Entrepreneurship and the Market Process

An Enquiry into the Growth of Knowledge

David A Harper

• Publisher: Taylor & Francis
• Year: 2002
• Print ISBN: 9780415130486
• eBook ISBN: 9781134791590
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

Enterpreneurship is central to the market process, and yet most theories of it fail to tackle the problem of how economic agents learn from their experience. This book redresses this by systematically applying the ideas of Karl Popper. It treats the entrepeneur as a theorist who develops conjectures which are then tested by exposure to the market, in an effort to eliminate errors. This is a critical aspect of the development of new ventures, as most entrepeneurial ideas turn out to be mistakes, at least in their original form.

Part I: BACKGROUND AND INTRODUCTION

1: INTRODUCTION

Beliefs are part of the fabric of economic life, woven into it in such a way that they cannot be taken out without disintegration of the cloth.

(Bacharach 1986: 178)

1.1 WHY DO WE NEED A THEORY OF ENTREPRENEURSHIP?

The objectives of this work are to explain entrepreneurial learning and to make some first steps in accounting for the ‘endogenous’ dynamics of the market process. In order to explain the disequilibrium process through which markets move, it is necessary to have a theory of entrepreneurship. Entrepreneurship is here defined as profit-seeking activity aimed at identifying and solving ill-specified problems in structurally uncertain and complex situations. It involves the discovery and creation of new ends–means frameworks, rather than the allocation of given means in the pursuit of given ends (see Chapter 3 for a more detailed description of entrepreneurship). It has been shown convincingly elsewhere that the market process cannot function, even within the market for a single commodity, if all market participants are assumed to be non-entrepreneurial maximisers who react mechanically to changes enforced upon them by external circumstances over which they have no control (Hayek 1949: ch. 5; Kirzner 1962a, 1973). Such an approach leaves the market process unexplained. This book aims to address this problem by laying the groundwork for a dynamic theory of how entrepreneurs learn. A theory of entrepreneurial learning is a prerequisite to any explanation of sequential entrepreneurial decision-making, and thus to any theory of the dynamics of the market process. It is crucial for explaining the revision over time of people’s knowledge, expectations, decisions and plans – changes which form the basis of the competitive market process. Indeed, it has been claimed that a theory of market dynamics is necessarily a theory of learning (Gordon and Hynes 1970: 377; White 1978: 4).

Given the failure of ‘mainstream’ economics (i.e. the prevailing neoclassical research programme) to examine entrepreneurship, it is necessary to turn to other approaches. It has been argued for some time that theories of the growth of (scientific) knowledge can provide significant insights into how markets operate and how economic agents learn from their experiences within the market.¹ Modern theories of the growth of science provide much scope for human imagination and experimentation, so that these approaches warrant investigation as a means of equipping economic agents within economic theories with entrepreneurial qualities. Boland (1982, 1986b) and Wible (1984) have independently argued that there is a need for a growth-of-knowledge conception of economic agents, which could lead to a more dynamic view of economic learning and to an alternative conception of economic rationality which goes beyond the narrow ‘mainstream’ view of rationality as typified by a maximising behavioural postulate. Theories of scientific development provide valuable insights which are useful for explaining the broad pattern of scientists’ behaviour in particular situations. By extending the scope of these theories, science can be taken as a generalised model of sophisticated decision-making in structurally uncertain and complex problem situations. Applied to the context of entrepreneurship, this model shows promise of providing a basis for a theory of entrepreneurial learning and of market processes.

Consequently, the theory developed in this book draws upon the abundant literature in the philosophy of science. In particular, it applies Popper’s critical rationalism and, to a lesser extent, Lakatos’s methodology of scientific research programmes. Popper’s theory of the growth of knowledge is chosen because it was the first non-justificationist philosophy in the history of the philosophy of science: it is non-justificationist in that it divorces knowledge from certainty, proof and ‘hard’ facts (Bartley 1964: 23). This conception of knowledge implies that there is no supreme, infallible method available to us for acquiring knowledge which can guarantee us the truth. Lakatos was convinced that Popper’s philosophy represents ‘the most advanced philosophy of our time’, an accomplishment ‘in the tradition – and on the level – of Hume, Kant or Whewell’ (Lakatos 1974: 263). In his opinion, ‘philosophical progress can only be based . . . on its achievements’ (1974: 263). The significance of Popper’s philosophy of science arises from its vindication of the problems of the growth of scientific knowledge. It employs a dynamic, evolutionary concept of knowledge, rather than a structural concept. Many philosophers in the growth-of-knowledge tradition (including Lakatos) have accordingly adopted Popper’s work as the starting point of their analysis (Caldwell 1982: 37).

This work represents the first major investigation into entrepreneurship (and, to a lesser extent, the market process) within a growth-of-knowledge (GK) framework.² It explores the implications of the GK approach for entrepreneurial learning and behaviour, the screening of entrepreneurial ideas, market adjustment and its continuity, and the coherence of the market system. This approach casts new light onto how economic agents in markets acquire, use and disseminate knowledge as they initiate and respond to change, and it highlights how agents must apply entrepreneurial imagination to generate their new conjectures. More specifically, the approach aims to develop a theory of how Popperian-style entrepreneurs improve their knowledge in a disequilibrium setting.³ The tentative and conjectural nature of entrepreneurial knowledge is emphasised, and so too is the consequent need for an interpersonal process by which knowledge is constantly communicated, acquired, tested and improved.

The commonalities of scientific progress and the market process are exploited to the utmost. Like scientific enterprise, entrepreneurship is described essentially as a problem-solving activity which must be conceived in terms of human ends and purposes. Like science, the market is regarded as an inter-subjective and pluralistic process for generating conjectures, exchanging and promoting ideas and attempting to refute them. Both learning processes require conventions, many of which have evolved spontaneously, to facilitate the efficient production, coordination and criticism of knowledge (Loasby 1989: 164–166).

Explaining entrepreneurship and market processes in terms of these philosophical theories of the evolution of ideas is not simply to rely upon metaphor, however: It is a direct application of modern theories of the growth of knowledge to the twin problems of entrepreneurship and the market process: ‘[W]hat I wish to emphasise here is that the relationship between scientific and market processes is not just that of analogy, for the growth of knowledge is the subject of both’ (Loasby 1989: 163).

1.1.1 What problems does the new theory attempt to solve?

The entrepreneurial function is the major driving force of the market economy. The entrepreneur is an agent who seeks to break outside the range of established routines and the existing framework of ideas. The imaginative, intuitive component of this activity is well-recognised (e.g. Schumpeter 1934, 1947, 1950; Shackle 1970, 1979a, 1979b). But previous theories have tended only to emphasise the non-rational, intuitive faculties required of an entrepreneur (e.g. Kirzner 1973, 1979b, 1982c, 1992). This perspective needs to be bolstered by emphasising in addition the rational and critical aspects of entrepreneurship which are a prerequisite to acquiring new knowledge. Though necessary, imaginative freedom and the generation of novel ideas are not sufficient for the evolution of knowledge. In attempting to solve market problems at a profit, the entrepreneur must also apply critical methods of error elimination: the entrepreneur’s creative imagination must be subject to critical control. Reconstructions of the process of entrepreneurial learning which fail to stress the role of criticism are thus inadequate.

Consequently, the central problem addressed by this book is to explain the growth of knowledge at the level of individual entrepreneurs: how entrepreneurs learn in the light of experience and feedback from the market, how they may retain some part of their systems of knowledge while modifying the rest, and how they may even devise entirely new systems to replace their original ideas and strategies. Explaining the nature, causes and effects of entrepreneurial error also falls within the ambit of this work. Similarly, I seek to account for the methods by which entrepreneurs may test their own hypotheses (before, during and after commercialisation) in order to identify and to learn from their mistakes. Moreover, I hope to explain the difficulties which entrepreneurs encounter in interpreting market evidence, in deciding whether their ideas have been effectively refuted and in determining whether to abandon a failing venture. Another goal is to provide an explanation of why entrepreneurs in similar circumstances may behave differently.

The solution of these problems requires the development of a more sophisticated theory of (entrepreneurial) learning than has hitherto been put forward in economics. It calls for a theory which analyses entrepreneurial knowledge as a dynamic, evolving system rather than as a static or stationary structure; a theory which depicts the growth of knowledge as a series of revolutions which overturn old ideas, rather than as an incremental, cumulative process of improvement; and a theory which characterises entrepreneurial learning as a process of discovery rather than as a procedure of imitation or of inductive instruction through repetition. In particular, what is needed is a theory which portrays all learning of new market ‘facts’ as a sequence of continuous conjecture and refutation.

A theory of entrepreneurial learning (viewed ex ante) cannot be a theory of ex post successful learning. Success depends upon many factors, including luck (cf. Popper 1976c: 47). An adequate theory of learning cannot exclude human fallibility which can manifest itself in entrepreneurial error, losses and failure. On the contrary, genuine uncertainty, the unpredictability of the future growth of knowledge and the potential for entrepreneurial mistakes and losses must all be emphasised. In summary, the required type of theory of entrepreneurial learning is critical rather than dogmatic, dynamic rather than static, deductivist rather than inductivist, Darwinian rather than Lamarckian, and fallibilist rather than justificationist or positivist.

In addition to examining how entrepreneurs operate within the market system, this book also seeks to tease out implications of the GK approach for the competitive process as a whole, that is, problems at the level of markets. The new research programme outlined in this chapter aims in the long term to provide a theoretical framework for analysing dynamic market processes taking place over time. It should be noted at the outset, however, that the immediate objectives of the specific theory presented in this book are far more modest. Analysis at the level of market processes is given much less emphasis. The present work seeks only a very partial explanation of such phenomena, a first step towards a more adequate theory. At this stage of theoretical development, I confine my attention to only a few aspects of the market process: namely, the pattern of organisation of conjecture and refutation within the market economy; the criteria by which markets screen entrepreneurial conjectures; the origins of the competitive market process and their implications for the nature of this learning mechanism; the comparative performance of the market process in generating and screening new entrepreneurial conjectures; and how the market process can be perpetuated by endogenous forces (i.e. forces within the system, as opposed to external shocks).

1.2 ENTREPRENEURSHIP AS A LACUNA IN MAINSTREAM ECONOMIC THEORY

One lesson to be learned from the history of economics is that the problem of the place of entrepreneurship in economic theory is not a problem of theory per se, it is a problem of method.

(Hébert and Link 1989: 48)

The absence of a neoclassical theory of the entrepreneur has been investigated at length within the economics literature and will not be discussed in detail here.⁴ At this juncture, it is sufficient to mention that the modern Walrasian theory of perfect competition (e.g. Arrow and Hahn 1971; Debreu 1959) cannot explain market processes – the way in which market forces bring about adjustments in prices and quantities and the introduction of new products and processes. At best, neoclassical theory describes the conditions for competitive equilibrium, without explaining adequately if or how equilibrium may be reached.

Of course, neoclassical models of market adjustment to equilibrium do exist, but they are unsatisfactory.⁵ In this section, emphasis is placed upon models of price adjustment. (Indeed, in the neoclassical literature all the adjustment seems to concern prices and/or quantities. There is little in relation to other elements of the marketing mix that entrepreneurs might see worth adjusting, such as the product or promotion methods.) The following discussion is extremely selective, being limited to two distinct lines of research within the neoclassical research programme: analyses of the stability of (mostly general) competitive equilibrium; and partial-equilibrium models of equilibrium price dispersion in markets with imperfect and costly information. Lack of space precludes an examination of alternative concepts of equilibrium (such as temporary general equilibria and rational expectations equilibria) which have been developed in response to a growing dissatisfaction with the original Arrow–Debreu model of general equilibrium.

1.2.1 Analyses of adjustment to competitive equilibrium

The seminal study within the neoclassical programme is that of Samuelson (1941, 1942, 1947: 257–349) who provided the first description of the price adjustment process in terms of a system of differential equations. Following Samuelson’s path-breaking contribution, the first neoclassical models of price adjustment were tâtonnement models in which no actual exchange occurred outside of equilibrium (see Arrow and Hurwicz 1958 and Arrow, Block and Hurwicz 1959). The tâtonnement process was not the only model to be offered of price adjustment in a competitive economy, however. Negishi (1961) was the first to show the stability of a non-tâtonnement process which does permit trading to take place out of equilibrium. These processes are generally more stable than tâtonnement processes. Two major types of non-tâtonnement models have been distinguished in the literature: those which model the Edgeworth process (Hahn 1962; Uzawa 1962) and those models based on the Hahn process (Hahn and Negishi 1962). The Edgeworth process assumes that trade will take place if and only if at least one individual gains in utility by exchange at current prices and no individual loses. In contrast, the basic assumption of the Hahn process is that markets are sufficiently orderly that after trade the goods that are in excess demand (supply) for a given agent are also in excess demand (supply) by the market as a whole. In other words, the Hahn process postulates that potential buyers and potential sellers can identify each other, so that at any time after trade there is not simultaneously both unsatisfied effective demand and unsatisfied supply for the same good (Fisher 1974: 472, 477; 1983: 31).

A major shortcoming of all these early models is that they failed to explain price changes as the result of rational decisions by individual market participants, because all economic agents were assumed to be price-takers. Thus, it was not explained who changes prices and why (Arrow 1959: 43; Koopmans 1957: 179). Price changes arose inexplicably as the consequence of a mythical auctioneer who sets and adjusts prices to their unique equilibrium levels or as a result of ‘impersonal forces of the market’⁶ (an auctioneer in disguise). The pricing rules of the auctioneer were not linked to the maximising actions of economic agents, actions which are supposed to constitute the basis of neoclassical theory. The price adjustment mechanism thus violated the requirements of methodological individualism (see Boland 1986b: 142; Hahn 1987: 137). The auctioneer, of course, is not a market actor but a deus ex machina. The appearance of the auctioneer is a methodological ruse, an attempt to lend plausibility to the Samuelsonian formulation by providing an “agent” whose behavior it describes’ (White 1978: 10).

Consequently, in these models knowledge is the outcome of some fictional process rather than the product of actual learning by individual economic agents. This epistemological flight of fancy is highlighted by the extremely severe knowledge requirements of the Edgeworth process. Unlike the Hahn process, the Edgeworth process requires that whenever the conditions for beneficial exchange exist, trade will in fact take place. Each market participant is required to be aware of all opportunities to personally gain through trade. In reality, of course, without an auctioneer, ‘exchange may fail to occur because knowledge is imperfect, in spite of the presence of the conditions for mutually profitable exchange’ (Kirzner 1973: 216). In addition, the Hahn process does not address the entrepreneurial element involved in the decision to trade.

Following Arrow’s (1959) criticism of Samuelson’s mathematical statement of price adjustment, some later non-tâtonnement models distinctly located the task of price adjustment with individual economic agents, rather than a fictitious auctioneer. Such adjustment processes have been term...

Table of contents

• COVER PAGE
• FOUNDATIONS OF THE MARKET ECONOMY: EDITED BY MARIO J. RIZZO, NEW YORK UNIVERSITY AND LAWRENCE H. WHITE, UNIVERSITY OF GEORGIA
• TITLE PAGE
• COPYRIGHT PAGE
• FIGURES AND TABLES
• PREFACE
• ACKNOWLEDGEMENTS
• PART I: BACKGROUND AND INTRODUCTION
• PART II: THE METHODOLOGY OF THE FALSIFICATIONIST ENTREPRENEUR
• PART III: AGENDA AND CONCLUSIONS
• BIBLIOGRAPHY