THE ENTREPRENEUR ACCORDING TO THE AUSTRIAN SCHOOL by EUGENIO COSME ANDRIEU Submitted in accordance with the requirements for the degree of MASTER OF ARTS in the subject ECONOMICS at the UNIVERSITY OF SOUTH AFRICA SUPERVISOR: PIET-HEIN VAN EEGHEN CO-SUPERVISOR: PROF JC LOTTER APRIL 2010 "I declare that “The entrepreneur according to the Austrian school” is my own work and that all the sources that I have used or quoted have been indicated and acknowledged by means of complete references". ________________ Eugenio C. Andrieu To Noreen, the best friend I could ever find. SUMMARY This thesis explores the concept of entrepreneurship. It aims at answering the question: does the Austrian view provide a comprehensive framework for the analysis of entrepreneurship? For this purpose the problem is separated into three main objectives: to trace its development, to describe its foundations and to explain its principal features. In order to achieve these objectives, the study is divided into six chapters. Chapter 1 outlines the historical origins of the Austrian School. Chapter 2 describes the uniqueness of the individual as the foundation of Austrian economic theory. Chapter 3 explains how individuals act in a society. Chapter 4 covers the idea of the market as a process. Chapter 5 analyzes the role of the entrepreneur. Finally chapter 6 presents some case studies from the IT industry. The thesis concludes that the Austrian school provides a fully comprehensive framework for the development of the concept of entrepreneurship. 4 TABLE OF CONTENTS Introduction ……………………………………………………….…….….…...…. 8 Methodology …………………………………………………………….………..… 9 Chapter 1 - Historical origins ………………………….......................................... 10 1.1 Introduction ……………………………………………..….…....… 10 1.2 Precursors …………………………...……………………….……... 10 1.2.1 The Franciscan theologians ……………………………….... 10 1.2.2 The Spanish scholastics ……………………...………….…. 12 1.2.3 The French physiocrats …………………………………….. 13 1.2.4 Early French liberals …………………………………….…. 14 1.2.5 Early liberalism ………………………………………….… 15 1.3 The Austrian school ……………...……………………………….. . 16 1.3.1 The first generation .………………………………………. 17 1.3.2 The second generation ……………….……………………. . 18 1.3.3 The third generation …………………………………….… 20 1.4 Conclusion ………………………………………………………….. 22 Chapter 2 - The individual: methodological foundations …….………….……... 23 2.1 Introduction ……………………………………………………….... 23 2.2 Earlier studies ……………………………………………………..... 23 2.3 Austrian studies ………………………………………..………....… 24 2.3.1 Methodology: the person as the foundation of economic science ………….. 24 2.3.1.1 Individualism …………………………….…. 24 2.3.1.2 Subjectivism …………………………..…… 26 2.3.1.3 Individual knowledge: the sensory order ….. 29 2.3.2 Economic science .…………………………………..………... 31 2.3.4.1 Menger: the essence of economic science ….. 31 2.3.4.2 Mises: the laws of economics, praxeology .… 35 2.3.4.3 Hayek: the aim of social sciences ……………39 2.4 Later studies ……………………………………………..………..... 41 2.4.1 Criticisms and other comments …………….……………....… 41 5 2.4.2 Other Austrian models: theory of expectations …..…………... 47 2.5 Conclusion ………………………………………...………..…….… 49 Chapter 3 - Society: how individuals cooperate …………….………..…….…... 50 3.1 Introduction ………………………………………………...……..... 50 3.2 Earlier studies and other influences .…………………...….…...…… 50 3.3 Austrian studies ………………………………………….………..... 53 3.3.1 Menger’s organic approach ..…...………………….…..…… 53 3.3.2 Mises’ theory of social cooperation ………...…………….... 54 3.3.3 Hayek’s theory of self-organizing systems ……………….... 55 3.3.4 Hayek’s theory of cultural evolution ………...............…...… 58 3.3.5 Consequences: the individual and society .……………….… 58 3.5 Conclusion ……………………………………………..………….... 60 Chapter 4 - The market: a framework for commercial transactions …...…..…. 62 4.1 Introduction …………………………..…………………..…..…….. 62 4.2 The market ………………..……………………………...………… 62 4.2.1 Mises: the market as an entrepreneurial process ………..…. 63 4.2.2 Schumpeter: the market as a process of innovation ……...… 64 4.2.3 Kirzner: the market as a process for creative acts of discovery ……………………………..….... 67 4.2.4 Lachmann: the market as a place for interpretation……….... 68 4.2.5 Hayek: the market as a place for knowledge sharing and freedom …………………...………. 70 4.3 Later studies …………………...………………………...………… 72 4.3.1 Criticisms and comments …. ……………...………………. 72 4.4 Conclusion ………………………...……………………………...... 76 Chapter 5 - The entrepreneur: explaining market change …...……………....... 78 5.1 Introduction ……………………………………………..……...…. 78 5.2 Earlier studies and influences ………………………...………...…. 78 5.2.1 A brief history of the term and its theoretical development... …..…………...…….…..….. 78 5.3 The Austrian entrepreneur …………………………...……...…….. 82 5.3.1 Menger: entrepreneurial activity ………………..………… 82 5.3.2 Mises: the entrepreneurial element ………………………... 83 5.3.3 Schumpeter: the innovative entrepreneur ………..……........ 84 6 5.3.4 Kirzner: the universal entrepreneur ……...…..…………….. 88 5.3.5 Comparison of Schumpeter’s and Kirzner’s entrepreneur ………..….…………………… 92 5.3.6 Holcombe: the link between present and past entrepreneurial opportunities …………………………...………………. … 92 5.3.7 High: the entrepreneur as originator of institutions …..…….. 93 5.3.8 Consequences …………………………………………....… 94 5.3.6.1 Entrepreneurship and ethics ….…...……………....... 94 5.3.6.2 Entrepreneurship, economic progress and context ..... 95 5.4 Later studies ………………………………………...………..….… 97 5.4.1 Criticisms …………………………………...……………… 97 5.4.1.1 Schumpeter’s entrepreneur ……………………....… 97 5.4.1.2 Kirzner’s entrepreneur and the finders-keepers principle ……..……………. 98 5.4.1.3 Entrepreneurship, economic progress and context .. 100 5.5 Conclusion ……………………………………….………...……… 103 Chapter 6 - Case studies ………………..……..……….….……………...……... 105 6.1 Introduction ………………………………………..…………...…. 105 6.2 History and the study of entrepreneurship ….…………….…...….. 105 6.3 The modern entrepreneur ………………………….…….…...…… 106 6.4 Competition in the knowledge economy …………….…….....…… 107 6.5 Defining moments in the IT industry ……………….…..………… 107 6.5.1 IBM and the mainframe revolution ..……….……..…..….. 107 6.5.2 Microsoft and the PC ……………………………...………. 109 6.5.3 Google and the search engine ………………………...…… 111 6.5.4 Facebook and the internet social network …….…….….…. 112 6.6 Conclusion ………………………………………………...…...….. 113 Conclusion …………………………………………………………………….….. 115 Final words ………..……………………………………………...…………...….. 116 Bibliography …………………………………………………………...……….... 117 7 INTRODUCTION This thesis explores an economic idea that emerged within the Austrian school: the concept of entrepreneurship. It aims at answering the question: does the Austrian view provide a comprehensive framework for the analysis of entrepreneurship? For this purpose the problem is divided into three main objectives: to trace its development and historical roots, to describe the main ideas within Austrian economic theory that prompted its appearance, and to explain its principal features. In order to achieve these objectives, the study is divided into six chapters. Chapter 1 presents a brief description of the historical origins of the Austrian school and its development, with particular emphasis on the aspects that characterize entrepreneurship. Chapter 2 describes the uniqueness of the individual as the foundation of Austrian economic theory. Chapter 3 explains how individuals act in a society and reveals that the fundamental problem of economics is one of knowledge. Chapter 4 covers the idea of the market as a process, which in turn defines the framework for the existence of the entrepreneur. Chapter 5 is the core of this thesis. It treats the concept and role of the entrepreneur, giving emphasis to the evolution of its meaning within the Austrian school. Finally chapter 6 presents some case studies from the IT industry. Each case makes an interesting story, as each contains a different approach to the essentials that defined entrepreneurial success. The thesis concludes that the Austrian school provides a fully comprehensive framework for the development of the concept of entrepreneurship and its different roles. This framework, which is based on the individual, includes a model of society, the market and of entrepreneurship in its different scales. For this reason, the Austrian model has produced a lasting contribution that should be included in mainstream economics. 8 METHODOLOGY In order to find an answer to the question “Does the Austrian view provide a comprehensive framework for the analysis of entrepreneurship?” this research is approached as a literature study limited to Austrian school sources. As this school of thought is mainly based on the seminal works of some few authors, the thesis is structured around their views. These selected economists are Menger, the founder of the Austrian school; Mises who developed this view to larger extends; Hayek the father of some key Austrian ideas such as self-emerging societies and the social mind; and finally Schumpeter and Kirzner who at different periods of time developed the foundations of entrepreneurship. Lachmann who contributed in the area of expectations is also considered. Complementing the explanation of these influential contributions are the views of some contemporary researchers such as High, Baumol, Boettke, Butos, Koppl, Garrison, Hodgson, Holcombe, Hoppe, Horwitz and Rothbard. Their research is important in that they have not only added criticism and debate but also in that they have extended Austrian ideas to further realms. For example, it is central to mention the work of Baumol in the area of productive and unproductive entrepreneurship, and the research of High which extends entrepreneurship to the formation of institutions. The thesis ends with some case studies from the computer industry. Their importance results from the fact that they show that Austrian thought, and particularly the concept of entrepreneurship, have useful application in the study of economic reality. 9 CHAPTER 1 HISTORICAL ORIGINS “Historically, liberalism was the first political movement that aimed at promoting the welfare of all, not that of special groups” (Mises 1927: 7). 1.1 INTRODUCTION This chapter deals with the first objective for this thesis: to identify the historical roots of Austrian economic theory and describe its development as a school of thought. It begins by describing the work of the Franciscan theologians, the Spanish scholastics and the French physiocrats, whose theoretical work in economics laid the foundations of modern capitalism. Then, it looks at liberalism and its main characteristics. It ends with a brief overview of the Austrian school: its historical setting and the lives and achievements of its main contributors. These achievements are important in that they highlight the main concepts that lay the foundations of entrepreneurship. 1.2 PRECURSORS From the thirteenth century onwards, many writers began to identify some of the concepts that were later developed into an integrated theory by the Austrian school. The discovery of these concepts can be grouped into five main schools of thought. Two of them are from catholic roots: the Franciscan theologians and the Spanish scholastics. The other three are the French physiocrats, the early French liberals and the liberals from Holland and England. 1.2.1 The Franciscan theologians During the thirteenth and fourteenth centuries the disciples of Saint Francis were in the cities and in contact with the predominant mercantile middle class. In their search for an integration of city life values and Christian ethics they developed an economic theory that was centred on the individual and defined many aspects of capitalism. The 10