragic events
that culminated with the death of his wife. And it is this edition that is known to
the English reader.
It is hard to believe that Schumpeter’s personal sense of despair and failure during
the months he put the final touches to Theory would not have interfered with his
earlier conception of the strong, almost super-human entrepreneur presented in
Theory 1911. Apart from the intellectual sources we have identified as possible
inspiration for the new depersonalised entrepreneur to appear in his writings after
1925, this conception of entrepreneurship must have made sense to Schumpeter
also for personal reasons. Rather than viewing entrepreneurship as a personal
virtue of the select few, the new depersonalised function of entrepreneurship that
personifies no one in particular, and anyone on some occasions, seems much easier
to reconcile with his personal experiences at the time he put the final strokes to the
revision of Theory.
A few weeks before Schumpeter completed the revision of Theory, he would
submit to the publisher on 7 September 1926 the final revision of Entrepreneur.
Since we now know that this was the first work Schumpeter assumed after the
tragic events in the summer of 1926, Entrepreneur marks the birth of the deper-
sonalised entrepreneur that was presented in the revision of Theory finished a few
weeks later. For this reason, and because it is only in Theory we find a treatment
of entrepreneurship that is paralleled in scope and detail, Entrepreneur must be
viewed as a companion article to the English translation of Theory. But it should
now be clear that Entrepreneur also presents new material that is not found in
Theory. In particular, it appears that Entrepreneur contains a profound vision on
economic selection that Schumpeter developed in a few forgotten articles during
the late 1920s, and then left for a future that never came.
We have further mentioned that Schumpeter’s new depersonalised view of the
entrepreneurial function retains the previous core idea, that economic development
happens because of new combinations introduced by entrepreneurs, but discards
the typological thinking of the German Historical School. Thus, Entrepreneur
(and Theory of 1926) explains entrepreneurship in terms of the economic
relations that appear through the middleman function, a particular instance
of social interaction, provided the middleman is capable of leadership and the
circumstances are favourable. Whereas entrepreneurship now comes in shades, the
previous explanatory starting point in Schumpeter’s earlier writings on economic
development was the stylised differences in two types of human nature. Since
Schumpeter in Entrepreneur for the first time explicitly centres on the economic
relation between social actors as the explanatory starting point, this article must be
viewed as a foundational work not only of economic theories of entrepreneurship,
but also of the emerging theory of economic sociology (Swedberg, 2000).
In order to introduce Entrepreneur we have chosen to situate this article within
Schumpeter’s work on entrepreneurship as it developed through time. A further
issue, however, deserves to be mentioned. Schumpeter has been associated with
a theory of economic democratisation according to which he was worried about
the negative effects of the spread of democratic practices into industry (Medearis,
2001), a theme he had begun to emphasize during the 1920s. As the reader will
see, the last paragraph of Entrepreneur considers this theme. Here it is important
to note that Schumpeter explains that incessant innovation drives a democrati-

sation of entrepreneurship and leadership that tends to weaken these functions.
Entrepreneur is therefore further important because it clearly denounces recent
theories, according to which Schumpeter attributes the democratisation of industry
to the influence of democratic beliefs and ideology, and the radicalising, dynamic
effects of social movements that attempt to realize democratic values and act on
democratic ideologies (e.g. Medearis, 2001). Entrepreneur is therefore important,
not only as an expression of Schumpeter’s views on entrepreneurship, but also as
a foundational article of economic sociology and a clear expression of his views
on democratisation.
With the new translation of Entrepreneur, one of the two main works on
entrepreneurship written by Schumpeter, the English reader can now access this
material. And Entrepreneur is significant, not only for historical reasons. Even
if Entrepreneur has clearly been out-paced on a number of scores, it remains a
rich source of inspiration that may help further the conceptual development of the
recent literature on entrepreneurship.
A NOTE ON THE TRANSLATION

When Erich Schneider and Arthur Spiethoff edited the German translation of
Schumpeter’s biographical papers and his papers on the history of thought shortly
after his death (Schneider & Spiethoff, 1954), they noted “we would have liked
to augment their number, but the difficulties of translation are so great that we
had to content ourselves” (Schneider & Spiethoff, 1954, p. v). We cannot but
agree. Translating Schumpeter’s German to English is a difficult task as well.
Furthermore, as explained in our article, Schumpeter himself was not content with
the linguistic expression he had given to his ideas in Unternehmer. And indeed,
in this piece we find some of his most complex and dense language. At times, it
is combined with very German sentence structures that are very hard to render
in English. We therefore often had to revert to the measure of redesigning the
sentence structures. Great care, however, has been taken at all times not to alter
the meaning. In order to trace the root of our translations in the original, we have
added a list of notes explaining the most important decisions.
NOTES
1. According to the American Heritage Dictionary, “depersonalise” has two related
meanings: (1) to deprive of individual character or a sense of personal identity; or (2)
to render impersonal. We use the term “depersonalise” in the first sense to denote that
Schumpeter’s concept of entrepreneurship became a function that was deprived of its

previous character in terms of a particular type of human nature, namely the energetic
or dynamic type. As explained in the following, the shift in Schumpeter’s thinking is
evidenced in the appearance in Entrepreneur of the expression “entrepreneurial function,”
which is here viewed as a depersonalised concept in the above sense.
2. Some commentators (e.g. Langlois, 1998) have claimed that there is no difference
between the early Schumpeter and the later Schumpeter. When such claims are limited
to a scrutiny of the previously available English translations of Schumpeter, they are
problematic, however. According to our argument, based on textual evidence (see Becker
& Knudsen, 2002), a number of significant changes can be traced in the writings of the
early Schumpeter, before his return to academia in 1925, and the later Schumpeter of
1925 and onwards. Note here, that the first English translation of Theory of Economic
Development, published in 1934, was based on the 2nd German edition that Schumpeter
thoroughly revised during 1926.
3. The material in this section is based on the standard secondary sources (Allen, 1991;
Stolper, 1994; Swedberg, 1991a).
4. Schumpeter served as a member of the German Coal Socialisation Commission from
January to March 1919, as the Austrian Secretary of State of Finance from 15 March 1919
to 17 October 1919, and as Chairman of the Board of the Biedermann Bank from 23 July
1921 to 11 Sept 1924 (Allen, 1991). The banking disaster also left him heavily indebted.
5. This description comes from Allen (1991).
6. In a letter to Wesley C. Mitchell dated 30 August 1926, Schumpeter looks back on his
first year in Bonn and notes that he was “feeling extremely happy” as he entered his duties
at the university and was “trying to make up for lost time.” Letter reprinted in Hedtke and
Swedberg (2000, pp. 126–127).
7. The characterisation “extremely happy” is Schumpeter’s own – in the letter to Mitchell,
reprinted in Hedtke and Swedberg (2000, pp. 126–127). Regarding the report on Schum-
peter’s mood, see Allen (1991).
8. The Schumpeters must have left for Bonn straight after their return from their
two-week honeymoon in Italy (cf. Allen, 1991).
9. According to Allen (1991), Schumpeter also set to work on a textbook of economics.
He never managed to complete this work, however.
10. According to Swedberg (1991a). The articles referred to are Social Classes in an
Ethnically Homogenous Environment published in 1927 and The Sociology of Imperialisms
published in 1918–1919.
11. Fritz Karl Mann eventually published an unfinished version of Schumpeter’s planned
book on money in 1970.
12. According to Swedberg (1991a), the most important work on this topic from the
period is The Instability of Capitalism from 1928.
13. We are grateful to Ulrich Hedtke for this point.
14. Further, in 1926, Schumpeter published the article Gustav von Schmoller und die
Probleme von heute (Schumpeter, 1926b), which may have been written before the revision
of Theory of Economic Development (Schumpeter, 1926a).
15. See the letter to Gustav Stolper of 29 May 1926: “. . . weil ich die mir unerträgliche
Arbeit an der 2. Auflage meiner leider vergriffenen ‘Theorie der wirtschaftlichen
Entwicklung’ vor allem loswerden muss” (Swedberg & Hedtke, 2000, p. 113).
16. We are grateful to Ulrich Hedtke for this information. Unternehmerfunktion und
Arbeiterinteresse (Schumpeter, 1927) is the published stenographic record of a lecture
with the same title that Schumpeter gave at Verband Deutscher Arbeitgeber (Federation of
German Employers) on 31 March 1927.
17. The four pieces on entrepreneurship by Schumpeter, written in the period
1927–1929, are: Unternehmerfunktion und Arbeiterinteresse (Entrepreneurial function
and workers’ interests) of 1927, published in the employers’ federation magazine
(Schumpeter, 1927); Unternehmer (Entrepreneur), the article in the 4th edition of the
Handwörterbuch der Staatswissenschaften of 1928 (Schumpeter, 1928); Der Unternehmer
in der Volkswirtschaft von heute (The entrepreneur in today’s economy) of 1929, published
in an edited volume (Schumpeter, 1929a); and a speech on Ökonomie und Psychologie des
Unternehmers (Economics and psychology of the entrepreneur) given to the Federation of
German Steel Industry, 22 May 1929 (Schumpeter, 1929b).
18. Schumpeter’s work on entrepreneurship also includes a few articles published in the
late 1940s as well as some passages of Capitalism, Socialism and Democracy (1942), but
none of these equal Entrepreneur or Theory in scope or detail.
19. Roughly speaking, from 1926 to 1929.
20. The first time was his Theory of Economic Development of 1911.
21. Except for the greetings.
22. One could also speculate that Schumpeter must have come across whatever new point
he had in mind only recently, as otherwise he might have integrated it earlier, in particular
if he thought it very important.
23. The precise reasons for such a shift from an emphasis of the personified entrepreneur
to the entrepreneurial function are not known. According to an anonymous reviewer, a
possible reason is that the Walrasian system he trumpeted in his 1908 book was becoming
more widely used within the profession. In response, Schumpeter may well have decided
that an analysis that depended too much on individual characteristics made less sense. Or
perhaps Schumpeter recognised the conflict between his 1908 and 1911 books (in terms
of their conflicting emphasis on the individual or the social level) and this was an attempt
to mend it? Above, we have mentioned a further reason, that Schumpeter because of his
personal experience may have lost faith in the personified entrepreneur.
24. The fact that the term “entrepreneurial function” shows up in a section heading
supports the idea that it represents a shift in Schumpeter’s thinking.
25. Schumpeter (1926a, p. 97), our translation.
26. In few instances, the term “middleman” is also used in contemporary studies of
entrepreneurship. Burt (1992, 1997) for instance has pointed out that networks rich in
structural holes present opportunities for entrepreneurial behavior, and interprets the
manager as “an entrepreneur in the literal sense of the word – a person who adds value
by brokering the connection between others.” In this perspective, entrepreneurs are people
skilled in building the interpersonal bridges that span structural holes (Burt, 1997, p. 342;
see also Bonacich, 1973, for an analysis of the causes for the existence of middleman
minorities). Note that Schumpeter’s notion of the entrepreneur as fulfilling the middleman
function is quite different from this contemporary notion, as is explained below in the text.
27. For an example in Schumpeter’s later writings, see Comments on a Plan for the Study
of Entrepreneurship (reprinted in Swedberg, 1991b).
28. Throughout the remainder of the present article, we are quoting passages from
Entrepreneur. These unquoted passages are all excerpts from our translations of
Entrepreneur.
29. These two articles were based on lectures held by Schumpeter. As mentioned in fn.
16, Unternehmerfunktion und Arbeiterinteresse (Schumpeter, 1927) was based on a talk
Schumpeter gave at Verband Deutscher Arbeitgeber (Federation of German Employers) on

31 March 1927. Der Unternehmer in der Volkswirtschaft (Schumpeter, 1929a) appears to
be the original version of a lecture with the same title that Schumpeter held at the Deutsche
Vereinigung für Staastwissenschaftliche Fortbildung (German Association for Education in
Political Economy) on 5 September 1927. It is important to note that although the latter
article was published only in 1929, Schumpeter actually had completed it by September
1927. We are grateful to Ulrich Hedtke for supplying us with this information.
30. Schumpeter (1911, p. 165), our translation.
33. In 1914, Schumpeter published Epochen der Dogmen- und Methodengeschichte as
a chapter in the first volume of Grundriss der Sozialökonomik. This volume of Grundriss
further contained a chapter by Bücher and von Wieser.
34. We thank Ulrich Hedtke for this insight.
35. Swedberg (1991b, p. 190).
36. In History of Economic Analysis, Schumpeter (1954) would later point to a number
of sources for the idea of rationalisation.
37. Swedberg (1991b, n. 24, p. 217). Schumpeter and Emil Lederer both served on the
German Socialisation Commission. Emil Lederer was a Marxist economist of high standing,
but despite being ideological adversaries, Schumpeter and Lederer were on friendly terms
(Stolper, 1994; Swedberg, 1991a).
38. Note also that Schumpeter (1954) in his own work traces the emergence of rationalism
in social thought to numerous sources.
39. This function is also described in Schumpeter (1927, p. 166).
40. That aspect is also present in Schumpeter (1929a, p. 231).
41. Schumpeter is quick to point out that the two categories of “owners of means of
production” and “consumers” in the end collapse into one, and the entrepreneur thus can be
seen as a middleman between different groups of “suppliers of means of production,” i.e.
workers, landowners and capitalists (p. 481).
42. With financial means provided by the capitalist.
43. This material in Entrepreneur can be associated with Schumpeter’s “transformative
thesis” of democracy, as Medearis (2001) has termed it.
44. Theory of Economic Development (Schumpeter, 1911, p. 189); deleted in 2nd edition.
45. Theory of Economic Development (Schumpeter, 1926a, p. 93).
46. Note here that this quote, and Entrepreneur in general, clearly shows it is mistaken
to argue that Schumpeter always shunned metaphysics.
47. Possible sources of Schumpeter’s use of the concept of collective level “mentalities”
include Rudolf Hilferding, Karl Marx, Werner Sombart (one of the two in-text references in
Entrepreneur), and Gabriel Tarde. Note, in passing, that the discussion whether Schumpeter
knew Tarde’s work can be settled unambiguously with textual evidence we have not yet seen
employed in this discussion: In Wesen, Schumpeter writes that he does not consider it useful
to emphasize the analysis of human behaviour from the perspective of motivations as much
as Tarde has done (Schumpeter, 1908, p. 79). While Schumpeter rarely mentions Tarde,
he was evidently strongly influenced by Marx’s writings (März, 1991; Swedberg, 1991).
The conception of mentalities rooted in ideology that Schumpeter presents in Entrepreneur
reads very much like Marx. This impression is supported by Schumpeter’s later assessment
of Marx in History of Economic Analysis (e.g. Schumpeter, 1994 [1954], pp. 35–38). In
a section of History, “The Marxian Exposition of Ideological Bias,” Schumpeter (1954,
p. 36) agrees with Marx that “Social location undoubtedly is a powerful factor in shaping
our minds” (emphasis in original), but immediately adds that “Marx and especially the
majority of his followers assumed too readily that statements which display ideological
influence are ipso facto condemned thereby.” Schumpeter (1954) then goes on explaining
that ideologies are rooted in specific historical periods and will inevitably colour the mental
schema of any person. Even the scientist’s vision would, according to Schumpeter (1954),
be subject to ideological influence, but due to empirical falsification, the scientist’s model
would gradually improve its validity or perhaps be rejected. According to März (1991,
p. 15) the depersonalised entrepreneurial function goes back to Marx, and can be traced to
Hilferding and Sombart.
48. Schumpeter’s conceptualisation of economic development as a process of unfolding a
particular set of core features that is influenced by the impression of the social circumstances
at the time of founding was later re-invented by Hannan and Freeman (1989) as a conceptual
basis for work on organisational ecology. Ironically, Hannan and Freeman (1989) would
acknowledge the influence of Darwin but not Schumpeter.
49. The selection argument is developed more fully in Schumpeter (1927) and
Schumpeter (1929a), but the combination of selection and adaptation exists only in
Schumpeter (1928).
50. Translated into English from Wirtschaft und Gesellschaft.
51. From 1916 to 1920, Schumpeter was co-editor of Archiv für Sozialwissenschaft und
Sozialpolitik together with Max Weber, which would have involved some mutual awareness
of their individual work. About the general relationship between Schumpeter and Weber,
we know that Schumpeter got on well with Weber (Swedberg, 1991a), that their personal
acquaintance “was much too limited” (Schumpeter, 1920, p. 221), and that Schumpeter
had never heard Weber speak himself (Schumpeter, 1920, p. 226). We further know of
two documented encounters between the two men, one in a Vienna coffeehouse, resulting
in a quarrel on the Bolshevik revolution and Lenin (this encounter has been preserved by
Somary; see Faucci and Rodezno, 1998; Perlman, 1994; Swedberg, 1991a). The second
encounter featured Schumpeter arguing for the independence of economic science and the
results of “a hundred-year toil by economists” in opposition to Weber, who argued that this
should be sacrificed to further the course of unification of the social sciences (this encounter
has been preserved by Tritsch, 1953; see Faucci & Rodezno, 1998).
52. Schumpeter (1920), reprinted in Swedberg (1991b, p. 225).
53. Weber’s early text first published in 1908 is Methodologische Einleitung für
Erhebungen des Vereins für Sozialpolitik über Auslese und Anpassung (Berufswahlen und
Berufsschicksal) der Arbeiterschaft der geschlossenen Grossindustrie (reprinted in Weber,
1988). Schumpeter (1954, p. 817) would later praise this work as an example of “the
freshness and the originality” of Max Weber’s ideas.
54. In the light of the material contained in Entrepreneur (and other articles written
by Schumpeter in the 1920s), a number of the issues raised in recent debate whether
Schumpeter’s theory can be viewed as Darwinian or not (Hodgson, 1997; Kelm, 1997)
must be revised.
55. Here, it is interesting to note that Schumpeter in Entrepreneur consistently used
the term “routine” to describe the contrast of “innovation.” Also in Theory of 1926
Schumpeter makes generous use of the term “routine,” whereas this term is used in
very few places in Theory of 1911. For some reason, Schumpeter started using the term
“routine” in Entrepreneur and Theory and continued to do so in his later writings, but he
did not consider routines in terms of a possible retention mechanism. Nelson and Winter
(1982) would later propose that “routines” might be viewed as the component of a social
mechanism of retention that is somewhat analogous to the gene.
56. It is no contradiction between the two conceptualisations that Weber defines selection
to take place within the lifetime of the individual, however. The effect of selection may well
last much longer, as considered by Schumpeter.
57. Similarities between Weber and Schumpeter’s entrepreneur are commonly stated
in the secondary literature (as are similarities in attitude as to the methodology and the
idea of a broad-based economics, or Sozialökonomik; see MacDonald, 1965; Salsano,
1993; Shionoya, 1997; Swedberg, 1991a). Usually, however, the similarities between
Weber and Schumpeter that are identified are those between Weber’s type of “traditional
capitalism” and Schumpeter’s circular flow (MacDonald, 1965, pp. 375–376), their use
(or rather, Schumpeter’s adoption) of ideal types – the entrepreneur and the circular
flow being the prime examples (Carlin, 1956; MacDonald, 1965), in the case of the 1st
edition of Theorie also the hedonistic or “rational” motives which animate the “Kreislauf”
(Faucci & Rodezno, 1998), and finally Weber’s charismatic leader and Schumpeter’s
entrepreneur, both strong leaders that make others follow them (Swedberg, 2000). As
Swedberg (2000) points out, the commonly received idea about this similarity might
however be “largely mistaken” (Swedberg, 2000, p. 25). According to Swedberg, Weber
makes a much more differentiated point about charisma, namely that charisma is much
less important in capitalist than in pre-capitalist society. The reason is that in the former,
economic change is driven mainly by enterprises. There are, however, similarities between
Weber’s and Schumpeter’s entrepreneur that are less visible, for the reason that “what
Weber says on entrepreneurship nearly always gets garbled, due to the complexity of
his thought,” and it is also scattered throughout his work (Swedberg, 2000, p. 25). If
one combs through Wirtschaft und Gesellschaft, however, more subtle parallels can be
found.
58. The letters are in the Thüringisches Hauptstaatsarchiv Weimar (ThHstAW), Archiv
Verlagshaus Gustav Fischer Jena, Korrespondenz 1926, Akte “Schu.”
59. English translation ours. We will be pleased to provide copies of the German originals
on request.
60. A “∗” indicates a handwritten word very difficult to read. The text here renders our
best guess, which, however, is still a guess.
61. Square brackets inserted by us.
ACKNOWLEDGMENTS
The authors are grateful to Ulrich Hedtke, Roger Koppl, Richard Swedberg and
two anonymous reviewers for helpful comments. The authors wish to thank Meta
Andrés for linguistic assistance with the translations of Entrepreneur, and Minna
Skafte Jensen for assistance with a particularly contrary Latin expression in
Entrepreneur. The authors would like to express thanks to Mr. Jörg Swidersky and
Mr. Bernd Rolle of Urban and Fischer Verlag, and Mr. Marek of Thüringisches
Hauptstaatsarchiv Weimar for helpful assistance in retrieving the correspondence
between Schumpeter and the publisher of Entrepreneur. The authors and the
publisher would like to thank Urban and Fischer Verlag for permission to print the
translation of Unternehmer, and for permission to print the letters on Unternehmer
that were written by Schumpeter and the publisher.
REFERENCES
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NJ: Transaction Publishers.
Baumol, W. (1968). Entrepreneurship in economic theory. American Economic Review (papers and
proceedings), 58, 64–71.
Becker, M. C., & Knudsen, T. (2002). Schumpeter 1911: Farsighted visions of economic development.
American Journal of Economics and Sociology, 61(2), 387–403.
Bonacich, E. (1973). A theory of middleman minorities. American Sociological Review, 38(5),
583–594.
Burt, R. S. (1992). Structural holes. Cambridge, MA: Harvard University Press.
Burt, R. S. (1997). The contingent value of social capital. Administrative Science Quarterly, 42(2),
339–365.
Carlin, E. A. (1956). Schumpeter’s constructed type: The entrepreneur. Kyklos, 9(1), 27–43.
Faucci, R., & Rodezno, V. (1998). On Schumpeter and the legacy of German-speaking economists –
Did Schumpeter change his mind? Notes on Max Weber’s influence on Schumpeter. History of
Economic Ideas, VI(1), 27–54.
Hannan, M. T., & Freeman, J. (1989). Organizational ecology. Cambridge, MA: Harvard University
Press.
Hodgson, G. M. (1997). The evolutionary and non-Darwinian economics of Joseph Schumpeter.
Journal of Evolutionary Economics, 7, 131–145.
Kelm, M. (1997). Schumpeter’s theory of economic evolution: A Darwinian interpretation. Journal of
Evolutionary Economics, 7, 97–130.
Krabbe, J. J. (1996). Historicism and organicism in economics: The evolution of thought. Dordrecht:
Kluwer Academic Publishers.
Langlois, R. N. (1998). Personal capitalism as charismatic authority: The organizational economics of
a Weberian concept. Industrial and Corporate Change, 7(1), 195–213.
MacDonald, R. (1965). Schumpeter and Max Weber – Central visions and social theories. The Quarterly
Journal of Economics, 79(3), 373–396.
März, E. (1991). Joseph Schumpeter. Scholar, teacher and politician. New Haven and London: Yale
University Press.
Medearis, J. (2001). Joseph Schumpeter’s two theories of democracy. Cambridge, MA: Harvard
University Press.
Perlman, M. (1994). Introduction (to Schumpeter, Joseph A.: History of Economic Analysis). London:
Routledge.
Salsano, A. (1993). Introduzione. In: A. Salsano (Ed.), L’imprenditore e la storia dell’impresa: Scritti
1927–1949 (pp. vii–xxvii). Torino: Bollati Boringhieri.
Schneider, E., & Spiethoff, A. (Eds) (1954). Schumpeter, Joseph A: Dogmenhistorische und biographis-
che Aufsätze. Tübingen: J. C. B. Mohr (Paul Siebeck).
Schumpeter, J. A. (1911). Theorie der wirtschaftlichen Entwicklung (1st ed.). Leipzig: Duncker &
Humblot.
Schumpeter, J. A. (1914). Epochen der Dogmen- und Methodengeschichte. In: Grundriss der Sozialöko-
nomik, I. Abteilung, Wirtschaft und Wirtschaftswissenschaft (pp. 19–124). Tübingen: J. C. B.
Mohr (Paul Siebeck).
Schumpeter, J. A. (1920). Max Webers Werk. First published in: Der Österreichische Volkswirt (Vol.
12, pp. 831–834). English translation in: R. Swedberg (1991). Joseph A. Schumpeter – The
Economics and Sociology of Capitalism (pp. 220–229). Princeton, NJ: Princeton University
Press.
Schumpeter, J. A. (1926a). Theorie der wirtschaftlichen Entwicklung (2nd ed.). Leipzig: Duncker &
Humblot.
Schumpeter, J. A. (1926b). Gustav von Schmoller und die Probleme von heute. Schmollers Jahrbuch
fuer Gesetzgebung, Verwaltung und Volkswirtschaft im Deutschen Reiche, 50(I), 337–388.
Schumpeter, J. A. (1927). Unternehmerfunktion und Arbeiterinteresse. Der Arbeitgeber, 17, 166–170.
Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 160–173).
Schumpeter, J. A. (1928). Unternehmer. Handwörterbuch der Staatswissenschaften (4th ed.). Verlag
von G. Fischer. Jena, VIII, 476–487.
Schumpeter, J. A. (1929a). Der Unternehmer in der Volkswirtschaft von heute. In: B. Harms (Ed.),
Strukturwandlungen der Deutschen Volkswirtschaft (2nd ed., Vol. 1, pp. 303–326). Berlin:
Verlag von Reimar Hobbing. Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 226– 247).
Schumpeter, J. A. (1929b). Ökonomie und Psychologie des Unternehmers. Vortrag vor der 10. Or-
dentlichen Mitgliederversammlung des Zentralverbandes der deutschen Metallwalzwerkes- und
Hütten-Industrie e. V. am 22. Mai 1929 in München. Leipzig: Haberland. Reprinted in: W. F.
Stolper & C. (1993) (pp. 193–204).
Schumpeter, J. A. (1934). The theory of economic development. An inquiry into profits, capital, credit,
interest, and the business cycle. Cambridge MA: Harvard University Press.
Schumpeter, J. A. (1954). History of economic analysis. London: Routledge.
Shionoya, Y. (1997). Schumpeter and the idea of social science. Cambridge University Press.
Stolper, W. F. (1994). Joseph Alois Schumpeter – The public life of a private man. Princeton, NJ:
Princeton University Press.
Stolper, W. F., & Seidl, C. (1985). Aufsätze zur Wirtschaftspolitik/Joseph A. Schumpeter. Tübingen:
Mohr Siebeck.
Swedberg, R. (1991a). Schumpeter: A biography. New Jersey, Princeton University Press.
Swedberg, R. (1991b). The economics and sociology of capitalism. New Jersey, Princeton University
Press.
Swedberg, R. (2000). The social science view of entrepreneurship: Introduction and practical applica-
tions. In: R. Swedberg (Ed.), Entrepreneurship – The Social Science View (pp. 7–44). Oxford:
Oxford University Press.
Swedberg, R., & Hedtke, U. (Eds) (2000). Joseph Alois Schumpeter. Briefe/Letters. Tübingen: Mohr
Siebeck.
Tritsch, W. (1953). Schumpeter avant 1925. Économie Appliquée, VI(1), 597–625.
Weber, M. (1978). Economy and society (2 Vols). G. Roth & C. Wittich (Eds). Berkeley: University of
California Press.
Weber, M. (1988). Gesammelte Aufsätze zur Soziologie und Sozialpolitik. Tübingen: J. C. B. Mohr
(Paul Siebeck).
APPENDIX
The Correspondence Between Schumpeter and the Publisher of Entrepreneur
(our translation)58
(1) F.Mo.
28 July 1926
Professor Dr. J. Schumpeter
Bonn a. Rh.
——————-
University
Dear Sir!59
As I come to know from Geheimrat Elster, you have, to Exzellenz von Wieser,
announced the delivery of the article “Unternehmer” for the “Handwörterbuch
der Staatswissenschaften” for 1 August of the present year. Because of the
latter’s death I would like to ask you to send the manuscript to me. I will then
present it to Geheimrat Elster before going to press. It is very important this
deadline is not disrespected, however, because the succeeding entries have
already been set for some time but printing plates can not be produced due to
the lack of your entry. For this reason I most respectfully ask you to stick to
the deadline and let me know on the attached postcard when I can expect the
arrival of the manuscript for certain.
Thank you very much in advance for fulfilling my request, with the very
best regards your most humble servant
(2) Bonn, Coblenzerstr. 39
1. VIII. 26
Dear Mr. Frohe,∗60
The manuscript of the article “Unternehmer” will be sent to you in the course
of this week. I do not schedule any other work and will use every free hour
to work on it. It is very embarrassing that disruptions arise again and again
and I ask you to be convinced of the fact that I do push myself just as much
as anyone could do. If needs be, I will leave the article as it is, so that you
can expect it within a few days. With the very best regards,
your humble servant Schumpeter
(3) Bonn, 10.VIII.26
Dear,∗
Unfortunately I have to inform you that due to a bereavement that occurred
on the 3rd of the month, and which momentarily shut down my capacity to
work, it was not possible for me to submit the article “Unternehmer.” I will
neither do anything else, nor leave Bonn, before I have finished it, but I first
have to see about my state of mind before I can give you a definite date. I
hope to be in a condition to start in some days, however, and to then be able
to finish the article within another week’s time.
Respectfully,
Schumpeter
(4) Jena, 11 August 1926
Professor Dr. J. Schumpeter, Bonn ———————————-
Dear Professor!
I have just received your kind postcard of the 10th of the month. I regret very
much that you have experienced a bereavement and understand that you have
been obstructed by it in your work on the article “Unternehmer.” I am very
grateful, however, if in the first place you could keep an eye on the completion
of this contribution and let me have the article, which indeed is needed very
urgently, as soon as that is possible for you.
With the expression of my very best respect I sign most humbly, F. J.
(5) F. J.
21 August 1926
Professor Dr. J. Schumpeter,
Bonn
Coblenzerstrasse 39
Dear Professor!
I very much hope that in the meantime you have been able to take up again
the work on your small contribution “Unternehmer” for the Handwörterbuch
der Staatswissenschaften. As you know, we have been waiting for it for a long
time and cannot proceed with the making of the printing plates for volume
eight. I therefore would be very grateful if you could finish the article, in
particular because according to your informations it was already finished by
the end of July. In advance, I thank you very much for fulfilling this request
and would like to ask you to let me know on the attached postcard when I
can expect, this time with certainty, to receive the manuscript.
With the very best regards, I am
Your very humble servant
(6) Dear Sir,
I hope to be able to answer: one of these days. In any case, you will receive
the article as soon as I can, and muster the necessary energy to work. I know
how unpleasant this new delay is for you, and how embarrassing for myself;
no reminder can be more impressive than how I feel it. Should you wish to
find out more on the reason, please ask Spiethoff. But, yes, I believe that it
will be possible now.
With the very best regards,
your humble servant Schumpeter.
(7) Prof. Dr. J. Schumpeter,
Bonn, 7/9 1926,
Coblenzerstr. 39
[printed letterhead]61
Dear Sir,
Today, I finally submit the article Unternehmer. I once more ask you to
apologize for the indeed inexcusable delay, which is all the more unpleasant
as I always held You and Your firm in the highest esteem and do not like to
be the source of incommodities in particular on Your part. Work on the art.
has, however, been broken off prematurely and much material has not been
considered. The execution, too, is lacking, and no one can regret that as much
as I do, as I would have very much liked to put the various new vantage points
on the topic, which I have to present, in more perfect terms. At any rate, the
essential of what has to be stated in the HWB [Handwörterbuch] has been said
– for the many defects in form I ask you and GHR [Geheimrat] Elster to excuse
me. Please allow the following remarks that I ask you to kindly take note of:
1. From tomorrow onwards, I shall be absent from Bonn for 10–14 days, during
which time I can best be reached at the address: Wien IX. Strudlhofstr. 17.
2. The late v. Wieser expressed the request that the references should cover
also the topic entrepreneurial profit. That has been done. Should the plan
have been changed the reference list would have to be revised.
3. Should the article exceed the allocated space (16 colums), which I do not
believe, however, pp. 8–16 (the historical overview) can be set in small
print, however excluding the last paragraph on page 16, and in the extreme
also the whole third section.
With the very best regards,
your humble servant
Schumpeter
(8) Jena, 9 September 1926
Professor Dr. J. Schumpeter, Wien —————————————–
Dear Professor!
Most gratefully, I have received Your kind letter of two days ago and the
manuscript of Your article “Unternehmer.” I shall immediately have the
printing plates produced and will send the corrections to Vienna within the
next fourteen days. Regarding the references I will inform Geheimrat Elster.
I hope the article will not exceed the allocated space of 16 columns.
With the very best regards I sign
most humbly
Br. J.
ENTREPRENEUR
Joseph A. Schumpeter
translated by Markus C. Becker and
Thorbjørn Knudsen
ENTREPRENEUR
1. The essence of the enterprise. Historical overview of its forms or types.
2. Development of the scientific analysis of the economic subject1 “entrepreneur.”
3. The entrepreneurial function.
4. Types of modern entrepreneurship.
5. Particular questions.
1. THE ESSENCE OF THE ENTERPRISE. HISTORICAL

OVERVIEW OF ITS FORMS OR TYPES
The collective2 economic process is always a coherent phenomenon whose lines
can be comprehended by the interlocking of its distinguishable elements. Not
always, however, does the social whole – be it a modern nation or a “culturally
poor” horde – run directly according to a comprehensive, conscious plan, carried
out, for the whole, by the whole: Where this is the case – in a completely pure form,
it would be in a socialist community – distinguishable tasks, facilities, etc. exist,
even if the expression of economic life has not achieved any particular form.3 If, on
the contrary, the social whole is leaving the responsibility for economic activity to
subgroups or individuals, then the collective production process is separated into
units that, seen from the outside, appear independent, autonomous, in principle left

ISSN: 1529-2134/doi:10.1016/S1529-2134(03)06013-7
235
to themselves, and forthwith only oriented towards their own concern for survival –
enterprises.
But also in the latter case, that of a market economy, production is not “anarchis-
tic.” Rather, the noted concern for survival is subject to the pressure of the given
circumstances4 on the one hand, and highly limited behavioural options on the
other. These highly limited behavioural options, expressed primarily in the facts of
demand, force an interlocking and adjustment to the – in this sense only “seen from
the outside” and “apparently” – independent units under the penalty of economic
annihilation, so that also in this case a collective economic plan is automatically
actualised, although not consciously devised as such, but only inferred by
analysis. However, even despite important differences compared to the deliberate5
economic plan of an “exchange-less economy,”6 the two forms of plan are indeed
analogous with respect to their essential economic principles and results. This in-
sight, basically simple, but forgotten again and again, also reduces the importance
of another contrast that we could have made our starting point here: the contrast
between subsistence-economy and profit-making7 economy. Yet another type of
constraint must be distinguished from the fundamental behavioural constraint
of the apparently independent units, which is similar in nature to the constraints
of a productive unit in a socialist collective, forced upon it by the orders of the
central directorate. This additional constraint limits the “autonomy” of the units
even further and makes them relative, similar to the way in which the concept of
sovereignty is relative: First, the social whole never completely delegates the care
of the collective economic process to the apparently independent units – not even
when this would be part of the ideology of national politics, for example according
to the spirit of the liberal principle – but always, only a limited domain is delegated
that changes according to time, place, situation etc., and whose boundaries cannot
be determined8 “notionally,” “generally,” or “factually.” Second, every epoch
exhibits its characteristic constraints related to private enterprising,9 of which the
following are particularly important today: surviving guild-like cooperation and
new forms of cooperative exchange; activities of interest groups that extend beyond
the sphere of lobbying for economic policy interests; agreements and cartels within
industries; the domination of individual units by a central power (“trustification”)
or by other individuals (external shareholders’ acquisition of units that remain
formally independent – one way of building a concern); the banking world influ-
encing the units financed by it, which can lead from mere acting in the interests of
the creditor to de facto management – another way of building a concern; finally,
power positions in the area of buyer- and supplier-relationships (e.g. the breweries’
domination of pubs). From the perspective of economic freedom, these phenom-
ena run counter to the norm. They are in fact of such importance that, besides a
narrow circle of questions belonging to theoretical economics, it is advisable at all
Entrepreneur 237
times, even for “liberal epochs,” to interpret the action of the group as the primary
and essential, and to understand the autonomy of the economic unit as a derivate
that has to be explained in each particular instance.
In scientific parlance, however, such apparently independent units are usually
and preferably only then called “entreprises” (while the French term “entreprise”
is equivalent, there is, apart from the use of this term, particularly in America, no
good English term for it – “business” might come closest), if they are exclusively
oriented towards market opportunities and capital accounting (M. Weber), and
are bearers of business processes differing from those of the private economic
subject (Sombart). According to this usage the notion of enterprise coincides with
a particularly sharp expression of its content, the “capitalist” enterprise, which,
however, neither conceptually nor historically, can be distinguished from other
expressions of the same basic phenomenon by purely economic characteristics,
unless one considers financing by bank-credit to be showing important economic
particularities that are characteristic of the capitalist enterprise, and of the
capitalist economic system in general. Obviously, the capitalist enterprise – in the
usual sense – already presupposes sufficient population density, security, division
of labour, sufficient wealth etc. Apart from these requirements, the origin and
functioning of the capitalist enterprise is a correlate of two groups of social facts:
first, of the existence of private – contractual – possibilities of command over the
means and outcomes of production. Private ownership is usually associated with
the existence of the physical means of production, even if this is not in principle a
necessity. In important historical cases, private ownership is also associated with
labour power. Second, it is a correlate of the existence of a mentality prone to eco-
nomic activity, whose most important derivates are an experimentally developed
technique of production, a mode of economic calculation geared towards being
useful for private enterprising, and a corresponding design of commercial law and
economic policy.
It is clear, however, that in any culture of this type, the “enterprise” as a form
of production is more than simply one of many cultural elements. Without doubt,
it is the “cause” of some and the “requirement” of other essential cultural char-
acteristics. The only point to be questioned is whether the enterprise, which can
be explained in pure economic terms, is the main cause of the expressed cultural
forms (economic interpretation of history), or whether – it itself being a product of
a fundamentally independent, viz. ideologically grounded, mentality – it just has
a counter-effect10 on this mentality (once it exists) and the cultural expressions
flowing from it. This question cannot be dealt with here.
It is also clear, however, that merely recognizing the economic essence of
the enterprise does not suffice to exhaustively explain the historical shaping of
the enterprise as a form of production through which the economic process is
characterised. Rather, the enterprise as a form of production is exposed to the

determining pressure of social facts that are completely accidental with regard to
the economic essence of the enterprise. The extra-capitalistic structural elements
of society have shaped the history and the present situation of industry. Such
extra-capitalistic elements are: [1. pre-capitalistic:]11 for example, the relations
of land-ownership belonging to the pre-capitalistic epochs; [2. extra-social:]
extra-social factors: inventions, discoveries, fortuity associated with the produc-
tion of precious metal; [3. not purely economic:] unintelligible circumstances,
or circumstances that are not entirely understandable in purely economic terms,
leading to the monopoly- and mercantilist policies of early capitalism – primarily
the formation and the struggle of the nation states and their colonial policy; [4.
brought about by state intervention:] the financial policy of the state, in particular
the mostly undesired inhibitions following from fiscal policy on the one hand, and
the very different policies leading to power positions of financial groups, on the
other – positions that can only be explained by the way in which the state’s demand
for credit was satisfied; the state regulation of monetary and banking matters and
of the employment relation, [5. due to individual influences:] the personal, national
and social quality of the people who actually founded enterprises and worked
there. Such extra-capitalistic structural elements of society have shaped the
history and the present situation of industry, and have, to a higher degree than the
process, which we can call the unfolding of the inner logic of the entrepreneurial
production, made the industry what it is, socially and culturally. But the fact
that these structural, extra-capitalistic elements had a shaping influence should
not mislead us to ignore the very real process of the unfolding inner logic of
production as a form of enterprise.12 In the formation of theories of “economic
stages,” it is nowadays common to construct historical epochs, and to associate
these epochs with “economic systems” and “economic mentalities” of a toto
coelo13 unique character (cf. mainly Sombart). It is further common to locate the
enterprising form of production in general within such epochs, or such forms of it
that presumably differ completely in their economic essence. Although necessary
for purposes of historical synthesis, and useful for purposes of attaining a fresh
perspective, such attempts of constructing historical epochs are never completely
satisfying: As pictures of life, they exhibit a uniformity and sharpness that are not
found in the stream of social life. As a means of analysis, however, they block
the view of important similarities in essence. Against this it must be maintained
that the enterprise – apart from the case of the most primitive hunt for food –
in principle only would be absent in the socialist form of organisation. Actually,
the enterprise exists in all observable historical situations – just like the existence
of regular trade, if ever so little, can only be questioned for prehistorical times –
and in its economic essence it always manifests itself in the same way. The
Entrepreneur 239
enterprise changes so much in the course of history that the outer characteristics
of the enterprise of our time, one after another, slip through our fingers while we
are observing it, and very quickly the eye, focused on the wealth of the empirical
phenomenon, no more recognizes any familiar traits. While the enterprise changes
incessantly, there is no change at all in its underlying principles, i.e. it is not to
say that in the distinguishable, changing “epochs,” revolutions in the nature of
economic activity14 take place, which correspond to principles that are distinct in
their economic core. Rather, that the changes in economic activity15 in general,
and to the productive apparatus in particular, ensue from the development of their
respective data: The merchant of the 11th century who imported silk, animal skins,
jewels, wine, oil, tusk, copper, tin, glass, silver etc. to England, is different from
the merchant of today, or the merchant of the times of Tacitus, neither because his
economic sense16 was any different, his thoughts were of a completely different
economic kind, nor because his acts followed different principles, but because he
faced different circumstances, and with that, different tasks. Therefore, we also find
that economic sociology distinguishes its epochs and types especially according to
non-economic characteristics, and to characteristics of very different kinds, such as
technical characteristics (use of machines, presence of orderly accounting), politi-
cal characteristics (type of economy of city and country17 ), cultural characteristics
(lifestyle of the economic subjects) or social characteristics (relative position of
employment18 in the hierarchy of occupations). As an example of a divergent
opinion let us point to Schmoller’s sentence, which is deep, although it only relates
to one aspect of the problem, that (Grundriß I, p. 462) “the merchant guilds of the
9th–12th centuries, the commercial trade guilds of the 13th–15th centuries, the
new merchant corporations of the 14th–18th centuries were in principle the same as
today’s cartels and labour unions.”
With these limitations,19 the following historical survey of forms and types can
be given:
(1) Conclusive evidence for the business cycle, which is characteristic of the
system of enterprise as a form of production, can, for England, only be
provided since the Napoleonic wars, and, for Germany, only since the 1840s.
Insofar as the business cycle represents a symptom of the relatively complete
carrying out of the production process through the enterprise, we thus seize
a classification criterion that is non-trivial with regard to the facts. Ever since
the appearance of the business cycle, the enterprise represents the mode of
production to such an extent that:
first, the enterprise completely permeates all the branches of economic
activity, no matter what their object – production, transportation, marketing,
financing, risk management etc. – so that also the social whole, where
it directly engages in economic acts,20 makes use of this form – fiscal,

municipal, cooperative, and mixed economic “enterprise”;
second, also establishments21 that did not originate as enterprises, in particular
the peasant farm, transform themselves or are transformed, into enterprises;
third, where the enterprise did not encounter any other kind of stratifications,
which is mainly the case in the United States of America, it created a social
structure in its own image to the effect that the social positions arranged them-
selves according to the functions that the individual economic subjects fulfil in
the scheme of the enterprise. And where the enterprise encountered structures
of a different kind, it triggered a process of rebuilding those structures, so
they tended towards reproducing the structural form of the enterprise;22
fourth, adapted to the enterprise, the technical and organizational methods
and forms developed more rapidly and would also become a common good
more rapidly than before;
fifth, little by little, the national- and ultimately the world-economy would,
through the system of interlocking elements of the exchange relationship,
become a “market” in the theoretical sense of the word, and
sixth, a payment- and credit-system23 encompassing the entire economic life,
and having the banking system at its centre, adapted itself to the vital require-
ments of the enterprise as it arose along with the money- and capital-market.
Within this epoch, one can further distinguish between
(a) the enterprise of the competitive economy, which broke through the old
constraints24 during the period of economic liberalism. The competitive
economy meant a complete, and incessantly revived, reorganisation of
the productive organism towards what is appropriate for the private
enterprise – and in many cases also socially – by the method of competitive
ejection25 of those that were neither adapted from the private enterprise
perspective – nor in many cases adapted from a social perspective. For
purely technical – that is, extra-social – reasons, the factory and earlier yet,
the large enterprise established themselves in this process as the typical
forms of production of physical goods, just as bank credit and association
of capital established themselves as the typical forms of financing. Given
somewhat larger dimensions, the de-coupling of the “household” from
the “firm,” which for similar reasons had already happened earlier, now
generally proved to be appropriate in technical accounting and absolutely
necessary when credit was used to a considerable extent. Parallel to this
development, there was the endeavour to achieve legal autonomy, for
Entrepreneur 241
which purpose the law of the profit-making companies,26 and in particular

the so-called five trading companies, was adapted and developed accord-
ingly. However great the importance of the elaboration of these legal
institutions, namely the stock company and the limited liability company,
for the development of the enterprise, and in particular for the supply of
capital, the little does the chosen legal form decide on the nature of the
enterprise and the de facto power relationships that concern it: The legal
form, which is sometimes based on empirically inaccurate legal theories,
does more to distort than to express the essence of the matter. Despite the
strong development of corporate law, the enterprise of “liberal” times was
usually the enterprise of one man, and one family, as the case might be.
(b) and the enterprise, as it may be said with even greater reservation, of
Neomercantilism. Actually, the name only fits the element of this time
that was a mere setback, a reaction carried by the circles whose existence
discouraged the unfolding of the competitive economy, above all the
craftsmen and the small “factory owners,” as well as the farmers. To
this category belong the formations of some cartels, above all of the
agricultural industry. But this current gained substantial and first of all
long-lasting importance, just as it gained its hostility against the form of
production and life of the enterprise, only by way of having – essentially
superficial – points of contact with a different current that transformed
the competitive economy and, what is solely of interest here, the form of
enterprise appropriate for the competitive economy. First of all, the estab-
lishment expanded many times over and, at a characteristically increasing
pace, rose above the size compatible with free competition and also
above the size of the establishment – notably, this latter event came about
organically, and not merely in the sense that one and the same firm led
several, similar or altogether different, establishments, which had always
occurred. For the two most important forms of merger, trust and concern,
typical organizational and administrative practices have quickly devel-
oped, and suitable legal structures less quickly. These two forms of merger
tend to develop from the mere merging of autonomous units (cf. above),
into the real units of the production process that contain the decisive
impulses – into enterprises. They further tend to make what had previously
been the enterprise of the competitive epoch, a mere technical estab-
lishment, a mere proxy,27 whose attributes cannot be inferred from the
entity itself.
This “movement toward concentration” – in the widest sense – is not as it
was formerly common to assume, in particular in association with Marx, the
necessary implication of the competitive economy. It is quite rare that normal
competition wipes out all but one or two28 establishments of an industry.

Rather, it was typically and as a rule deliberate activity, focussed on conquer-
ing and shaping anew, that agglomerated the establishments into the new big
units. As far as competition played a role as one of the tactical means – always
only one of many – it was not the competition of the “liberal” system, which
is tied to the law of cost and thereby finds a limit, but “cut throat competition.”
Already the mere dimensions of the new units29 give them a quality differ-
ent from that of the units of the competitive economy. From the perspective of
economic theory, the framework intended to capture the competitive economy
is bound to the assumption that the individual enterprise is but “a drop in the
sea,” and the bulk of results of this framework, in particular the fundamental
proposition that in equilibrium, all prices and quantities of goods are uniquely
determined, is the conclusion of this very assumption. From the perspective
of economic policy, the behaviour and fate of units of such dimensions
necessarily become a public matter, in many cases of national, perhaps even
international relevance; even for a state with an extremely “liberal” attitude
– if such a state could exist under such circumstances – a laissez-faire30 –
approach towards the individual enterprise therefore becomes practically
impossible. From the perspective of economic sociology, the modern enter-
prise transcends the driving forces and the kind of people associated with
the enterprise of the competitive economy, and in its essence, structure and
methods increasingly approaches the character of a public administration.31 In
part from this source, but mainly from other sources, which already appeared
in the competitive economy, the economic subjects develop a mentality
that detaches them from emotional and interest-led relations to individual
enterprises and individual persons, changes their old motivation, deprives their
accomplishment of its personal character and moves their psychological focus
away from family life towards professional life, dilutes private ownership
of the means of production to majority ownership and tends to strip private
ownership of its lively content and its cultural-sociological importance.32
(2) In retrospect, the first time we can identify all the mentioned elements, without
exception, is in the 18th century, and they only differ in their forms from the
present ones by the degree to which they have been unfolded. We find the
factory, the manufactory that quickly lost importance – if one wants to make
the difference between those production units oriented towards a mechanical
process and those that are mere agglomerations of labour at a production
site – and the putting out enterprise, which disappeared even more quickly,
ejected33 by factory and manufactory since the centres of consumption
attained the strength the latter two required. The further we go back – and the
lower a population density we meet – the more factory and manufactory fade
Entrepreneur 243
away, until they disappear completely in the 14th century whereas the putting
out system gains importance. Even if the putting out system does not require
strong markets to the same extent, it can still be a large enterprise, but a large
establishment only in strictly commercial terms.34 Since the 13th century,
the putting out enterprise and the household industry emerge alongside the
trades,35 which primarily means the trades are superseded according to
the possibilities of the time, i.e. in utilising the widening commercial reach,
where the trades, according to their nature, fail completely. In the second place,
the putting out enterprise often also represented the financial and commercial
organisational form of the crafts, which were already deteriorating.
The crafts of a medieval city are nothing but the organisational form of
the enterprises of a poor and small society. That the crafts survived until the
present day can be explained by social inertia, and by a partial change of func-
tion. The very pronounced cultural expression that the crafts have produced is
more important from a sociological and cultural-historical perspective than an
economic perspective: The professional spirit of the crafts, the master’s pride
in the product, is an essential element of any type of professional work, even
in modern industrial work. Not that the attitude towards market opportunities
would be absent – but these opportunities were just so narrow and unchanging
that utilising them did not constitute a particular function. In principle, all
production is production for consumers, the only difference is that in the case
of a small number of customers you know the individual customer personally
– but that is not essential. A small number of customers leads to primitive
technique, limited possibility of expanding sales, and a simple and transparent
commercial combination. In this instance, the rate of profit is therefore
commonly known and subject to control by the peers and by the public. This,
in turn, leads to the idea of a “civil earning of your keep,”36 which does not
constitute a particular principle of economic activity, nor a symptom of an
absent, or a fundamentally different, profit-making instinct. It is for these
reasons that a commonly known profit rate explains the policy of fixed prices
as well as the constraining of the individual’s freedom by his peers or by the
authorities. Finally, the small number of customers and the precarious position
of the city in a hostile environment explain the strong cohesion in the guild,
where the behaviour associated with individual situations has crystallised into
stable37 rules, into objective life-forms, so that we now get the impression that
the crafts were a unique entity, fundamentally different from what came later.
In the first place, the trade enterprise always co-exists with the industrial
enterprise that it complements, and that it is complemented by: the regularly
traded merchandise must be produced somewhere and with a consideration
of the demand of the merchants, the only exception being the case of trade
in stolen goods. The relative importance of both the trade enterprise and
the industrial enterprise, and also the type of trade enterprise (namely the
degree of its technical sophistication38 and specialisation – e.g. wholesale-
or retail-trade enterprise, trade- or transport-enterprise) simply depend on the
necessities of the particular case. The further back in time we go, the more
the trade enterprise gains in importance compared to the industrial enterprise.
As a large enterprise it persists longer than the industrial enterprise, and as a
small enterprise it extends beyond the times in which we can trace industrial
production as the basis of important social formations, such that the trade
enterprise appears to be the “original” form of enterprise. We can thus say
that “trade has created the enterprise.” The sole sources of this effect were the
lack of security in trade, and the difficulties associated with crossing space,
both of which used to assign an importance to the function of trade in the
economic process, an importance it could not possibly have at the present
day: The character of the enterprise and of entrepreneurial activity is always
determined by the particular task39 that presents most difficulties. Accounting
for the total mass of economic activity, the importance of the trade enterprise
is nonetheless decreasing the more we go back in time because – particularly
advantageous cases apart (for instance a production location at the seaside
or next to a river) – transportation costs disqualified goods produced in large
quantities from trade across large distances. Furthermore, transportation costs
made the other goods much more expensive. Even relative to the lower overall
population, the potential customer segments were thereby invariably shrink-
ing. That medieval trade was relatively negligible is explained only by this40
argument, not by some un-commercial way of thinking that the economic
actors of the day might have had. This would have to be explained in a different
way. Moreover, relative to the population, medieval trade and the importance
of trade enterprises was not as small as it was previously common to assume.
Neither the landowner’s manor estate,41 nor the medieval farm estate
were enterprises. The life-form of the manor- and the medieval farm estate42
certainly rests on principles very distinct from those of the enterprise. That is
not to say that such a life-form would be as different from the enterprising or-
ganisation of the economic process as, for instance, the socialist organisation
of the economic process. This is because the manor estate and the enterprise
are rendered incommensurable because of an extra-economic factor. The
manorial organisation, developed for a ruling class of warriors, is more than
an economic organisation. According to its underlying idea, the manorial
organisation has to fulfil tasks that are nowadays considered tasks of the state.
Its methods and ideals are comprehensible only from such a vantage point.
To the extent that the manorial organisation was an economic organisation,
Entrepreneur 245
it was incomplete and never able to completely shake off the trade enterprise
and the industrial enterprise. Similarly, the other way round, the manorial
organisation has always produced “for the market” to a modest degree, i.e. to
the best of its possibilities it sold agricultural products where the situation and
the modest capabilities43 of the warrior lord and his servants made it possible.
Far-reaching – but never complete – autarchy of the manorial estate was a
consequence of the circumstances,44 and not a consequence of a particular
economic principle. Moreover, the manorial estate’s trade with merchants
was a trait of its essence, and not a completely uninteresting aberration from
its essence. In this connection, we want to refer especially to the research of
A. Dopsch. Whether this also applies to the economy of antiquity and for
peoples outside the Mediterranean culture cannot be dealt with here, neither
can special forms of the enterprise, in particular the colonial- and the
war-enterprise.
We further want to point to a second meaning of the term “enterprise” in
science, which from a linguistic point of view is the original one: “Enterprise”
does not just refer to the unit of production, the shop,45 the firm itself. It
also refers to the process by which this unit, the shop, the firm, emerges, the
activity of certain economic subjects that create it. As we will see, only in
that sense the entrepreneur is the subject of the enterprise.
2. DEVELOPMENT OF THE SCIENTIFIC ANALYSIS OF

THE ECONOMIC SUBJECT “ENTREPRENEUR”
The historical and sociological analysis of entrepreneurship is of a recent date and
was originally developed by the historical school, and the tendencies stemming
from it. The economic analysis of the economic subject “entrepreneur” has
earlier origins, however. Scientists of the late 17th century developed a notion –
completely superficial, but not inappropriate – of the entrepreneur (who is usually
called “merchant” according to the empirical material of the time, e.g. by Locke).
In particular, they captured the entrepreneur in his characteristic juxtaposition
to the investor.46 Scientists of the 18th century and the classics did not hold on
to this idea, but – in accordance with the ever more spectacular emergence of
the industrial entrepreneur – they saw the entrepreneur mainly as the employer
(master, employer) on the one hand, and the owner of “physical capital” on
the other. Already the classics had sharpened the notion of the entrepreneur as
employer into that of the exploitation of labour. The English socialist theorists
of the first three decades of the 19th century and particularly Karl Marx then
continued this approach. Although the existence and importance of a capitalist
class that is not engaged in any entrepreneurial activity was not overlooked, and
could indeed not be overlooked, Smith always argues as if the possession of capital
and the entrepreneurial role would be inseparable. In principle more correctly than
this idea of his, Smith repeatedly mentions the entrepreneur’s administration and
utilisation47 of capital (e.g. Wealth, ed. Cannan I, p. 53) – Ricardo and his follow-
ers up to the younger Mill, who represents a remarkable progress, emphasised the
distinction between administration and utilisation of capital even more. Finally,
Marx exclusively contrasted the labour class with the capitalist class – and only
with the capitalist class.
That was completely wrong, however, and spoiled the understanding of the
mechanism of the market economy and its social consequences, of the essence
of interest and entrepreneurial profit, of the real structure of how oppositions
of interests and communities are textured, and of the tendencies inherent in the
capitalist form of economic organisation. It is the substantial merit of continental
science to have taken no part in this. In France, the chief merit of this belongs
to J. B. Say, in Germany to Hermann. Even if their works recognise and identify
the character48 and function of the entrepreneur,49 these issues are still analysed
in an unsatisfactory way. Moreover, character and function of the entrepreneur
are not completely separated from the feature of capital possession. The doctrinal
development of the 19th century has increasingly led to an emphasis on the partic-
ular personal performance of the entrepreneur and the particular competences50
necessary for that. The analysis of such performances has made very slow progress
beyond general insights, however. Still today, heterogeneous elements are sum-
marised under an “umbrella” term the meaning of which is best conveyed by the
English term “management.”
Initially, this term described a simple super-ordinate position in the organism of
the enterprise, as well as the functions of control, representation, and maintenance
of discipline, etc. The function of all kinds of current administrative work is
connected with the above functions, but has to be conceptually distinguished from
them. Everything that is thought to be included in these functions is obviously
work like any other form of work, and would clearly not be suited to characterise a
particular type of economic subject. Moreover, when removing the still remaining
associations between the possession of capital and the notion of the entrepreneur
(in particular the function of risk-bearing – which concerns the entrepreneur
legally, but not economically, apart from the case where he also is a capitalist),
we are left with the function of combining the production factors into the product.
The fulfilment of this function by a private economic subject also represents the
essence of the market economy: According to this interpretation, the entrepreneur
is the carrier of the exchange acts through which, in the case of an economy organ-
ised as a market economy, the economic process is realising itself. On the market
Entrepreneur 247
for means of production, the entrepreneur carries out the production-process

in his role as buyer, and on the market for consumer goods, he carries out the
distribution-process in his role as supplier.51 He does so uno actu, as the transac-
tions52 by which he acquires the means of production at the same time give rise to
the income of these factors. The entrepreneur is therefore simply the middleman
between the owners of productive services and the consumers, or, because the two
categories will eventually merge into one, he can also be seen as the middleman
between different groups of “suppliers of means of production,” thus ultimately:
a middleman between workers and land owners (according to most theories also:
capitalists). Only one point of this extraordinarily important aspect for the theory
of the market economy is of interest here: in an economy in a balanced state of
equilibrium, repeating its life cycle year in, year out (a “static” economy), no
long-lasting profit that could be distinguished from labour wage could under
perfect competition possibly be secured by the fulfilment of this middleman
function. Although occasional profits and losses would occur, the profit rate in the
equilibrium state would be zero: such an entrepreneur would, essentially and also
by inclination, be an entrepreneur faisant ni bénéfice ni perte (Walras). Therefore,
the true importance53 of the function of the entrepreneur consists, not in the mere
running, but only in the creation of an enterprise; in other words, in the second
meaning of “enterprise” referred to in the above.54 In that meaning, the function
of the entrepreneur is a special case of the social phenomenon of leadership. This
function will now be analysed in brief from this position, the only one that renders
it understandable.
3. THE ENTREPRENEURIAL FUNCTION

In all spheres of social life we observe the distinction between leaders and those that
are led, a distinction that in the end rests on differences in individual competencies.
Because of the stability of social positions once they are created, and the possibility
of their frequent inheritance, however, the distinction does not always immediately
rest on the just mentioned differences in individual competencies. Intellectual
characteristics (breadth of horizon, “alertness,” etc.) are only of secondary
importance, strength of will55 is, however, of primary importance. Formal56
characteristics of social positions and positions of other kind apart, this distinction
manifests itself both in the character57 of the functions of the leaders and of those
that are led, and in the way they behave. The essence of leadership is initiative, not
– or at least not necessarily – in the sense of mental initiative, i.e. for instance the
conception of new ideas. It is rather initiative in the sense of practical initiative, of
deciding what should take place, and carrying it out. In contrast, to receive orders
and carry them out is the essence of being led. Moreover, although leadership is
an activity, it is an activity to be called labour (we do not do this in the following)
only if we acknowledge it is a special kind of labour, which in its character stands
out against any other kind of labour. The leader is not simply a more able fellow or
a kind of foreman.58 Even when he is acting primarily, or maybe even exclusively,
by way of his example (as for instance in the arts and in science), it is not his
achievement as such that is decisive, but its effect on others. This effect per se is
not an integral part of his performance. Not the work on the desired object matters,
but the influence on and the domination over others. Others, whose activity, in
turn, is characterised as working according to given objectives, and according to
given rules. While the motivations that the leader-role is based on belong to the
sphere of the “urge to act,” of the will to dominate and win, the motivations of
those that are led, can essentially be described either as hedonic, or59 by means of
concepts like “devotion to duty.”
Leadership only has a function when something new60 has to be carried out, not
something already established by experience and routine. Precisely for this reason,
no leader is merely, and nothing but, a leader; he is not even then merely a leader
when he lacks a formal61 position and solely has an impact through his personal
weight, for the reason that in between the moments in which he “leads” – and such
moments are in principle the exception – there are always additional things that
he must take care of. It is much less the case that a leader is merely a leader and
nothing but a leader when he, as is the rule, is holding a formal position in some kind
of organism, the leader-function thereby being blurred with the execution of the
current tasks of that position. For this reason, leadership is never purely embodied
in concrete persons, and its essence therefore has to be carved out of a more or
less complicated conglomerate by way of analysis.62 But it is easy to convince
oneself that only the above mentioned function is essential for the leader, while
all other functions usually63 associated with the leader-function are accessory,
non-essential and conceptually separable from it. If only the execution of routine
activity would do when an army is in action, and it did not also depend on the
making and implementation of ever new projects and decisions; if a political body
would never encounter new situations, but rather what happened in the previous
year would just repeat itself; if science would not always run into new problems
but just had to apply a known stock of knowledge according to known rules, then,
generally speaking, an organisation would still be required, which in the first two
cases also would require an administrative hierarchy. Finally, one would also need
a somehow structured individual or collegial apex for such a hierarchy – but there
would be no need of any “leading men.” The administrative tasks to be taken care
of would not be substantially different from other tasks, and their fulfilment would
be trivial labour of implementation that does not represent a function sui generis.
Entrepreneur 249
The entrepreneurial function is nothing but such a leader-function in the sphere

of the economy. At every point in time the economy works with a stock of given
experiences and is based on given data that are familiar by virtue of recurring
routinely. Every economic period is similar to the previous one, as well in its basic
outline as in the mass of details. In essence – producing and consuming – it fulfils
the same tasks as the previous one. This is the case not only because the continuous
circular flow of production and consumption times and again creates the same
objective situation – so to speak year in, year out – a situation that always offers
essentially the same opportunities and excludes others. It is also the case because
the economic subjects always approach them64 and, as a rule, under the pressure of
the necessities of everyday life, have to approach them, with essentially the same
ingrained and slow-changing mentality, the same knowledge and experience, the
same openness of horizon, the same production methods, business habits, tastes,
and the same relations to customers, suppliers, and competitors. The fact that the
mass of economic activities each move in well-trodden and familiar tracks on
the one hand explains the relative promptness that characterises behaviour in the
economic sphere, which otherwise would require a much higher degree of ratio-
nalism, alertness and energy than the average person can draw on. On the other
hand, it explains the failure of the average economic subject whenever it faces new
situations, such as a crisis for instance. It also explains the smooth, almost auto-
matic course of the normal economic period: Every element of productive power65
follows in principle the same path year in, year out. As if it were happening by
itself, i.e. with the help of a relatively minimal addition to the mental performance
that has been pre-performed by decades and even centuries, and has become
subconscious and habit, the means of production offers itself to the producer, the
desired consumer good to the consumer. In each economic period, the producers
use technical manipulations and commercial calculi that for the most part remain
forever unaltered. Finally, in each economic period the consumers employ,
on the whole, the very same demand- and value-estimations, and they exhibit
the very same actions constituting demand.
Now, there are three ways in which the transition from such a given state
of the economy to another state takes place, in which the “data of the equilib-
rium state” change, and in which “economic development” takes place: first,
through continuous growth, in particular of the population and the apparatus
of produced means of production. Second, through extra-economic events that
permeate the economy, such as events of nature, social upheavals, and political
interventions. Third, because some individuals recognise and carry out new
possibilities within the given circumstances of economic life, possibilities that
extend beyond economic experience and tried and familiar routine. The third type
of development is by far the most important, it is further the case that the first
two types become partly effective through it – that is, they give occasions for the
emergence of new possibilities. The essence of the entrepreneurial function lies
in recognising and carrying out new possibilities in the economic sphere. Such an
economic leadership thus occupies itself with tasks that can be summarised in the
following types:
(1) the production and carrying out of new products or new qualities of products,
(2) the introduction of new production methods,
(3) the creation of new forms of industrial organisation (for instance trustification),
(4) the opening up of new markets,66
(5) the opening up of new sources of supply.
All these are cases of carrying out a different use of national productive forces from
the previous one, of taking them away from their previous uses and putting them into
the service of new combinations. The nature of the achievement to be accomplished
in this process is characterised first, by the objective and subjective difficulty of
taking new paths, and second, by the resistance of the social environment against
doing so. For instance, the data required for the production and marketing67 of
a so far unknown product are obviously not known from experience in the same
sense that they are known for the organisation of production and marketing, which
for all practical purposes involves the same tasks as in the previous year. Rather,
the data have to be estimated (expected demand, for instance), or even created.68
The sources of error are therefore not just marginally, but substantially larger.
The relationship between pre-performed activity that just has to be mechanically
repeated on the one hand, and new performance that still has to be consciously
executed, on the other hand, is likewise not just marginally, but substantially more
unfavourable. Furthermore, from a subjective point of view it is more difficult to
do something new than something familiar. In doing something new we are not
supported by the same feeling of solid reality, and we have to overcome our mental
and behavioural habits and have to liberate ourselves from the dictation of routine.
Finally, our environment opposes unfamiliar behaviour. In the yearly circular
flow of what is familiar, however, people cooperate automatically, and on a whole
willingly. The worker opposes new methods, the consumer new products, and the
public opinion, public administration, the law, and creditors oppose new forms of
establishments. It lies in the nature of routine work following well-trodden tracks
that the average intelligence and will power of the actors of a particular place
and period is sufficient. Overcoming the difficulties just mentioned, on the other
hand, requires characteristics that are only possessed by a small percentage of the
population. In order to pull the whole of a national economy into such new tracks
and give new shape to the stock of economic experience, the economic leadership
of such individuals is therefore required. For a comprehensive justification
Entrepreneur 251
see the author’s “Theorie der wirtschaftlichen Entwicklung,” 2nd ed. 1926.
(Cf. also entry on “Leadership,” Vol. IV, p. 530ff.)
4. TYPES OF MODERN ENTREPRENEURSHIP

Economic leadership has to exist in all forms of economic organisation.69 In
organisational forms other than the market economy, economic leadership would
either be tied to an administrative position70 – for instance in the socialist
economy – or to a position of dominance that has its base outside the economy –
in which case it would make use of feudal authority. The form of economic
leadership associated with the market economy is the entrepreneurial function.
It is distinguished from the other types of economic leadership by its focus
on self-interest, by the mode of selection of leaders, and by the way in which
the leader, who does not have any authority in such an organisational form,
acquires the necessary means of production – namely, purchases them on the
market for means of production. The basic function of the capitalist is to provide
the financial means for this purpose, which in this case cannot be provided by
current income stemming from already completed production. The first two
characteristics mentioned above, however, cannot always be found in pure form in
the multi-facetted types of entrepreneurship, of which we want to underline four.
(a) The dominant type of the competitive era, still common today, was the factory
owner and merchant. In his person, he united so many heterogeneous functions
– which in his person were combined into a whole71 – so what is most essential
often completely disappears from sight. Above all, he was very much a cap-
italist. As such he had a definite social position that the entrepreneur as such
lacks: the entrepreneurs per se do not form a social class – in accordance with
the personal character of their function. The successful ones amongst them
nevertheless build a basis for themselves and their families,72 in order to have
a position in the capitalist-, maybe also in the landowner-class. Even if this was
the case then, and even if the entrepreneur had usually achieved his success by
struggling on through his debts,73 it occurred much more frequently than today,
that an individual, and particularly, in the course of generations, a family, rose
to the entrepreneurial position. In this picture, we should also include the role of
other positions of dominance in the development process of the entrepreneurial
position (factory foundations by landowners). Property and entrepreneurial po-
sition thus coincided to a higher degree than today, such that the entrepreneurial
position also offered an impression of inheritability – only an impression, how-
ever, because inherited property facilitates the entrepreneurial role in the sense
described here, but it does not already represent it (as opposed to the capitalist
role). While that does not change the essence of the matter at all, it nonetheless
explains the social and psychological habitus of this type and its culture. The
dominant type of the competitive era is in the centre of the bourgeois economic
and mental universe, whose strongest element he represents. He embodies and
endeavours ideals of bourgeois properness, business acumen, and life form.
He is the man with family spirit and the autocrat of “his” establishment, with
a tendency to consider any intervention by law and administration not only as
unpleasant but also pointless. His self-interest is mainly oriented towards the
care of the family, now and in the future, and towards a non-rational love for the
firm, and his social feeling is oriented towards acts of voluntary “care.” Today,
we have a better overview of those matters and of the processes of rise and
fall of the entrepreneurial personality – or more correctly, the entrepreneurial
family – than it appeared in the literature of the 19th century, especially the lit-
erature coloured by a socialist perspective. However, only the detailed research
commencing now will be able to provide full clarity, in particular also on the
question precisely to which extent – without doubt it was the case to a very high
degree – this entrepreneurial type grew out of the working class74 and basically
only represented its upper stratum – a very instable upper stratum.
Furthermore, this type was the manager75 of the current business of the
enterprise. As a rule, he was his own technician and commercial manager,
and in current business, often also his own lawyer. His education was mainly
technical and commercial, but sometimes also legal. It is, however, important
to note that this fact did not pertain to the entrepreneurial function. In
particular, it is simply a chance encounter if the entrepreneur also happened
to be the technical inventor, or if the plan that he implemented was in any way
his own intellectual creation. That all these functions can be distinguished
from the basic function of the carrying out of new economic combinations
is proven by the fact that, in practice, the various functions are also found to
be separated from the basic entrepreneurial function, and are often provided
as a service against separate payment. Nevertheless, as described above,
these elements of technical and commercial competence also pertain to the
entrepreneurial type as a real phenomenon.
(b) The type of the modern captain of industry is not only distinguished from
the factory owner and merchant type described above in terms of the lack of
such accessory functions, which makes him a “purer” type of entrepreneur.
As a rule, his position as entrepreneur depends on the possession of, or the
authority over majority shareholdings, and in the latter case, his position will
ultimately depend on a personal influence on the capitalists, and in particular
on the banks which own majority shareholdings. The main outer expression
Entrepreneur 253
of the entrepreneurial position lies in the positions that the development of

the law on stock companies has created (president, managing- or executive
supervisory board member,76 administrateur délégué, etc.). A man of this type
does not necessarily have a relationship to a concrete factory or labour force.
He merely coordinates the general direction of the business policy of his com-
panies, he creates something new from them and with them, and he decides in
dangerous situations. He is not simply the representative of his own interests,
or his family’s interests. Were this solely his function, it would be considered
inappropriate by him, and by others. He is not the typical bourgeois77 that in
the first place takes care of his family, and whose motivation is rooted in his
family home. For him, it is “problems” more than “business” that matter. He
has a characteristically different relationship to labour than the factory owner,
and even if, on certain occasions, he often has the opportunity to consider
a trade union as an opponent, he could not make it without labour unions
because of his mode of operation. His self-interest is not simply oriented
towards profit as such, but towards power, performance, the will to win, and
the urge to action. He is, against his will, the pioneer of the planned economy.
(c) Because the person that actually carries out the entrepreneurial function is
entrepreneur, also a “manager” who enters this position by way of an employ-
ment contract can be entrepreneur. Although in this case, self-interest, in the
sense of a connection between success and monetary profit, is not absent, it is
an example of an intermediate form that is particularly interesting, precisely
for this reason. Apart from the striving for sufficient income, it is mainly a case
of orientation towards the ideal of good professional performance, towards
the applause of the colleagues, the stakeholders and the public, and towards
personal reputation. These ideals, rather than entrepreneurial profit, are the
decisive motives of behaviour. Lifestyle and attitude to life are adjusted to this
orientation, and a far-reaching indifference towards the involved capitalist
interests is a frequently observed effect. The ascent follows a path that often
is more like the career of a public servant than that of a factory owner.
(d) Finally, by its purpose, the “founder” (promoter)78 is a type who is completely
focused on the entrepreneurial function. This type is characterized above all
by the lack of a social reference point, the focus on seeking and carrying out
new possibilities, and the lack of enduring relationships to individual estab-
lishments. Even if he also regularly carries out legal work and tends to matters
of technical finance, this only plays a minor role. Furthermore, the often low
social and moral status of this type has the effect that practice and science
show a reluctance to recognize him as a normal element of modern business
life, and in particular, as an economic “leader.” Nevertheless, when all is said,
what is called an economic “leader” is often nothing more than a middleman.
This observation notwithstanding, one can best epitomize the entrepreneurial

role as such by this type – even if the higher-situated representatives of this
type are not known by the denomination of entrepreneur.
5. PARTICULAR QUESTIONS
Despite all discussion, much research on the following fundamental questions

regarding social forecasting and economic policy still has to be done. Even so, at
least a preliminary answer is possible:
(1) In how far is self-interest and private property of the means of production an
indispensable driving force and a requirement, respectively, for the successful
accomplishment of the entrepreneurial function? The previous description
shows that self-interest – which hardly ever can be understood as merely
hedonic, rational and individual egoism – can adopt many different forms. It
shows that self-interest can adapt to very different social circumstances, and
in its most simple forms – the striving for maximal personal monetary profit
– very often, even today – for some types more than for others – is substituted
by objectives of a different kind. It is possible that a progressing conformity
of everyday habits and a progressing decline of the importance of the family
for individual life might, in times to come, still further loosen the link between
entrepreneurial profit and activity, something that no legislation could enforce
on actual entrepreneurial types without paralysing their activity. As opposed to
that, the importance of private profit as a fund available for further expanding
the reach of the entrepreneur-personality’s activity – and it is indeed for this
purpose, for further investments, that it is mainly used – is not influenced by
the tendency to loosen the link between entrepreneurial profit and activity.
The case is similar with regard to the entrepreneur’s private property, and the
freedom of the employment contract. The practice of the stock company, and
of collective contracts, shows that they could be missing. It would also be
conceivable that land belonging to the state, and labour force paid by the state,
would be delegated to the entrepreneur. But thereby, the possibility of prompt
and frictionless disposition would be reduced, just as the disappearance of
the particular property relation between the entrepreneur and the apparatus of
physical production, already at the present time, is a source of passive entries
on the balance sheet, because they trigger a particular behaviour that does not
at all merely depend on profit interest.
(2) What is the origin of the superiority of the private enterprise over the public
enterprise? This superiority is remarkable, not seriously questioned, and even
Entrepreneur 255
greater than it seems because the example of the private enterprise is viewed in
direct comparison to the public enterprise, and because new methods – e.g. in
the form of new machines – are perpetually offered to, and even forced upon it,
by the private enterprise. Considering what has been said above, it is clear that
this cannot simply be explained by claiming that everyone works better when
he does so on his own account. Neither can a higher level of professional
knowledge in the private industry be the explanation, because the state can
always acquire the best available knowledge. The explanation rather seems to
lie in the following two facts: In effect, the private industry is mainly directed
by a circle of persons that still today, even when they have not personally
gone through the school of the competitive struggle, hold on to its tradition,
and represents the result of its selection. Moreover, the one-man-enterprise
of the competitive era is a unique method to provide a complete freedom of
choice, and at the same time, the strongest assurance against a lack of a sense
of responsibility. As a rule, the modern large enterprise, and in particular the
trust – trusts and concerns that are absolutely dominated by one man still exist
– have grown beyond the possibilities awarded by this method. Nevertheless,
much of the principles of the competitive struggle are still preserved in the
modern large enterprise, while the leading man of the public enterprise is
paralysed. He is paralysed, not so much because of the awareness that only a
small share, if any, of the pecuniary success of an innovation will be his, but
because of the need, in each and every case, to convince numerous constituents.
(3) Is the importance of the entrepreneurial function increasing or decreasing?
It is beyond doubt that the question has to be answered in the latter sense,79
notwithstanding the impression to the contrary that the figure of the “big” en-
trepreneur has become a particularly noticeable element of modern economic
and social life because of the increasing size of the unit of the enterprise. This
is because the social whole is getting ever more used to incessant innovation
within the realm of the economic process, and it is becoming ever more taken
for granted that every new insight, as soon as it presents itself, is also carried
out into economic practice. Just as the bounds of what is strictly calculable –
technically as commercially – are expanding to intrude ever further into other
fields of activity, they are intruding into the field of economic activity. Both
circumstances80 not only facilitate and democratise the leader function in
general, and the function of the entrepreneur in particular, but also decrease
their importance: a number of the difficulties that were, and still are, essential
tasks for the entrepreneur to overcome, tend to disappear. And oftentimes,
what earlier required – and to a large extent still today requires – “eye”
and “personality,” is today becoming specialised professional work that can
be learned. The only thing that can be questioned is how far this process,
which in its nature cannot be stopped, has already progressed, how fast it will
progress, and whether a rational economic policy can reasonably build on the
present results of this process.
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NOTES
1. Schumpeter uses the expression “economic subject” to denote what we today would
call an “economic agent.”
2. The original term is “soziale.” Throughout the text, we translate this as “collective”
as Schumpeter contrasts this level with the individual level.
3. The original term is “wirtschaftliches Sonderleben.” The meaning of the term is
“economic, as opposed to general, life.”
4. The “pressure of given circumstances” not only parallels the contemporary use of the
term “selection pressure” in behavioural economics and theories of economic evolution, but
more importantly also Schumpeter’s own use of the term Auslese (selection) to characterize
the process of competition in a string of works during the late 1920s (Schumpeter, 1927,
1929a, b). Thus, among the most important topics Schumpeter focussed upon after resum-
ing his academic career in 1925 was the role of the entrepreneur in economic development,
and related, the characterisation of competition by the severe behavioural limitations of
economic agents; the latter point leading to the understanding of competition as a selection
process. Weber had a few years earlier, partly on grounds of empirical realism, concep-
tualised (economic and social) competition as a selection process, and explicitly related
this conceptualisation to the idea of biological selection (see e.g. Weber, 1978, pp. 38–40).
Moreover, Weber (1978) consistently emphasized the importance of behavioural limitations.
5. Although the original German term “bewußt” has been translated as “conscious” a
few words before, it here has a different meaning in referring to plans: “deliberate.”
6. That is, a planned economy.
7. The original term is “Erwerbswirtschaft.” We have chosen to translate this as “profit-

making economy” because it emphasizes the opposition with “subsistence economy.”
In the translation of Weber’s Economy and Society (1978), “Erwerb” is also rendered
consistently as “profit-making.” Thus, we view Schumpeter’s contrasting categories of
“profit-making economy” versus “subsistence-economy” as a close parallel to Weber’s
distinction between Capitalism associated with “profit-making” (Erwerben) and Economic
Traditionalism associated with the pursuit of immediate wants (Swedberg, 1998). This
statement is, therefore, quite important since Schumpeter in proposing selection pressure
and behavioural limitations downplays the importance of the fundamental dichotomy used
consistently by Weber in a number of works including Economy and Society.
8. The original term is “feststellen.” It could also have another meaning, which is “fix,”
“set in a fixed position.”
9. The original term is “privatwirtschaftlicher Natur.” We use “private enterprising” for
“privatwirtschaftlicher” and subsume “Natur” in the qualifier “related to.”
10. The original term is “zurückwirken.” We have translated it as “counter-effect” in line
with our translation of Schumpeter (1911), see Becker and Knudsen (2002).
11. Here and in the following, we have added the square brackets and their content in
order to give the reader some help in the long enumeration of extra-capitalistic elements
that follows. The classification into five categories of extra-capitalistic elements is ours.
12. In the original the expression “diesen letzteren” unambiguously refers to “Of the
unfolding inner logic of production.” “Of the unfolding inner logic of production” is
therefore inserted for clarity.
13. Toto coelo is the local ablative form of the Latin word coelum, which means “sky” or
“heaven.” The expression literally means “the whole sky.” In the present context, it qualifies
the term “unique.” After consultation with a Latin scholar, we arrived at the conclusion that
the meaning of the term here is “completely unique.”
14. The original term is “Wirtschaften,” we have stayed close to the Weber translation
(Weber, 1978) of the term as “economic action” but have amended it to “economic activity”
for reasons of elegance.
15. The original term is “Wirtschaften,” we have stayed close to the Weber translation
(Weber, 1978) of the term as “economic action” but have amended it to “economic activity”
for reasons of elegance.
16. In deviation from the translation used throughout the text for “Erwerb,” “profit-
making,” we chose to translate the term “Erwerbssinn” as “economic sense” because it
refers to a broader concept here.
17. The original term is “Stadt- und Territorialwirtschaft.” Our translation refers to the
famous title of Henry George’s essay “City and Country” first published in 1883 in his book
“Social Problems.”
18. The original term is “Erwerbstätigkeit.” The translation used in Weber (1978) is
“Acquisitive activity.” We use the freer translation “employment.”
19. The limitations mentioned refer to whether the survey reports changes in the expres-
sions of economic life (the phenomenal level) or rather in its underlying principles. This
becomes clear in the above passage, where Schumpeter describes two different opinions
about what it is that you can observe when tracing the change of economic life.
20. We have translated “wirtschaftet” as “engages in economic acts” rather than choosing
the more ambiguous “acts economically” or “economically acting.”
21. We translate “Betriebe” as “establishments,” following the Weber translation (Weber,
1978).
Entrepreneur 261
22. The original reads “nach ihrem Ebenbilde hin.” Schumpeter here uses the words
of Gen. 1:27, a point we thank our referee for. A verbatim translation would be “towards
its own image.” Referring to the American Heritage Dictionary, we define “image” as “A
reproduction of the form of a person or an object, especially a sculptured likeness.” This
leads to the above translation.
23. The original term is “Kreditwesen,” which literally means a credit system, even if
has found use as (modern) technical term for “banking.”
24. The term “Bindungen” has been translated as “constraints.” The term can also have
the meaning of “links” or “connection.” However, in our interpretation the constraining
character of links is in the focus here.
25. The original term is “Niederkonkurrieren.”
26. “Erwerbsgesellschaften” has been translated as “profit making companies” where
“Erwerbsbetrieb” has been translated as “profit-making enterprise” (Weber, 1978).
27. The original term is “Expositur.” The usual translation is a “wing,” for example to
a school or a church. In the Austrian vocabulary, however, “Expositur” also takes on the
meaning of a “proxy.” We have chosen the latter translation because it fits the meaning of
the sentence, and because Schumpeter was an Austrian, and would therefore be inclined to
use “Expositur” in the sense particular to the Austrian.
28. A precise translation would be the slightly more awkward “all but one or few.”
29. I.e., trusts.
30. The original term is “der Grundsatz prinzipiellen Sichselbstüberlassens.”
31. The original term is “öffentlichen Verwaltungskörpers.” In the context that the
term is used in here, “Körper” also shows up in “Körperschaft,” which denotes a
public institution (e.g. ministries, district attorneys, etc.). Therefore, the translation as
“institutions” seems to be the most appropriate one. It would also have been possible (at
least in modern German) to say “öffentliche Verwaltung” in German, dropping “Körper.”
The term “public adminstration institution” is somewhat clumsy in English, however.
32. The original term “Bedeutung” has a double meaning: “importance” and “meaning.”
We chose “importance” here as it captures the implication of a loss of meaning, and thus
encompasses both terms in their implications.
33. The original term is: “niederkonkurriert.”
34. As mentioned above, the point is that the enterprise and the establishment are
distinguished on the basis of technical and commercial aspects of economic organization. In
the particular instance of the putting out system, Schumpeter points out that the constraints
on size appear when it is viewed as an establishment, not when it is viewed as an enterprise.
35. The terms “trades” and “crafts” are used interchangeably.
36. The original term is “bürgerliche Nahrung.” In the context of the present discussion of
the medieval – and small – city, Schumpeter emphasizes in particular the fact that economic
life is taking place in small circles of participants. For this reason, we have chosen to
translate “Nahrung” with “earning of income,” referring to the meaning of “Nahrung” as
“Ernährung,” or “Erwerb.” In the present context, “bürgerliche” seems to refer to a principle
of how to do that. Again, for us the term refers primarily to the small number condition,
i.e. the fact that economic activity takes place in small circles. This implies taking into
consideration the others to some extent, behaving in a “civilised way” defined by the rules
of the civilisation in question.
37. The original term is “fest,” which could also mean “fixed” (hinting towards
the institutional support for the stable behaviour pattern rather than this phenomenon
itself).
38. The original term is “Ausbildung” which means “expression.” In the present
context, the degree of expression is best rendered by “degree of sophistication.” Note
that “Ausbildung” could also mean “education” or “formation.” The two meanings are
connected, in that higher sophistication requires higher education to operate.
39. The original term is “Teilaufgabe.” The precise meaning is “sub-task,” a part of a
bigger one. This component of the meaning has been omitted. It should be kept in mind
that Schumpeter refers to a task that is part of a bundle of tasks.
40. Italics added in order to convey the emphasis on the word in the original.
41. The original term is “grundherrlicher Fronhof.” The precise meaning of this term
is that of a (large) farm the owner of which not only owned the land, but also had some
kind of property rights over the employees (“Leibeigene,” those “whose body is owned by
someone else”). These have to perform labour not out of their own decision, i.e. they have
to perform forced labour.
42. Schumpeter subsumes both manor estate and farm economy under one life-form.
43. The original term is Eignung.
44. The original term is “Verumständung,” which is different from “Umstände” (which
means circumstances). However, this difference – a participle, i.e. a process – is very difficult
to render in English. A word like circumstantification would be needed.
45. The original term is “Geschäft.” This term could also have the meaning of “affairs,”
but in our understanding in the present context Schumpeter emphasises physical aspects of
business activity.
46. In the sense of “money lender.”
47. Italics added to better bring out the contrast to the sentence before, i.e. between
possession vs. administration and utilisation of capital.
48. Original: “Typus.” We have chosen to render this as “character,” as this is what
Schumpeter is talking about: the character and the function of the entrepreneur. In the
passage under consideration, he does not develop a typology of the entrepreneur, but reviews
different opinions regarding the character (essence) and function of the entrepreneur. A
typology is then presented towards the end of the article.
49. “Of the entrepreneur” added for clarity. Considering the previous as well as the
following passages, there is no doubt that “Typus” refers to the entrepreneur.
50. We have chosen to render “Eignungen” with “competences” because they are linked
to performances.
51. Similarly, the original term here is “Anbietender.” Thus, Schumpeter describes the
actions of demanding and offering something to and from the market, not the fulfilment of
these demands and offers through market exchanges, as our translation implies. However,
the translation has been chosen because to make what has just been said clear is a task not
possible simply by choosing other terms.
52. The original term is “Kaufakte.” This term is more specific than “transaction,”
referring to “purchasing transaction.” As they refer to means of production (factors), it is
clear that the transactions in question are the acquisitions of the factors, not their sale.
53. The original term is “Bedeutung,” which can mean “meaning” as well as “impor-
tance.” We choose “importance,” because it also encompasses the implications of “true
meaning,” too. Surely, the implications are not to be ignored, and thus the translation as
“importance” is the safer choice here.
54. Schumpeter here refers to Section I of this text, where he distinguished two meanings
of the term “Unternehmung”: the institution, or “unit” in his parlance, and the activity of
entrepreneurs that leads to the emergence of enterprises.
Entrepreneur 263
55. The original term, “Willenseigenschaften,” is more encompassing: “characteristics

of will.” Our translation emphasizes the strength of will as its most important characteristic,
an interpretation in line with Schumpeter’s early writings (see Becker & Knudsen,
2002).
56. The original term is “äussere” – this literally means “external” in the sense of
superficial or at first sight. As becomes clear on the next page, this does not make very much
sense, because Schumpeter talks about “äussere Position in irgendwelchem Organismus” –
so it is internal, not external. We think that Schumpeter here means another connotation of
“äussere,” the fact of being recognizable from the outside. This meaning is best conveyed
by the term “formal,” as in a formal hierarchy.
57. Although the original term “Wesen” also carries the meaning of “essence,” we believe
Schumpeter does not talk about the essence of the function here, but about its phenomenal
expression.
58. The original term is “Vorabeiter.” The usual meaning is a man who serves as the
leader of “ordinary” workers of a workcrew.
59. Our translation of “sei es . . . sei es’ is a little stronger than the original term, as it
introduces – at least implicitly – an element of opposition in the pair that is not emphasised
by Schumpeter.
60. Italics added to better bring out the contrast with “something already established.”
61. See footnote on “external” above.
62. Schumpeter here refers to a complicated intertwining of factors, not a conglomerate
in the sense of “trust,” i.e. an organisation.
63. The original term is “mehr oder weniger regelmässig,” and the straight translation of
that would be “on a more or less regular basis.” It renders the translation a bit clumsy, though,
and it can be argued that “usually” also encompasses, if however does not emphasise, the
“more or less”-aspect.
64. These possibilities.
65. The original term is “Produktivkraft.”
66. The original term “Absatzmärkte” emphasises that it is markets for the sale of
products, not markets for purchasing of supplies.
67. “Absatz” has been translated as marketing, giving the term a wider interpretation
than the alternative, “sales.”
68. The original says: “oder selbst erst geschaffen werden.” There are three possibilities
of how “selbst” could be used here: (i) it refers to the subject, i.e. the one who has to estimate:
“or yet have to be created by oneself”; (ii) it refers to the object of the estimation: “or yet
have to be created themselves”; (iii) it has a mere gap-filling/sentence-flow function, and
thus can be dropped in the translation.
69. When Schumpeter talks about “organisational forms” (“Organisationsformen”), he
thinks about the organisation of an economy – and not, as a modern perspective would imply,
firms. This becomes clear when considering the alternative organisational forms available:
market economy and socialist economy. Therefore, the term “organisational forms” has the
meaning of “forms that an economy can be organised in.”
70. The original term is “Organstellung.” Note how the word “Organ” is close to the
“Organism” that Schumpeter talks about elsewhere in the text. In our interpretation –
and translation of the term “Organstellung” as “administrative position” – (at least) one
important meaning of “Organism” for Schumpeter is what we today would call hierarchy.
71. The original term here is “Einheit.” We have chosen to translate this as “whole,”
because we think what is emphasised here is not the meaning of “Einheit” as a “unit” (that
can be counted for example), but the fact that this it forms a recognisable whole (Ein-heit,
literally “one-being”).
72. The original term is “die Ihren.” Strictly speaking, this could mean all persons that are
somehow attached to the entrepreneur. However, the family seems to be the most important
group of such persons.
73. The original term is “durch seine Schulden hindurch den Erfolg erstritt.”
74. The term “Arbeiterschaft” has been translated as “working class” although the term
“class” might introduce a new emphasis here. It has been chosen because it is the best term
available for a collective of workers, on whom the emphasis is here.
75. The original term “Leiter” is best translated as “leader.” This, however, is also the
best translation of the term “Führer” and has been used as such in our translation. In order
not to confound “Leiter” and “Führer,” we decided to translate “Leiter” as “manager,” in the
sense that this is the person who directs others. Another possibility would be “Director.” In
contemporary use, “manager” rather than “Director,” however, better captures the meaning
associated with the use of the term “Leiter” in the present text.
76. This is the precise translation of the term “leiternder oder geschäftsführender
Aufsichtsrat.” From a modern perspective, the executive and management positions would
be located on the executive board, while the supervisory board would have supervisory
tasks. It seems that in the context Schumpeter wrote in, this was different.
77. The orginal term is “Bürger,” which also, more generally, means “citizen.”
78. The original line reads “des Gründers (promoter).”
79. I.e., in the negative, the importance of the entrepreneurial function is falling.
80. (i) That the social whole is getting ever more used to incessant innovation within the
realm of the economic process; and (ii) that it is becoming ever more taken for granted that
every new insight, as soon as it presents itself, is also carried out into economic practice
because the possibilities for calculation are improving.
ACKNOWLEDGMENTS
The authors and the publisher would like to thank Urban & Fischer Verlag for the
permission to print the translation of Unternehmer (Entrepreneur). The authors
are very grateful to Meta Andrés for linguistic assistance with the translation, to
Minna Skafte Jensen for assistance with a particularly contrary Latin expression,
to Richard Swedberg for the inspiration that led to the translation, and to Ulrich
Hedtke, Roger Koppl and an anonymous reviewer for very useful comments on a
draft of the translation.
REFERENCES
Becker, M. C., & Knudsen, T. (2002). Schumpeter 1911: Farsighted visions of economic development.
American Journal of Economics and Sociology, 61(2), 387–403.
George, H. (1953) [1883]. Social problems. New York: Robert Schalkenbach Foundation.
Entrepreneur 265
Schumpeter, J. A. (1911). Theorie der wirtschaftlichen Entwicklung (1st ed.). Duncker & Humblot,
Leipzig.
Schumpeter, J. A. (1927). Unternehmerfunktion und Arbeiterinteresse. Der Arbeitgeber, 17, 166–170.
Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 160–173).
Schumpeter, J. A. (1929a). Der Unternehmer in der Volkswirtschaft von heute. In: B. Harms (Ed.),
Strukturwandlungen der Deutschen Volkswirtschaft (2nd ed., Vol. 1, pp. 303–326). Berlin:
Verlag von Reimar Hobbing. Reprinted in: W. F. Stolper & C. Seidl (1985) (pp. 226–247).
Schumpeter, J. A. (1929b). Ökonomie und Psychologie des Unternehmers. Vortrag vor der 10. Or-
dentlichen Mitgliederversammlung des Zentralverbandes der deutschen Metallwalzwerke- und
Hütten-Industrie e. V. am 22. Mai 1929 in München. Leipzig: Haberland. Reprinted in: C. Seidl
& W. F. Stolper (1993) (pp. 193–204).
Swedberg, R. (1998). Max Weber and the idea of economic sociology. Princeton, New Jersey: Princeton
University Press.
Weber, M. (1978). Economy and society (2 Vols). In: G. Roth & C. Wittich (Eds). Berkeley: University
of California Press.
SCHUMPETER’S “ENTREPRENEUR”
IN HISTORICAL CONTEXT
Geoffrey M. Hodgson
Markus Becker and Thorbjørn Knudsen have rendered a valuable service

by bringing the attention of the English-speaking academic world to Joseph
Schumpeter’s important 1928 article on the entrepreneur.
One of the important features of this article is the acknowledgement of the
influence of the German historical school on Schumpeter’s writing. The German
historical school was prominent in Germany from the 1840s to the 1940s
(Hodgson, 2001). It was also internationally influential. Leading economists
such as Alfred Marshall, Richard Ely, Edwin Seligman, John Bates Clark and
others traveled to Germany to study under leading members of that school
(Herbst, 1965). The idea that the German historicists made no contribution to
economic theory is a modern myth. Marshall (1890, 1919), for example, praised
the contribution of the German historicists in his Principles and his Industry and
Trade, where numerous references were made to members of this school.
Schumpeter acknowledges their influence when he writes: “it is nowadays
common to construct historical epochs, and to associate these epochs with
‘economic systems’ and ‘economic mentalities’ .” The construction of systems
of historical periodisation was characteristic of the German historical school
from its inception. This led to important methodological debates concerning the
methods and criteria of classification, to which Max Weber among several others
made a significant contribution. Weber regarded himself as a member of the
German historical school and Schumpeter (1954, pp. 815–816) acknowledged
him as such. The article under discussion makes approving references to German

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268 GEOFFREY M. HODGSON
historicists such Gustav Schmoller, Karl Bücher, Albert Schäffle, Max Weber and
Werner Sombart. Schumpeter’s links with the German historical school are thus
worthy of emphasis (Ebner, 2000; Streissler, 1994).
In this article Schumpeter also makes a very important statement concerning the
German historical school, which we should note well: “The historical and socio-
logical analysis of entrepreneurship is of recent date and has developed exclusively
through the historical school.” Although Schumpeter did not regard the work of
the historical school as “pure economics” he makes a very important concession
here. Indeed, Nicholas Balabkins (2000) has shown that several of Schumpeter’s
views concerning entrepreneurship have their origin in the work of Schäffle.
The enduring influence of Karl Marx on Schumpeter’s thought is also evi-
dent here, for example in his approving discussion of the “movement toward
concentration” and monopoly or oligopoly with an industry.
However, a tension existed in Schumpeter’s thought between, on the one hand,
what he described as “pure economics” and on the other hand, the historical
approach. Schumpeter (1908, 1926) had attempted to resolve the ongoing
Methodenstreit by arguing that the two approaches were logical compatible with
one another, as long as it is recognized that they are addressing different problems.
Pure economics addressed supposedly universal principles of individual choice
and allocation. Historicism addressed matters of historical specificity. But the
tension occurs when Schumpeter wavers to some degree over whether to make
categories such as “the enterprise” universal or historically specific.
This tension is evident in the article under discussion. When addressing the
enterprise, Schumpeter attempts to claim it for “pure economics” by proclaiming
without discussion that “the enterprise exists in all observable historical states . . . in
its economic essence it always manifests itself in some way.” It is rather obvious
that no historical state is literally “observable” because it is impossible to travel
into the past. But if Schumpeter had the means in 1928 to visit New Guinea,
northern Canada or the African interior he would have found it very difficult to
find any institution remotely resembling the capitalist enterprises of Europe or
the United States. He could, of course, have described Inuit fishing expeditions
or Masai cattle herding as “enterprises” but this would be stretching the word
to the point where its important capitalist substance is lost. Clearly, in asserting
an ahistorical “economic essence” for the enterprise, Schumpeter was making
a genuflection to Carl Menger’s (1883) famous position in the Methodenstreit.
Yet in other passages of this same article, Schumpeter clearly and specifically
associates “the enterprise” with the modern capitalist period. He thus also turns
and bows to the German historical school.
Schumpeter’s discussion of entrepreneurship and leadership, its relationship
with Walrasian equilibrium analysis, and its stress on the vision and capacity
Schumpeter’s “Entrepreneur” in Historical Context 269
of the entrepreneur to break with convention, is largely familiar already in

the English language literature on Schumpeter (Hagedorn, 1996; Santarelli &
Pesciarelli, 1990).
Another related part of the Schumpeter story is less well known, and presents a
serious problem for historians of economic thought, as well as for those interested
in Schumpeter’s ideas for other reasons. I have raised this problem elsewhere
(Hodgson, 2001) but for convenience I also relate it briefly here. The article
under discussion is typical of a period when Schumpeter was acknowledging the
importance of the historical school and trying to find them a place alongside, but
not within, “pure economics.”
Hence Schumpeter (1926, pp. 3, 18, 22, 24 n., 46) in an article published two
years earlier wrote of Schmoller’s “great achievements,” of his “greatness,” of his
work being “the programmed for the future,” of “his overall achievements” and
of his “success.” By 1930, however, Schumpeter was to shift the balance of his
assessment of historicism and institutionalism, towards criticism alone.
Sometime after his first visit to Harvard in 1927, Schumpeter became more
openly critical of the historical school and highly dismissive of the institutionalist
tradition. In the Harvard-based Quarterly Journal of Economics Schumpeter
(1930, p. 158) referred scathingly to the intellectual capacities of both Schmoller
and Thorstein Veblen, and to “the serious and even glaring defects in their equip-
ment, both natural and acquired.” This atrocious personal abuse was supplemented
with sweeping dismissals of much of historicism and institutionalism. Schumpeter
(1930, p. 159) thus complained of the “unsatisfactory state of economic science
in Germany.”
Also, in a talk in Japan in 1931, Schumpeter (1991, p. 292) referred to the
“methodological errors of German historians.” He also described institutionalism
as “the one dark spot in the American atmosphere.” Overall, there was a remarkable
transformation from Schumpeter’s 1926 and 1928 articles with their sympathetic
mentions of the historical school, to the hostile statements of 1930–1931, in
which Schumpeter was seemingly keen to dismiss – and to detach himself from –
the entire German historical school and American institutionalism.
The question I raised elsewhere (Hodgson, 2001) was the explanation of
Schumpeter’s motivation for this strange and sudden switch of attitude. We have
to consider the unpalatable possibility that Schumpeter was trying to curry favor
with a group of anti-institutionalist American economists in order to obtain his
professorial appointment in Harvard in 1932. The timing is too close to ignore this
possibility. I do not claim to have proved this hypothesis. It should also be noted
that even within Harvard there were some with institutionalist sympathies. But
the possibility remains, to be proved or disproved, that Schumpeter was acting
with a measure of careerist motivation.
270 GEOFFREY M. HODGSON
If so, the appearance of Schumpeter’s 1928 article on the entrepreneur would

not be without irony. Did Schumpeter himself take on an “entrepreneurial func-
tion” involving an amount of “self-interest” when he suddenly and subsequently
changed his public views on the importance and worth of the German historical
school? Is there an element of self-referentiality here? In any case, Schumpeter
was not without a good measure of entrepreneurial spirit when he uprooted himself
from Germany to move to the United States. Schumpeter remains, as always, a
magnificent enigma.
REFERENCES
Balabkins, N. W. (2000). Schumpeter’s “creatively adapted” innovator. Paper prepared for the 13th
Heilbronn Conference on Schumpeter’s German Works, June 23–25, unpublished mimeo.
Ebner, A. (2000). Schumpeter and the “Schmollerprogramm”: Integrating theory and history in the
analysis of economic development. Journal of Evolutionary Economics, 10(3), 355–372.
Hagedorn, J. (1996). Innovation and entrepreneurship: Schumpeter revisited. Industrial and Corporate
Change, 5, 883–896.
Herbst, J. (1965). The German historical school in American scholarship: A study in the transfer of
culture. Ithaca, NY: Cornell University Press.
Hodgson, G. M. (2001). How economics forgot history: The problem of historical specificity in social
science. London and New York: Routledge.
Marshall, A. (1890). Principles of economics: An introductory volume (1st ed.). London: Macmillan.
Marshall, A. (1919). Industry and trade. London: Macmillan.
Menger, C. (1883). Untersuchungen über die methode der sozialwissenschaften und der politischen
Ökonomie insbesondere. Tübingen: J. C. B. Mohr. Published in English in 1985 as: Investiga-
tions into the method of the social sciences with special reference to economics. New York:
New York University Press.
Santarelli, E., & Pesciarelli, E. (1990). The emergence of a vision: The development of Schumpeter’s
theory of entrepreneurship. History of Political Economy, 22, 677–696.
Schumpeter, J. A. (1908). Das wesen und der hauptinhalt der theoretischen nationalökonomie.
München und Leipzig: Duncker und Humblot.
Schumpeter, J. A. (1926). Gustav v. Schmoller und die probleme von heute. Schmollers Jahrbuch für
Gesetzgebung, Verwaltung und Volkwirtschaft im Deutschen Reiche, 50, 1–52.
Schumpeter, J. A. (1954). History of economic analysis. Oxford and New York: Oxford University
Press.
Schumpeter, J. A. (1991). The economics and sociology of capitalism. In: R. Swedberg (Ed.). Princeton:
Princeton University Press.
Streissler, E. W. (1994). The influence of German and Austrian economics on Joseph A. Schumpeter.
In: Y. Shionoya & M. Perlman (Eds), Schumpeter in the History of Ideas. Ann Arbor, MI:
University of Michigan Press.
A TRANSLATION TOO FAITHFUL?
Nicholas W. Balabkins
Schumpeter is popular these days among the economic policy makers and
politicians in Washington, DC. In “high tech” America, Schumpeter’s felicitous
phrase “creative destruction” is on many lips. The recent meltdown of numerous
dot.com firms on the NASDAQ exchange has taught formerly optimistic baby
boomers how hard the “creative destruction” process can hit their pocketbooks
and wipe out their accumulations of “shareholders value.” Yet for many, “creative
destruction” is still the guidepost to a better and more prosperous future.
The translation of Schumpeter’s German article “Unternehmer” into English
is a belated addition to the rapidly growing literature on Schumpeter. During the
“Schumpeter Renaissance” of the last two decades, hundreds of articles have been
written on various aspects of his work. The Library of the Institut für Weltwirtschaft
in Kiel, Germany, has the most complete listing of this literature.
All translations are difficult, but Schumpeter’s writings are particularly
challenging. The late Gottfried Haberler wrote in 1951 that Schumpeter’s
German writing style resembled Baroque. He wrote in long sentences, with many
qualifying phrases, and sometimes extravagantly ornate dangling participles.
His paragraphs were veritable monuments to his incredible erudition and elitist
intellect. For these reasons, Markus C. Becker and Thorbjørn Knudsen faced
a daunting task in converting the original German text into an acceptable,
present-day English. Sometimes they may have erred on the side of excess fealty
to Schumpeter’s German style. Some parts of the translation have become what
might be called Mexican Churriguresco, which is an overloaded Rococo. For this
reason, some parts of the translation appear to be anachronistic. English is the lan-
guage of economists these days, but this translation would offer more accessibility

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272 NICHOLAS W. BALABKINS
to the reader if the two translators had cast their product into a staccato English
form of presentation, with a simple sentence structure of noun, verb, object, and
adverb sequences.
The first section of the translated essay is called “The Essence of the Enterprise.
Historical Review of its Forms or Types.” To understand why Schumpeter’s
baroque writing style has become Mexican Churriguresco, try to read and
understand these first 10 pages! This wordy section could have been omitted by
translators. It adds virtually nothing to the understanding of the essence of Joseph
A. Schumpeter’s innovator.
The second section pp. 13–16, dealing with the concept of entrepreneur in
the economic literature, is more accessible to the modern reader. The third part,
pp. 16–20 presents the essence of Schumpeter’s notion of the entrepreneur. Here
the leadership phenomena in the form of “something new” is imbedded in the
“circular flow” setting.
Page 19 lists the five forms of innovations, well-known from Schumpeter’s
The Theory of Economic Development of 1934 (Reprint of 1969, p. 66). For
Schumpeter, innovations take the form of producing new commodities, organizing
technological changes in the production of commodities already in use, opening
up new markets, discovering new sources of raw materials, and setting up new
management organizations, such as the creating or breaking up of a monopoly.
By carrying out all of these innovations, singly or in combination, the en-
trepreneur earns more than just the customary return on his business operations.
This extra profit represents his reward for doing new things in economic life.
Schumpeter gave three reasons why the entrepreneurial function is rare and why
it is difficult to become an innovating entrepreneur. To produce a new commodity,
one must act outside customary channels and depend more on intuition than on
facts or custom. Secondly, one must break through very fixed habits of thinking,
and their energy-saving function, that have become subconscious. This requires
personal force and vigor, which are rare in life; and this makes the entrepreneur
something that is sui generis. Thirdly, in order to introduce a new product on the
market, the entrepreneur has to “overcome” the reaction of the social environment
and convince people that his product is of superior quality. To Schumpeter, it is
innovation, not routine, that enables the entrepreneur to make pure profits. All this
is faithfully and elegantly translated in the third section. Students of economics
will love this section for its brevity, clarity and precision. Section IV, pp. 20–24
deals with the multifaceted types of entrepreneurship and shows how the 19th
century innovator has slowly become the pioneer of the planned economy. Unlike
Section III, this section is wordy and confusing. Section V raises three questions
about entrepreneurship and discusses briefly why private enterprise is superior to
public enterprise and why the entrepreneurial function is decreasing. Pages 26–30
A Translation too Faithful 273
contain the literature on entrepreneurship extant in the 1920s. The footnotes on

pp. 31–35 are full of fascinating examples of why the two authors chose particular
English terms to represent Schumpeter’s expressions. The translators reflect
thorough knowledge of the two languages and should be congratulated for making
Schumpeter’s article available to the tongue-tied economists of the present day.
Finally, it may be proper to raise the question of the genesis of the innovator’s
concept. What were the spiritual roots of Schumpeter’s innovator? Which
thinkers led Schumpeter to the fertile concept of the innovating entrepreneur, who
unleashed the process of “creative destruction”? There is substantial literature on
this topic. Eduard März wrote that the innovator idea was not a bolt out of the
blue and cited Marx, Wieser, Sombart, Wirth, Tarde and Pareto. Erich Streissler
added Gottlieb Hufeland, Karl H. Rau, Riedel and Wieser as possible influences.
Nicolo DeVecchi felt that Philippovich, Schäffle and Schmoller influenced him.
One of the most overlooked influences in Schumpeter was by Albert Schäffle.
Schäffle, who was born in 1831 and died in 1903, was government official, journal-
ist, professor at the Universities of Tübingen and Vienna, a minister of commerce
in the Austro-Hungarian Empire in 1871, author of numerous books, and the editor
of the Zeitschrift für die gesamte Staatswissenschaft for more than three decades.
In 1981, when I was a visiting professor at the University of Frankfurt in
West Germany, I read an essay by Professor Knut Borchardt, who was teaching
then at the University of Munich. Published in 1961, in the Zeitschrift fur die
gesamte Staatswissenschaft, Borchardt’s essay asserted that Schäffle was the most
Schumpeterian economist of the 19th century.
In the German version of “Entrepreneur,” Schumpeter cites Schäffle’s article
of 1869 and his 1870 book, Kapitalismus und Sozialismus. Schumpeter does
not mention Schäffle’s 1867 work, Die nationalökonomische Theorie der
ausschliessenden Absatzverhältnisse, insbesondere des literarisch-artistischen
Urheberrechts, des Patent-Muster, u. Firmenschutzes nebst Beiträgen zur
Grundrentenlehre.1 The translators could have mentioned this work by Schäffle.
NOTE
1. On p. 268, Schäffle differentiated between two kinds of innovations:
(1) what he called commercial innovations, consisting of the discovery of new sources
of inputs, such as raw materials, and new marketing outlets; and
(2) what Schäffle called industrial innovations, referring to the introduction of new
products and/or new production methods for an existing commodity.
The genesis of Schumpeter’s innovator was not a part of Schumpeter’s original essay.
SCHUMPETER ON
ENTREPRENEURSHIP
Young Back Choi
The English translation of Schumpeter’s essay on entrepreneurship, writ-

ten around the time when he prepared the second edition of Theorie der
Wirtschaftlichen Enwicklung (1926), from which the English translation The
Theory of Economic Development (1934) was made, contains many of the ideas
found in The Theory of Economic Development and in Capitalism, Socialism
and Democracy (1942). Since the essay, “Entrepreneur” (1928) is relatively
short, yet contains most of the central ideas developed in his later works, the
essay can be regarded as a blueprint for his life’s work. The task of evaluating
the significance and the value of the translation in addressing the questions of
whether or not, and the extent to which, Schumpeter had changed his ideas
on entrepreneurship since the first edition of Theorie (1912), however, falls on
Schumpeter scholars (e.g. Elliott, 1983; Shionoya, 1997). My comment here,
instead, will be limited to Schumpeter’s concept of entrepreneurship as stated
in the essay.
For Schumpeter, the entrepreneur, stripped of various historical manifestations,
is a leader in the economic sphere, carrying out new combinations. Repeatedly,
Schumpeter emphasizes that the essence of entrepreneurship is not so much the
discovery of profitable opportunities as the will, and the provision of leadership,
to carry out new combinations to take advantage of the opportunities, in the
face of various obstacles (against innovation) present in the stationary state.
The entrepreneur is meant as a means of explaining the process of economic
development, including business cycles.

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276 YOUNG BACK CHOI
The entrepreneur, however, is a distinct type grafted on to the traditional

economic theory, leading some critics to doubt whether Schumpeter’s conception
of entrepreneurship adds anything to economic theory, other than colorful descrip-
tions of what economists normally call exogenous shocks (e.g. Demsetz, 1983).
Schumpeter’s treatment of the entrepreneur as a distinct type is not only unsatis-
factory from the point of view of formulating a theory of economic development,
but probably is a reflection of a faulty understanding of the market processes,
leading to some questionable statements he makes in the essay, especially when
he tries to answer “particular questions.” For example, in several places (pp. 9,
21, and 25) Schumpeter speaks of competitive economy as a thing of the past (in
contrast to the “modern economy” of 1926, characterized as being dominated by
large corporations and trusts). In keeping with the preceding view, Schumpeter
predicts gradual marginalization (or professionalization, or routinization, or
even the eventual disappearance) of entrepreneurship with the advent of large
corporations, a theme Schumpeter is later to develop more fully in Capitalism,
Socialism and Democracy. Schumpeter’s keen interest in demonstrating the
dialectical process of capitalism (perhaps, meant as a substitute for Marx’s laws of
the motion of capitalism), which might have been of interest in his contemporary
intellectual milieu, now appears to be misdirected. Finally, his reasoning for the
superiority of private enterprises (or the inferiority of public enterprises), that
the entrepreneur in a private enterprise has complete freedom of action, whereas
the leading man in a public enterprise is paralyzed by having to answer numerous
constituents, is also indicative of deficiencies in his understanding of the market
processes. Does Schumpeter presume that a public enterprise run by a despot
who does not owe any explanation to anyone will be as productive as a private
enterprise? The real difference, I believe, is not whether or not the leader is
restricted in his freedom of choice, but competition and the feedback it provides.
Despite his colorful descriptions of the function of the entrepreneur in the market
economy, Schumpeter seems to have under-appreciated the fact that in the market,
competition is perennial and even in “modern economy” – dominant firms are
constantly challenged by entrepreneurs and often supplanted by them.
The deficiency of Schumpeter’s concept of the entrepreneur, grafted onto the
apparatus of competitive equilibrium as a means of understanding the market
process, is abundantly clear when Schumpeter’s concept is compared to that of
Kirzner. Kirzner (1973, 1979) argues that the concept of competitive equilibrium
is deficient in capturing the essential feature of the market process, on the ground
that the competitive equilibrium portrays a state of the exhaustion of profitable
opportunities and, therefore, permits no room for the entrepreneur, the real driving
force of the market process. Kirzner believes that economic agents should be
portrayed not as maximizing satisfaction given the means-ends framework, but as
Schumpeter on Entrepreneurship 277
groping for a serviceable means-ends framework so that different individuals may

come to perceive a situation differently and behave accordingly. By discarding
the competitive equilibrium apparatus, Kirzner takes as given the existence of
profitable opportunities, represented by price inconsistencies or by the possibilities
of deploying resources and goods at higher valued uses. It is as if there are free
hundred dollar bills lying on the street to be picked up by those who merely
notice them. For Kirzner, therefore, entrepreneurship consists of alertness to (and
exploitation of) profitable opportunities neglected by others.
Compare to Schumpeter’s entrepreneur as innovator, Kirzner’s conception
of entrepreneur as arbitrageur, seems to be in the mold of the age-old idea of
profit making. It appears that Schumpeter and Kirzner have in mind different
types of entrepreneurs. The examples they use reinforce the impression. But it
should be noted that Kirzner’s concept of the entrepreneur is not inconsistent with
epoch-making innovations; For Schumpeterian entrepreneur’s new combination to
be profitable, the going prices of the input the entrepreneur acquires must be such
that the revenue from the enterprise results in profit. In this sense, Schumpeter
and Kirzner can be seen as presenting different perspectives on the self-same
entrepreneur (e.g. Choi, 1995; Hebert & Link, 1982). Yet, their conceptions of
entrepreneurship are different enough to imply different views on the prospect
of the market; Kirzner would never have said that competition is passé, or that
entrepreneurship will be routinized, or even marginalized.
This is not to say that Schumpeter’s ruminations on the sociology and psychol-
ogy of the entrepreneur are of no interest. On the contrary, they point to some
of the missing elements in contemporary economic analysis. In emphasizing
the leadership role of the entrepreneur Schumpeter highlights the difficulties of
innovation, i.e. successfully deviating from conventional practices – the difficulty
of conceiving profitable new combinations, of summoning courage to carry them
out in the face of resistance, and of acquiring necessary cooperation of others, in-
cluding consumers. Schumpeter’s evocative descriptions of the entrepreneur point
to possibly fruitful areas of inquiry concerning the processes of belief formation
and knowledge-sharing. Schumpeter’s attempt to find connections between the
predominance of stock companies and the composition of entrepreneurs, and
their selection, is also of great interest from the point of view of social mobility.
Whether or not Schumpeter’s sociological and psychological insights into
the entrepreneur is original to him (which may be a question of interest to
Schumpeter scholars, but not necessarily to others), whether or not he succeeded
in integrating the entrepreneur into economic theory (which many feel that he fell
short), there is little doubt that his conception of entrepreneurship has excited the
imagination of many economists and other students of society. Schumpeter was
an entrepreneur.
278 YOUNG BACK CHOI
REFERENCES
Choi, Y. B. (1995). The entrepreneur: Schumpeter versus Kirzner. Advances in Austrian Economics,
2A, 55–65.
Demsetz, H. (1983). The neglect of entrepreneurship. In: J. Ronen (Ed.), Entrepreneurship
(pp. 271–280). Lexington, MA: D. C. Heath.
Elliott, J. E. (1983). Introduction. In: J. A. Schumpeter (Ed.), The Theory of Economic Development:
An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. New Brunswick, NJ:
Transaction Publishers.
Hebert, R. F., & Link, A. N. (1982). The entrepreneur: Mainstream views and radical critiques. New
York: Praeger.
Kirzner, I. M. (1979). Perception, opportunity and profit. Chicago: University of Chicago Press.
Shionoya, Y. (1997). Schumpeter and the idea of social science. New York: Cambridge University
Press.
Schumpeter, J. A. (1983) [1934]. The theory of economic development: An inquiry into profits, capital,
credit, interest, and the business cycle. New Brunswick, NJ: Transaction Publishers.
Schumpeter, J. A. (1942). Capitalism, socialism and democracy. New York: Harper.
SCHUMPETER’S “ENTREPRENEUR”
AND WHY WE NEED
ECONOMIC SOCIOLOGY
Richard Swedberg
Let me start by thanking Markus Becker and Thorbjørn Knudsen for making this
important article available to us all and for providing such a careful translation.
“Entrepreneur” is a central piece in Schumpeter’s production, and it is a sad fact
that it has not been available in English till now. This article, to be more precise, is
one of Schumpeter’s key writings on entrepreneurship. It is only rivaled, in this re-
spect, by Chapter 2 in Theory of Economic Development (1911, 1926, 1934), some
passages in Capitalism, Socialism and Democracy (1942), and a few articles from
the late 1940s. The sections on entrepreneurship in the two books I just mentioned
are subordinate to the wider themes of these books and integrated into these; and
the articles from the late 1940s represent primarily an attempt from Schumpeter’s
side to forge a union between the economic theory of entrepreneurship and the
economic history of entrepreneurship. When it comes to a single, comprehensive
work that is exclusively devoted to entrepreneurship, “Entrepreneur” is unique
and alone.
As to translations of Schumpeter into English, I am sure that Becker and
Knudsen have much to say on this account because Schumpeter as a master of
the German language, and Schumpeter as a master of the English language are
two very different people. Or to put it in more plainly: it is very hard to translate
Schumpeter from German into English. There are essentially two options available
to the translator, according to Stolper and others who have attempted to render

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280 RICHARD SWEDBERG
Schumpeter into English. Either one keeps Schumpeter’s long German sentences,
which means that one keeps close to the original, even if this will produce a
strange effect in English. Or one can chop up Schumpeter’s sentences into short
Anglosaxon sentences, and lose quite a bit of the bite and charm of Schumpeter’s
original formulations. Becker and Knudsen have made their choice, and a wise one:
a compromise. An abundance of notes have also been included to assist the reader
who has questions.
In commenting on “Entrepreneur” one can obviously pick different topics. One
of these would be to set this article into the general context of the development of
Schumpeter’s theory of entrepreneurship, from 1911 and onwards. This is what
Becker and Knudsen have done in their introduction. Another way to proceed
would be to highlight the importance of this article for Schumpeter’s economic
sociology, something which I will try to do. Other topics as well are naturally
possible, as illustrated by the other comments in this issue. All of these different
perspectives clearly point to the richness of “Entrepreneur.”
There is also the fact that Schumpeter, like all the classics, always has some
extra wealth to spread around – and this is also true for “Entrepreneur.” There
is as always the vibrant formulation, the brilliant aside, and the new idea that
Schumpeter suddenly springs on the reader. The reader of “Entrepreneur” has no
doubt found this out for herself. I will nonetheless cite a few of my own favorites,
before concentrating on what I think constitutes the main contribution of this
article, from the viewpoint of economic sociology.
One of these fine points is to be found in a passage on the difficulty of being
entrepreneurial, from the viewpoint of the actor. Schumpeter pinpoints the
difficulty as that of every creator: on the one hand there is the social reality of
what already exists (and which is not very good); and on the other hand there is
the unreality of what is what has not yet come into being (but which is better).
I quote:
From a subjective point of view it is more difficult to do something new than something familiar.
In doing something new we are not supported by the same feeling of solid reality (p. 19).
Another handsome point can be found in Schumpeter’s discussion of self-interest.

For most economists self-interest means maximizing profit or utility. In a sentence
that deserves to be much cited, Schumpeter says something different:
Self-interest can adopt many forms. Self-interest can adapt to very different social circum-
stances, and . . . its most simple form – the striving for maximal personal monetary profit – is
substituted by objectives of a very different kind (pp. 24–25).
Several other examples could be cited, but I would now like to say something
about the significance of “Entrepreneur” for economic sociology. Schumpeter,
Schumpeter’s “Entrepreneur” and Why We Need Economic Sociology 281
as we know, is the first economist to have realized the contribution that eco-
nomic sociology can make to the understanding and explanation of economic
phenomena; and he repeatedly emphasized that economic sociology should be
part of the economist’s “tool box.” The main reason for this, he said, is that
economists and economic sociologists look at different parts of the same economic
process; economic theory looks at the economic mechanisms, and economic
sociology at their institutional frame. Both, in other words, are needed to supply a
full picture of what is going on. As we know from History of Economic Analysis,
contributions from the historian and the statistician are needed as well.
But there is more. Sometimes the institutional element in the economy can
take over and interfere with the workings of the economic mechanisms, instead
of supporting their functioning. This is the great theme of Capitalism, Socialism
and Democracy – and it is also the great theme of “Entrepreneur,” produced some
fifteen years earlier. Both works raise the question “Why do we need economic
sociology?”, and both give the same answer: “Because otherwise you will not
understand what is going on at the very heart of the economy.”
Capitalism, Socialism and Democracy makes this argument louder and in much
more detail than what “Entrepreneur” does. But Schumpeter also serves the reader
so many other treats in Capitalism, Socialism and Democracy that this particular
one tends to get lost. This work, to recall, contains a history of socialism (including
a masterful analysis of Marx), a path-breaking new theory of democracy, a theory
of economic competition, a theory of political entrepreneurship, and quite a bit
more. In “Entrepreneur,” in contrast, Schumpeter had been assigned one specific
topic and a limited space in which to discuss it – and this means that we get his
argument about economic sociology in a more straightforward version.
Since “Entrepreneur” can be found in the same issue as this comment, it is
not necessary for me to go through Schumpeter’s argument in any detail. A
quick summary may nonetheless be helpful, and would go as follows. Economic
sociology essentially looks at the impact of institutional or non-economic forces
on economic topics. This type of analysis can be of great assistance in analyzing
entrepreneurship, or more precisely, in analyzing firms led by entrepreneurs.
The firm is the key unit in a capitalist economy. As long as the entrepreneurial
function (leading the firm in an innovative way) coincides with the goal of capital
(making a profit), there is no problem. In modern capitalist society, however,
there is an agency problem, or in Schumpeter’s terminology “the link between
entrepreneurial profit and activity [of the leader of the firm]” (p. 25) tends to be
loose. The reasons for this are the ones that we are familiar with from Capitalism,
Socialism and Democracy and have much to do with the emergence of the
giant corporation. Entrepreneurship, in all brevity, is becoming more and more
accepted, and managers are becoming more and more like civil servants. The
282 RICHARD SWEDBERG
entrepreneurial energies of today’s managers have been drained, and this poses a
threat to capitalism.
Was Schumpeter right that capitalism was threatened? The conventional answer
these days is “No – socialism has clearly failed and capitalism is stronger than
ever.” As far as it goes, this answer is correct. Schumpeter’s argument about the
giant corporation, however, would seem to be essentially correct. The enormous
firms that started to come into being in the late 1800s, and which Alfred Chandler
has praised in book after book, may well have had a deadening impact on
entrepreneurship. One indicator of this is the problems of IBM and many similar
giant companies have had in renewing themselves. Schumpeter was also correct
in pinpointing the agency problem between investor and manager as being central
to a vital capitalism. And he surely was correct in his main thesis, insofar as
methodology is concerned: we need economic sociology if we are to understand
what is happening at the very heart of the economy.
SCHUMPETER AND THE
OBSOLESCENCE OF THE
ENTREPRENEUR
Richard N. Langlois
ABSTRACT
This paper argues that the well-known “two Schumpeters” thesis, as under-
stood in the Anglo-American literature on technological change, is clearly
wrong. Equally wrong is the idea that the fundamentals of Schumpeter’s
thought on entrepreneurship were influenced importantly by his observation
of large firms in the United States after 1931. The obsolescence thesis speaks
to a distinction between early capitalism and later capitalism, perhaps,
but not to an earlier and later Schumpeter. A more important point is that
the obsolescence thesis is wrong. It rests on a confusion – or perhaps a
bait-and-switch – between two quite different kinds of economic knowledge.
I. INTRODUCTION
From relative obscurity, the name of Joseph Schumpeter has leapt to prominence
in recent years. In part, this reflects the blossoming of entrepreneurial studies as a
distinct field of research1 (Shane & Venkataraman, 2000). Schumpeter’s famous
discussion of the role of bold entrepreneurs in creating new combinations and
redirecting the means of production into new channels is an important founding
stone for any study of entrepreneurship. During the three or so decades after

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284 RICHARD N. LANGLOIS
Schumpeter’s death in 1950, however, a quite different set of Schumpeterian

ideas had entered public consciousness, largely through the popular writings of
John Kenneth Galbraith (1967). Far from exalting the role of individual initiative
in economic change, this literature foretold – or even claimed to be chronicling –
the demise of the entrepreneur. Innovation would become – or even had become –
a matter of routine in the large bureaucratic corporation. Perhaps astoundingly,
these two seemingly incompatible sets of ideas do both emanate from Schumpeter.
The Anglo-American literature of technological change is one of the few areas
of economic writing in which Schumpeter maintained a following and in which
he has long been accorded some modicum of the attention he deserves. This
literature was quite naturally forced to deal with the problem of the obsolescence
thesis and its relationship to the theory of (individual) entrepreneurship. The
result has been a standard interpretation of the mechanization-of-progress thesis
that has become an unexamined conventional wisdom. It goes something like this.
The argument in Schumpeter’s early writings is really quite different from that
in his later work. There are, in effect, two Schumpeters: an “early” Schumpeter
and a “later” Schumpeter. It was the former who believed in the importance of
bold entrepreneurs, while the latter envisaged their demise and replacement by a
new mode of economic organization. Moreover, the reason Schumpeter changed
his views is that he was reacting to the historical development of capitalism as he
saw it taking place around him. As he moved from the world of owner-managed
firms in turn-of-the-century Vienna to the world of large American corporations
in the 1930s and 1940s, his opinions changed appropriately.
The paper attempts to make two points. The first is that, as a doctrinal matter,
the “two Schumpeters” thesis, as it is understood in the Anglo-American literature
on technological change, is clearly wrong. Equally wrong is the idea that the
fundamentals of Schumpeter’s thought on entrepreneurship was influenced by
any observation of large firms in the United States after 1931. Schumpeter’s ideas
were remarkably consistent from at least 1928 (three years before he came to
the U.S.) until his death. The obsolescence thesis speaks to a distinction between
early capitalism and later capitalism, perhaps, but not to an earlier and later
Schumpeter. The second, and more important, point is that the obsolescence
thesis is wrong. It rests on a confusion – or perhaps a bait-and-switch – between
two quite different kinds of economic knowledge.
II. THE SCHUMPETERIAN DICHOTOMY

The conventional-wisdom analysis of Schumpeter’s obsolescence thesis is in
part a matter of oral tradition among (mostly) English-speaking writers whose
Schumpeter and the Obsolescence of the Entrepreneur 285
interest in Schumpeter traces to a concern with innovation and technical change.

But documentation in print is far from lacking. There are, in fact, several related
versions of this conventional analysis. One of the clearest and best known traces
to Almarin Phillips (1971), who focuses primarily on Schumpeter’s view of
technological innovation.2 To Phillips, Schumpeter’s early writings – by which
he means the 1934 English translation of The Theory of Economic Development –
present a very different picture of the logic of technological change in industry
than do his later writings – by which Phillips means Capitalism, Socialism,
and Democracy.
In the “early” Schumpeter – Schumpeter I – the innovation process might best
be characterized as a linear one. Christopher Freeman (1982) describes it this way.
Basic inventions are more or less exogenous to the economic system; their supply
is perhaps influenced by market demand in some way, but their genesis lies outside
the existing market structure. Entrepreneurs seize upon these basic inventions
and transform them into economic innovations. The successful innovators reap
large short-term profits, which are soon bid away by imitators. The effect of the
innovations is to disequilibrate and to alter the existing market structure – until the
process eventually settles down in wait for the next wave of innovation. The result
is a punctuated pattern of economic development that is perceived as a series of
business cycles. “The main differences between Schumpeter II and Schumpeter
I,” says Freeman, “are in the incorporation of endogenous scientific and technical
activities conducted by large firms . . . . Schumpeter now sees inventive activities
as increasingly under the control of large firms and reinforcing their competitive
position. The ‘coupling’ between science, technology, innovative investment and
the market, once loose and subject to long time delays, is now much more intimate
and continuous” (Freeman, 1982, p. 214, emphasis original).
There is no doubt that Capitalism, Socialism, and Democracy was far more con-
cerned with the large corporation than was The Theory of Economic Development.
Furthermore, it may even be that the former contains a more developed “model” of
the process of technological change in industry than does the latter. But saying this
still leaves us with at least two distinct interpretations of the early/late thesis. The
weaker interpretation would be that, although Schumpeter’s theory of innovation
and development remained essentially the same in his later as in his earlier work,
the “later” Schumpeter simply chose, for various reasons, to elaborate more
fully on the nature of the large corporation and its role in his theory. And this
weak form may well be what some writers have in mind. But it also seems quite
clear that a good many other writers have a far stronger version of the early/late
thesis in mind. The change from the “early” to the “later” Schumpeter reflects
not a mere shift in his emphasis but a fundamental alteration of his underlying
economic vision.
A principal manifestation of this change is held to be Schumpeter’s revised

assessment of the role of – and of the necessity for – market competition in the
process of innovation. Richard Nelson’s discussion is representative.
The early Schumpeter certainly did not view the economic problem as that of the control of
clerks. His belief was that not only preferences and resources, but also technologies, change
over time. Schumpeter, and Marx before him, saw the real power of a capitalist market system
in terms of the ability of that system to spur innovation. He also believed that competitive
markets provided an environment (monitored by final consumers and powered by competition)
that controls the processes of technological change and spreads benefits widely. In his later
writings, he recanted the proposition that market competition was necessary for the genera-
tion of innovation, positing that in large corporate enterprises, innovation itself has become
largely routinized. Therefore, he foresaw no particular disadvantages from socialization of
the innovation process, as well as the more routine activities of the economy (Nelson, 1977,
pp. 134–135).
Moreover, Schumpeter’s “recantation” of his earlier position is sometimes traced

to or associated with a fundamental shift in philosophical orientation. “As it
happens,” writes Burton Klein, “Schumpeter expressed very different views in
his later writings than in his earlier works, so much so that one has the impression
there were two Schumpeters: Schumpeter the revolter against determinism, and
Schumpeter the determinist” (Klein, 1977, p. 133).
A corollary to this conventional-wisdom interpretation is the notion that
Schumpeter “changed his mind” because of what he saw developing in the
contemporary economy. As Freeman puts it, the “shift of emphasis from the early
Schumpeter . . . to the late Schumpeter . . . reflected the real change which had
taken place in the American economy between the two World Wars and the rapid
growth of industrial R&D in large corporations during that period” (Freeman,
1982, p. 8). This is certainly not an implausible interpretation. Schumpeter did
believe that economic history influences economic theory – not in a historicist
sense, but in the sense that some essential theoretical features are always outlined
more sharply at some periods than at others. “Personally,” he wrote, “I believe
that there is an incessant give and take between historical and theoretical analysis
and that, though for the investigation of individual questions it may be necessary
to sail for a time on one tack only, yet in principle the two should never lose sight
of each other” (Schumpeter, 1951, p. 259).
Ultimately, however, this conventional interpretation – that Schumpeter changed
his fundamental position on the nature of innovation, and that he did so because
of trends he saw developing in twentieth-century American capitalism – is, I’m
afraid, clearly wrong.
First of all, one can find examples from Schumpeter’s work written after 1942
that present very much the same theory of entrepreneurship as does The Theory
of Economic Development (Schumpeter, 1947, 1951). More significantly, the idea
that the entrepreneur will eventually become “less important” or “obsolete” is

already present in the 1934 translation of The Theory of Economic Development.
The historical trend in favor of large firms that is theme of Capitalism, Socialism,
and Democracy also turns up in the earlier book.
And if the competitive economy is broken up by the growth of the great combines, as is
increasingly the case today in all countries, then this must become more and more true of real
life, and the carrying out of new combinations must become in ever greater measure the internal
concern of one and the same economic body. The difference made is great enough to serve as the
water-shed between two epochs in the social history of capitalism (Schumpeter, 1934, p. 67).
The contrast – or, rather, lack of contrast – between the English version of The
Theory of Economic Development and Capitalism, Socialism, and Democracy
can perhaps best be seen in the juxtaposition of the following passages. The first
is from the “later” Schumpeter.
This social function [entrepreneurship] is already losing importance and is bound to lose it at
an accelerating rate in the future even if the economic process itself of which entrepreneurship
was the prime mover went on unabated. For, on the one hand, it is much easier now than it has
been in the past to do things that lie outside the familiar routine – innovation itself is being
reduced to routine. Technological progress is increasingly becoming the business of teams of
trained specialists who turn out what is required and make it work in predictable ways. The
romance of earlier commercial adventure is rapidly wearing away, because so many things can
be strictly calculated that had of old to be visualized in a flash of genius (Schumpeter, 1942,
p. 132, emphasis added).
Schumpeter quickly goes on (p. 133) to liken the changes he foresees in the
entrepreneur’s role with those that have already taken place in the function
of military commander. Now consider the following passage from the “early”
Schumpeter.
The more accurately, however, we learn to know the natural and social world, the more perfect
our control of facts becomes; and the greater the extent, with time and progressive rationalisation,
within which things can be simply calculated, and indeed quickly and reliably calculated, the
more the significance of this function decreases. Therefore the importance of the entrepreneurial
type must diminish just as the importance of the military commander has already diminished
(Schumpeter, 1934, p. 85, emphasis added).
These passages are important, and I shall return to them presently.

In their translation of Schumpeter’s 1928 essay “Entrepreneur,” Becker and
Knudsen (in this volume) show clearly that Schumpeter’s mature theory of
entrepreneurship was already in place by 1926, when he revised the first German
edition of Theory of Economic Development. That 1926 edition formed the basis
of the 1934 English translation, which, as I have shown, is fully consistent with the
obsolescence thesis in Capitalism, Socialism, and Democracy. This immediately
puts to rest the notion – which has never been based on any textual evidence
anyway, as far as I can tell – that Schumpeter was somehow influenced by his
observations of large American corporations in the 1930s. Becker and Knudsen
see a real change in Schumpeter’s theory of entrepreneurship between 1911 and
1926.3 Rather than conceptualizing entrepreneurship as a psychological charac-
teristic of a subset of the population, he came to portray entrepreneurship in a
“depersonalized” way as an ideal type.4 In the post-1926 theory, entrepreneurship
needn’t fill the vessel of any actual person; it reflects instead a category of action
into which individuals (organizations?) may fall at various times and places. To
Becker and Knudsen, this change enables the obsolescence thesis, since it makes
the entrepreneur less “pushy” and therefore permits an easy movement to an
institutionalized version of entrepreneurship. As they put it, the entrepreneur has
become a carrier of change rather than a cause of change. However one interprets
this transition from the “old” Schumpeter to the “new,” however, it is not the
transition that writers in the Anglo-American literature of technological change
think they see. That one never happened.
III. THE SCHUMPETERIAN TENSION

Why then are so many writers inclined to see “two Schumpeters”? The simple
answer is that Schumpeter has the distinction of being the principal source for
the notion that entrepreneurship (a word that is shorthand for a complex set of
theoretical ideas) is crucial to the economic process and – at the same time – the
principal source for precisely the opposite conception: that entrepreneurship is no
longer (or will soon no longer be) of any consequence whatever for the economic
process, having been replaced entirely by rational calculation. There are two iden-
tifiable strands of thought in Schumpeter; they are self-consistent, but they cannot
be reconciled with one another. Reading him is thus a kind of litmus test: picking
out one of the strand leads in one direction; picking out the other leads in precisely
the opposite direction. Schumpeter I gives you such neo-Schumpeterian writers
as Nelson and Winter (1982) and Klein (1977). Schumpeter II gives you John
Kenneth Galbraith.
But if, as I’ve argued, this coexistence does not reflect a change of opinion, then
what is the source of Schumpeter’s litmus effect? The answer, I believe, is that the
“Schumpeterian tension” arises from the unreconciled coexistence in his writings
of two incompatible epistemic theories, to use the suggestive term of G. L. S.
Shackle (1972) – two inconsistent views of the role of knowledge and ignorance
in the economic process.
Perhaps the best way to explicate this claim is to recast it in terms of another –
closely related – tension in Schumpeter. It is well known that Schumpeter was
a great admirer of Walras. “[S]o far as pure theory is concerned,” he wrote in

his History of Economic Analysis, “Walras is in my opinion the greatest of all
economists.” He goes on to suggest that Walras’s work “will stand comparison
with the achievements of theoretical physics” (Schumpeter, 1954, p. 827). Yet,
while his professed scientific attitude and aesthetic sensibilities may have been
Walrasian, his own theory is in substance very un-Walrasian. Indeed, many have
portrayed Schumpeter – with a good deal of justification – as representing a
theoretical perspective and tradition alternative and antagonistic to the Walrasian
approach that, by all accounts, dominates modern economic thought (Nelson &
Winter, 1982, pp. 39–40). More precisely, one might say that Schumpeter’s theory
is in substance Mengerian rather than Walrasian.
There are really only two attitudes with which to approach economic doctrine.
One can take the position that, beneath the inevitably discordant pronouncements
of the various theorists with whom one is concerned, there lies an essential
unity; the differences are unimportant, merely epiphenomenal to that underlying
unity. Or one can take the position that it is the differences that are essential, that
whatever superficial similarities may appear among theories are in fact merely
a cover for fundamentally divergent views. Schumpeter adopted the former
attitude, at least so far as the marginalist revolution – and indeed the economics
of his own day – was concerned. “Nobody denies that, numerous differences in
detail notwithstanding, Jevons, Menger, and Walras taught essentially the same
doctrine”5 (Schumpeter, 1954, p. 952).
However true such an assertion might have been in 1950, it is clear that, in the
last few decades at least, quite a number of historians of thought have begun to
deny just that. The marginalist revolutionaries have been “dehomogenized” (to use
Jaffé’s (1976) expression), a development that may say as much about the status
of present-day economics as it does about that of the 1870s. And most of the deho-
mogenizers wish to enlist the syncretist and Walras-admiring – but also Austrian –
Schumpeter into the dissident Mengerian camp. “It is just because he admired
Walras so much,” writes Erich Streissler, “that Schumpeter is such a bad guide
to the real Austrian achievement, which has always been in complete contrast to
Walras” (Streissler, 1972, p. 430n). One might also say that Schumpeter’s admi-
ration for Walras also served to mask the distinctly non-Walrasian character of his
own achievement.
There are a number of ways in which Schumpeter’s work displays affinities to
that of Menger. In one important sense, both were more in the classical than the
neoclassical tradition.6 Like Adam Smith, they were concerned with the problem
of economic development – of the creation of wealth – rather than with questions
of the simple allocation of resources. “It is in the true tradition of Menger that
Schumpeter’s treatment of technical progress is so much more inclusive than
the Marxian or modern neoclassical treatment” (Streissler, 1972, p. 431). Other

similarities between Schumpeter and Menger would include an emphasis on
disequilibrium processes; a concept of competition very unlike the Walrasian
“perfect competition” construct; and a concern with social institutions.7 For
present purposes, though, the most important way in which Schumpeter’s theory is
Mengerian (or at least non-Walrasian) is in its attitude toward economic knowledge
and learning.
Having appropriated Shackle’s term “epistemic,” let me now turn it to my
own uses. There are, it seems to me, two fundamental categories of epistemic
theories – that is, two categories of theories about the way economic agents know
and learn.8 One category is that of rationalist theories. Broadly speaking, such
theories portray the rationality of economic agents as consisting entirely in logical
deduction from explicit premises. In ordinary neoclassical models – which clearly
fall into this category – the agent faces a problem of maximization (or minimiza-
tion). The agent is rational when he or she solves that problem correctly. The data
of the problem – what the agent “knows” – is always given, and any learning
that takes place is also a matter of logical processing (e. g. Bayesian updating) of
given data.
The other category is that of empiricist theories. In an empiricist the-
ory, the criterion of rationality is less demanding, typically requiring only
reasonable behavior in light of the situation the agent faces, not behavior
reflecting the substantively correct solution to an explicit (and sometimes
quite complicated) problem. More importantly, the nature and source of the
agent’s knowledge is empirical in character; it is gained from experience
rather than deduced. As a result, the agent’s knowledge is frequently tacit
(Polanyi, 1958) or contained inexplicitly in various habits, conventions, and
institutions.
In his discussion of the role and importance of entrepreneurship, Schumpeter
places himself squarely in the empiricist camp. “The assumption that conduct
is prompt and rational,” he says, “is in all cases a fiction. But it proves to be
sufficiently near to reality, if things have time to hammer logic into men . . . .
But this holds good only where precedents without number have formed conduct
through decades and, in fundamentals, through hundreds of thousands of years,
and have eliminated unadapted behavior” (Schumpeter, 1934, p. 80). This is
a conception of behavior as fundamentally rule-governed.9 For Schumpeter,
rationality as conscious calculation exists only within a small sphere carved
out from and defined by the larger mass of the agent’s inexplicit knowledge.
Within this sphere, “we can depend upon it that the peasant sells his calf just as
cunningly and egotistically as the stock exchange member his portfolio of shares”
(Schumpeter, 1934, p. 80).
The other important aspect of an empiricist epistemic theory of the sort

Schumpeter adheres to in these passages is the inherently open-ended or evolu-
tionary character of economic knowledge it implies. Since economic knowledge
is not a matter of logical deduction from givens, that knowledge is potentially
unbounded. There is always new knowledge that is not yet not within the
agent’s “calculative sphere” or means/ends framework. Indeed, the job of the
entrepreneur is precisely to introduce new knowledge.10 The “Circular Flow of
Economic Life” is a state in which knowledge is not changing. Economic growth
occurs at the hands of entrepreneurs, who bring into the system knowledge
that is qualitatively new – knowledge not contained in the existing economic
configuration.
This novelty is what distinguishes the entrepreneurial function from that of
manager or the capitalist. This is why one is an entrepreneur only while carrying out
new combinations, not once the business is well established. To Schumpeter, “the
distinctive element is readily recognized so soon as we make clear to ourselves what
it means to act outside the pale of routine. The distinction between adaptive and
creative response to given conditions may or may not be felicitous, but it conveys
an essential point; it conveys an essential difference” (Schumpeter, 1951, p. 253).
The crucial point for my argument is that a conception of entrepreneurship
(or something very much like it) is essential for any theory that proposes to deal
with innovation and economic growth.11 Conventional neoclassical models tell
stories about the adjustment of known means to given ends, but they say very
little about how those means and ends change or come into being in the first place.
Schumpeter would seem to agree strongly that a concept of entrepreneurship is a
theoretical necessity. In a vibrant passage, he describes the epistemic role of the
entrepreneur (if I may put it that way) in a manner that emphasizes the empirical
nature of his conception.
What has been done already has the sharp-edged reality of all things which we have seen and
experienced; the new is only the figment of our imagination. Carrying out a new plan and acting
according to a customary one are things as different as making a road and walking along it.
How different a thing this is becomes clearer if one bears in mind the impossibility of
surveying exhaustively all the effects and counter-effects of the projected enterprise. Even
as many of them as could in theory be ascertained if one had unlimited time and means must
practically remain in the dark. As military action must be taken in a given strategic position
even if all the data potentially procurable are not available, so also in economic life action
must be taken without working out all the details of what must be done. Here the success of
everything depends on intuition, the capacity of seeing things in a way which afterwards proves
to be true, even though it cannot be established at the moment, and of grasping the essential
fact, discarding the unessential, even though one can give no account of the principles by
which this is done. Thorough preparatory work, and special knowledge, breadth of intellectual
understanding, talent for logical analysis, may under certain circumstances be sources of failure
(Schumpeter, 1934, p. 85).
Entrepreneurship – introducing the qualitatively new – is an activity inherently

different, it would seem, from the kind of rational calculation portrayed in the
imagery of neoclassical modeling.
It is interesting that Schumpeter regards the entrepreneurial act as requiring
in fact greater conscious rationality than routine activity (Schumpeter, 1934,
p. 85). This re-emphasizes the empirical nature of his conception of economic
knowledge. Routine behavior requires less conscious rationality because it is
essentially “preprogrammed” through trial-and-error learning. Notice, of course,
that the conscious rationality of the entrepreneur is not adequate – in “early”
capitalism, at any rate – to the task of innovation. This is why entrepreneurship
requires intuition, the leap of logic.
But – and here we get to the heart of the matter – conscious rationality, for
Schumpeter, is in fact becoming increasingly adequate to the job of dealing with
the radically new.
The more accurately, however, we learn to know the natural and social world, the more perfect
our control of facts becomes; and the greater the extent, with time and progressive rationalisation,
within which things can be simply calculated, and indeed quickly and reliably calculated, the
more the significance of this [entrepreneurial] function decreases. Therefore the importance of
the entrepreneurial type must diminish just as the importance of the military commander has
already diminished (Schumpeter, 1934, p. 85, emphasis added).
Notice the syllogism. Because the unknown can be increasingly calculated ra-
tionally, the “extra-logical” function of the entrepreneur becomes increasingly
unnecessary, and so the importance of the entrepreneurial type must diminish.
What this amounts to is a strange commingling of an empiricist and a rationalist
theory of economic knowledge. In “early” capitalism (not the “early Schumpeter”)
economic rationality derived largely from evolved habit and convention; attempts
to step outside this configuration of knowledge could not be accomplished by
conscious rationality and explicit calculation. Rationality was “bounded,” in
effect. In “later” capitalism (not the “later Schumpeter”) the bounds of rationality
are being broken. Conscious rationality is beginning to conquer not merely the
entrenched conventions of the past but also the previously unknowable future.
Perhaps the analogy with a more recent writer will make this clearer. Schum-
peter’s epistemic theory (if I may use that high-blown phrase again) is ultimately
very close to that of Herbert Simon (Langlois, 1990, 2003a). Simon is, of course,
the author of the expression “bounded rationality.” The basic idea is that human
information-processing capacity is limited, making conscious rationality of the
neoclassical variety quite impossible. The agent must therefore “satisfice” and rely
on heuristic approximations. What is typically overlooked in Simon’s conception,
however, is that it is at base a strongly rationalist theory of knowledge. For Simon,
one is rational only when one has reached the substantively correct solution of the
explicit choice problem one faces. His preferred imagery includes chess games
and complex differential equations, problems that do in fact have substantively
correct solutions, even if they are solutions to which we can at present only
aspire. His innovation, in short, is to suggest that one may only approximate true
rationality; he does not ultimately call the notion itself into question. Moreover,
Simon like Schumpeter is convinced that improvements in computational and
management technique will provide closer and closer approximations to true
rationality and may even unbound rationality in some spheres.
IV. THE SCHUMPETERIAN IRONY
What, then, are we to make of the “Schumpeterian tension”? I contend that it has
strong implications for Schumpeter’s assessment of the workability of socialism
and the eventual demise of capitalism.
Schumpeter’s argument, we saw, goes something like this. Entrepreneurship –
bringing the radically new into the economic system – has been the province of
bold individuals because, in a world of limited knowledge, it is necessarily an
unpredictable and extra-rational activity. Notice that this is in effect an argument
in favor of a capitalist (or, more correctly, a liberal) social order. For Schumpeter,
the relative efficiency of an economic system depends not on how it “administers
existing structures” (Schumpeter, 1942, p. 84) but on how well it generates innova-
tion. Because of limited knowledge, “planning” is incompatible with innovation;
progress depends on the ability of individuals to command resources and direct
them in unconventional and surprising directions. But the limits to knowledge are
disappearing, Schumpeter believes, and socialism will thus eventually come to be
roughly as effective as capitalism in generating economic growth.
But does the argument hold water? Does the growth of economic and technical
knowledge in fact imply that innovation is becoming predictable and routine?
This is a matter of some dispute. It is certainly true that innovation – or R&D,
at any rate – is more organized today than it was in the nineteenth century. This
is a manifestation of the growing division of labor, one that would not have
surprised Adam Smith and the classicals (Langlois, 2003b). But for Smith, the
increasing division of labor did not generate innovation because it made the future
predictable; rather, the division of labor heightened innovation because it increased
the diversity of ideas in society. Innovation remained a matter of empirical trial
and error.
We can put the issue somewhat differently. I have argued that Schumpeter’s
story of a transition from bounded to unbounded rationality actually implies a
transition from an empiricist to a rationalist theory of economic knowledge. Is
such a transition possible? Or does Schumpeter’s account ultimately rest on a

confusion of two logically distinct kinds of knowledge? Although I cannot mount
the arguments here,12 there is good reason to think that such a confusion is indeed
in operation in Schumpeter. If so, the mechanization-of-progress thesis loses much
of its force.
In order to see what this would mean, we need to understand the routinization
of progress, and thus the passing of the entrepreneur, in the complete context of
Schumpeter’s sociological argument. “We have seen,” he says, “that, normally,
the modern businessman, whether entrepreneur or mere managing administrator,
is of the executive type. From the logic of his position he acquires something of
the psychology of the salaried employee working in a bureaucratic organization”
(Schumpeter, 1942, p. 156). This is not an unfamiliar observation. The conclusion
usually drawn from it, especially by writers in the now well-developed tradition
of Berle and Means (1932), is that it is therefore a matter of indifference, from
a functional standpoint, whether the productive organization is privately or state
owned; indeed, state ownership would seem preferable since its motives are
“public” and hence purified of the taint of private desire.
Schumpeter draws a much different conclusion from this observation. To
Schumpeter, the crucial fact about the modern corporation is that its managers
cannot fill the strong social role played by the entrepreneur. Entrepreneurs are
pillars of strength, symbols of legitimacy, role models. They provide the new
ideas and new blood that refresh the “bourgeois stratum.” “Economically and
sociologically, directly and indirectly, the bourgeoisie therefore depends on the
entrepreneur and, as a class, lives and dies with him, through a more or less
prolonged transitional stage – eventually a stage in which it may feel equally
unable to die and to live – is quite likely to occur, as in fact did occur in the case
of the feudal civilization” (Schumpeter, 1942, p. 134). Socialism will succeed
because, without the entrepreneur to guard it, “the bourgeois fortress . . . becomes
politically defenseless.” It is not the managerial class who are the plunderers; it
is a New Class of socialist intellectuals and government officials. “Defenseless
fortresses invite aggression, especially if there is rich booty in them. Aggressors
will work themselves up into a state of rationalizing hostility – aggressors
always do. No doubt it is possible, for a time, to buy them off. But this last
resource fails as soon as they discover that they can have it all” (Schumpeter,
1942, p. 143).
Schumpeter is thus after bigger game than Berle and Means: nothing less
than Marx himself. Schumpeter has no great love for a socialist system (or, in
particular, a socialist culture); but he does see the similarities between private
and state bureaucracy as smoothing the way for socialism. “Thus the modern
corporation, although the product of the capitalist process, socializes the bourgeois
mind; it relentlessly narrows the scope of capitalist motivations; not only that, it
will eventually kill its roots” (Schumpeter, 1942, p. 156). Like Marx, then, he sees
capitalism as leading to its own destruction. But unlike Marx, Schumpeter sees
capitalism as the victim of its own economic success not its economic failure. This
tale stands Marx on his head, its plot laced with a heavy and self-satisfied irony. The
tone is disinterested and the attitude fatalistic; but the message is largely caution-
ary. At base, Schumpeter is nothing so much as a neoconservative, perhaps the first
neoconservative.
How would this story have to change if Schumpeter is wrong about the
mechanization of progress? On one level, the effect is significant. An economic
system that continues to rely on tacit, empirical knowledge – what Hayek (1945)
called “the knowledge of the particular circumstances of time and place” – would
sacrifice much of its innovativeness, and thus much of its engine of progress, by
consigning its industry and commerce to a bureaucratic socialism. This would
certainly make the transition to socialism much more painful to the voting
population, and thus would likely slow or modify (if not necessarily prevent) its
advent. Needless to say, this interpretation seems far more compelling now after
1989 than it did perhaps when Schumpeter was writing.
The role of the mechanization-of-progress thesis in the larger sociological
theory is to underscore the power of bourgeois capitalism on an economic level:
it is so efficient that it has conquered even our ignorance of the unknown; it can
stamp out innovation with all the efficiency that it brings to bear on stamping
out mass-produced goods. To deny capitalism this power over the future mars the
aesthetic of Schumpeter’s panorama somewhat, for it makes the inversion of Marx
less perfect than otherwise, and it diminishes the fatalism that gives the story much
of its color.
In the end, however, taking all this too seriously puts us in danger of reading
Schumpeter literal-mindedly. The force of the argument is in the texture of the
landscape – not in its details. Indeed, there is a sense in which the “Schumpeterian
tension” – the tension between the Schumpeter who comes to praise entrepreneur-
ship and the Schumpeter who comes to bury it – actually enriches the majestic
irony of Capitalism, Socialism, and Democracy.
NOTES
1. One might also mention the more dubious recent association of Schumpeter with
so-called endogenous growth theory, on which see Langlois (2001).
2. In fact, Schumpeter’s concept of innovation goes far beyond technological change in
the narrow sense. He is concerned with what he calls “the carrying out of new combinations”
interpreted broadly. “The concept,” he writes, “covers the following five cases: (1) The
introduction of a new good – that is one with which consumers are not yet familiar – or of a
new quality of a good. (2) The introduction of a new method of production, that is one not
yet tested by experience in the branch of manufacture concerned, which need by no means
be founded upon a discovery scientifically new, and can also exist in a new way of handling
a commodity commercially. (3) The opening of a new market, that is a market into which
the particular branch of manufacture of the country in question has not previously entered,
whether or not this market has existed before. (4) The conquest of a new source of supply of
raw materials or half-manufactured goods, again irrespective of whether this source already
exists or whether it has first to be created. (5) The carrying out of the new organisation of
any industry, like the creation of a monopoly position (for example through trustification)
or the breaking up of a monopoly position” (Schumpeter, 1934, p. 66).
3. But even in the 1911 original, Schumpeter toyed with the idea that the state could
take over the entrepreneurial role. (See especially Schumpeter, 1911, pp. 173ff. Thanks to
Wolfgang Gick for help with the German.) A more detailed study might well discover that
the continuity really goes back to 1911 or earlier, not merely to 1926.
4. Becker and Knudsen attempt to explain Schumpeter’s new stance on entrepreneur-
ship in terms of events and tragedies in his personal life. I find far more compelling the
possibility, which Becker and Knudsen discount, that, always ambitious and sensitive to
intellectual fashion, Schumpeter was simply reflecting the widespread popularity of Max
Weber’s approach in the German-speaking world of the 1920s, an approach that had pushed
into the background the older traditions of Austrian economics and the German Historical
School that had influenced the 1911 edition.
5. Regarding Schumpeter’s attitude toward the unity of economic thought in his own
day, see Schumpeter (1982). In an article written not long after Schumpeter’s death, Fritz
Machlup defended this syncretism – “a conciliatoriness which could be misjudged as weak
eclecticism” – as a form of methodological tolerance or methodological pluralism (Machlup,
1951, p. 146).
6. “Schumpeter is much closer intellectually to Marshall and Smith than he is to Samuel-
son and Arrow” (Nelson, 1977, p. 136). “Schumpeter was well within the classical tradition”
(Nelson & Winter, 1977, p. 64).
7. Streissler (1972, passim); Jaffé (1976, passim); and Kirzner (1979, esp. p. 3). But see
also Kirzner (1979, pp. 53–75).
8. I have developed these ideas at some length elsewhere, especially in Langlois (1985)
and Langlois (1986). See also Boland (1982) and Littlechild (1986).
9. See especially Schumpeter (1934, p. 83).
10. As Schumpeter repeatedly stressed, the knowledge with which he was concerned is
new from the economic point of view – not necessarily from the scientific or technical point
of view. For him, an idea becomes an innovation when it is tried out in practice for the first
time – again emphasizing the empirical character of the conception.
11. Indeed, from the point of view of internal logical consistency, the issues Schumpeter
raises are fundamentally troubling ones for neoclassical theory. If rationality is defined as
optimally adjusting means to ends, then the act of choosing the framework of means and
ends in the first place can never ultimately be a rational one (Elster, 1983, pp. 74–75; Kirzner,
1982, pp. 143–145; Langlois, 1986, p. 227; Winter, 1964, pp. 262–264 and passim).
12. But see Lavoie (1985) for a discussion of the “socialist calculation debate” along
these lines.
ACKNOWLEDGMENTS
The ideas in this paper occurred to me when I was working on my Ph.D.
thesis at Stanford University in the late 1970s, and a version of this argument
appears there (Langlois, 1981). I presented a draft of this paper at the History of
Economics Society annual meeting, June 21, 1987, Boston. I revised it slightly
after conversations with the late László Csontos, and it circulated as Working
Paper 91-1503, Department of Economics, University of Connecticut, November
1991. It has been available on the web since the late 1990s. The Becker-Knudsen
translation of Entrepreneur and the accompanying translator’s introduction finally
galvanized this revision and publication. I am grateful to Thorbjørn Knudsen and
Roger Koppl for encouraging me to publish the paper now, and to many people
who have given me comments along the way.
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LIST OF CONTRIBUTORS

David B. Audretsch Institute for Development Strategies,

Thorbjørn Knudsen Department of Marketing,

Don Bellante Uskali Mäki

Publication of Advances in Austrian Economics has been interrupted for several

Austrian Economics and Entrepreneurial Studies

Entrepreneurship, Mises said, “defies any rules and systematization. It can be

Scholars interested in entrepreneurship and growth should probably consult

reasonable to hope that a serious look at problems in entrepreneurial studies

this opportunity to publish his 1928 essay “Entrepreneur” as translated by

Austrian Economics and Entrepreneurial Studies

and economic growth (Reynolds et al., 1999). Entrepreneurship is now at center

new opportunities. If the opportunity discovered is a real one, the entrepreneur

2. ENTREPRENEURS AND NEW VENTURE CREATION

In general, in cognitive psychology, perceptions and interpretations are said to

starting a business is an intentional act that involves repeated attempts to exercise

Overall, the psychology literature and, in particular, Shaver’s attribution argu-

3. THE ENTREPRENEURIAL CONTEXT

In Kirzner’s theory of entrepreneurship, discovery is not only possible in the

Social capital is important because it allows individuals to obtain resources that

individuals. Embeddedness is relevant to entrepreneurship because it helps the

The contribution of the literature on social networks to our understanding of

4. ENTREPRENEURIAL FIRMS AND STRATEGIC

particular, entrepreneurial firms may be described as those exhibiting openness to

firm’s sustainable competitive advantage. In particular, the role of entrepreneur-

provided ways to endogenize the long-run rate of economic growth and, as a

Giddens, A. (1984). The constitution of society. Cambridge, UK: Polity Press.

David B. Audretsch and A. Roy Thurik

Austrian Economics and Entrepreneurial Studies

2. INNOVATION AND ENTREPRENEURSHIP

greatest investments to R&D. Little innovative output is associated with less

The theory of firm selection is particularly appealing in view of the rather

of the forest, where incumbent establishments are displaced by new entrants.

of entrepreneurship on economic growth may be attributable to a paucity of

link changes in entrepreneurship to changes in economic performance. Different

The eclectic framework of the determinants of entrepreneurship as presented in

Austrian Economics and Entrepreneurial Studies

THE ENTREPRENEUR AS EQUILIBRIUM AND

PRODUCTIVE AND UNPRODUCTIVE

it will be allocated. Now one can be innovative and enterprising in a variety of

ROUTINIZATION OF INNOVATION AND THE

Peter J. Boettke and Christopher J. Coyne

Austrian Economics and Entrepreneurial Studies

Keynesian-dominated discussion of economic development focused on and

a narrow reading of entrepreneurship cannot help us explain why some nations

2. ENTREPRENEURSHIP IN THE LITERATURE

Moreover, Schumpeter realized the necessity of private property in providing

The entrepreneur, working within the societal institutional framework will

According to Kirzner, competition exists as long as there are no arbitrary

3. MECHANICS OF ECONOMIC DEVELOPMENT

The standard neoclassical growth model is defined as:

Y = K, L, Tech, SK, NR, ST

involvement in the institutional environment. Finally, adaptive institutions, which

4. INSTITUTIONS AS CAUSE, ENTREPRENEURSHIP

In discussing overall economic development as well as capital flight, one of

5. In his analysis of the entrepreneur, Schumpeter attempted to consider the various

It is in the tradition of the Austrian School to seek to explain economic phe-

Austrian Economics and Entrepreneurial Studies

decision taking in the foreground – a circumstance of which I first became aware

does play an important role in the process of resource allocation. No economic

function as promoting only efficiency in a narrow sense. I referred earlier to differ-

Austrian Economics and Entrepreneurial Studies

time, Kirzner’s theory of entrepreneurship, which centers on alertness, discovery,

KIRZNER’S THEORY OF ENTREPRENEURSHIP