The Entrepreneur Jude Wanniski May 30, 1997

Supply-Side Economics Lesson No. 25

Memo To: Students of Supply-Side University
From: Jude Wanniski
Re: The Entrepreneur

This topic will eventually require a website lecture series, but I thought it about time that we introduce a discussion of the entrepreneur and entrepreneurship. If all economic growth is the result of risk-taking, which is a central tenet of our understanding of supply-side economics, the entrepreneur is an important agent of growth. Conventional demand-side economists usually give a nod to the role of the entrepreneur, but because demand-side economics assume that demand creates its own supply, the entrepreneur is not a figure of primary importance. That is, if the entrepreneur were not around to supply demand, someone else would be. Established enterprise, perhaps, or government enterprise. Webster's Ninth New Collegiate Dictionary defines the entrepreneur as "one who organizes, manages and assumes the risks of a business or enterprise." It is a pretty feeble definition, one not entirely accurate, in that the entrepreneur frequently requires a capitalist to assume many of the risks of organizing and managing an enterprise.

In this first session on the topic, we will simply review briefly other material available in the economics textbooks in use in introductory college courses today. First, though, we offer the best description of an entrepreneur we've encountered in the past, one that is almost never encountered in a modern college course. It appears on pg. 584 of Human Action, the magnum opus of Ludwig von Mises, first published in 1949. In the passage cited, von Mises is addressing a flaw in a demand-side doctrine of the day, "the acceleration principle," which held that "A temporary rise in the demand for a certain commodity results in increased production of the commodity concerned. If demand later drops again, the investments made for this expansion of production appear as malinvestments." Von Mises goes on to say....

The fundamental error of this doctrine is that it considers entrepreneurial activities as a blindly automatic response to the momentary state of demand. Whenever demand increases and renders a branch of business more profitable, production facilities are supposed instantly to expand in proportion. This view is untenable. Entrepreneurs often err. They pay heavily for their errors. But whoever acted in the way the acceleration principle describes would not be an entrepreneur, but a soulless automaton. Yet the real entrepreneur is a speculator, a man eager to utilize his opinion about the future structure of the market for business operations promising profits. This specific anticipative understanding of the conditions of the uncertain future defies any rules and systematization. It can be neither taught nor learned. If it were different, everybody could embark upon entrepreneurship with the same prospect of success. What distinguishes the successful entrepreneur and promoter from other people is precisely the fact that he does not let himself be guided by what was and is, but arranges his affairs on the ground of his opinion about the future. He sees the past and the present as other people do; but he judges the future in a different way. In his actions he is directed by an opinion about the future which deviates from those held by the crowd. The impulse of his actions is that he appraises the factors of production and the future prices of the commodities which can be produced out of them in a different way from other people. If the present structure of prices renders very profitable the business of those who are today selling the articles concerned, their production will expand only to the extent that entrepreneurs believe that the favorable market constellation will last long enough to make new investments pay. If entrepreneurs do not expect this, even very high profits of the enterprises already operating will not bring about an expansion. It is exactly this reluctance of the capitalists and entrepreneurs to invest in lines which they consider unprofitable that is violently criticized by people who do not comprehend the operation of the market economy. Technocratically minded engineers complain that the supremacy of the profit motive prevents consumers from being amply supplied with all those goods with which technological knowledge could provide them. Demagogues cry out against the greed of capitalists intent upon preserving scarcity.

Text Books

William J. Baumol, Alan S. Blinder; Economics: Principles and Policies (Sixth Edition), 999 pp. Harcourt Brace & Company, 1994

William J. Baumol is professor of economics at NYU, Alan Blinder a professor at Princeton. Blinder was a member of President Clinton's Council of Economic Advisors in 1993 and was Vice Chairman of the Federal Reserve from 1994-96. Baumol and Blinder's discussion of entrepreneurship and risk-taking covers only several pages and is hardly satisfactory for a book of its size and pretensions. But they do a fair job on p. 3 82 of citing the contribution of the entrepreneur as an innovator.

The entrepreneur who is first to market a desirable new product or employ a new cost-saving machine will receive a profit higher than that normally accruing to an uninnovative (but otherwise similar) business manager. Innovation is different from invention. Invention is the act of generating a new idea; innovation is the next step, the act of putting the new idea into practical use. Business people are rarely inventors, but they are often innovators.

When an entrepreneur innovates, even if her new product or new process is not protected by patents, she will be one step ahead of her competitors. She will be able to capture much of the market either by offering customers a better product or by supplying the product more cheaply. In either case, she will temporarily find herself with some monopoly power left by the weakening of her competitors, and monopoly profit will be the reward for her initiative.

However, this monopoly profit, the reward for innovation, will only be temporary. As soon as the success of the idea has demonstrated itself to the world, other firms will find ways of imitating it. Even if they cannot turn out precisely the same product or use precisely the same process, they will have to find ways to supply close substitutes if they are to survive. In this way, new ideas are spread through the economy. And in the process the special profits of the innovator are brought to an end. The innovator can only resume earning special profits by finding still another promising idea. Entrepreneurs are forced to keep searching for new ideas, to keep instituting innovations, and to keep imitating those ideas that they were not the first to put into operation. This process is at the heart of the growth of the capitalist system. It is one of the secrets of its extraordinary dynamism.

It is when Baumol and Blinder come to taxation of the profits that flow from entrepreneurship that they fall to pieces. Both liberal Democrats, they go on to advise the students who use their textbook that this topic is one beyond their ken.

So profits in excess of the market rate of interest can be considered as the return on entrepreneurial talent. But this is not really very helpful, since no one can say exactly what entrepreneurial talent is. Certainly we can not measure it; nor can we teach it in a college course (though business schools try!). Therefore, we do not know how the observed profit rate relates to the minimum reward necessary to attract entrepreneurial talent into the market — a relationship that is crucial for the contentious issue of profits taxation....

Critics of big business [emphasis added] who call for high, if not confiscatory, profits taxes seem to believe that profits are mostly economic rent. But if they are wrong, if most of the profits are necessary to attract people into entrepreneurial roles, then a high profits tax can be dangerous. It can threaten the very lifeblood of the capitalist system. Business groups predictably claim that this is  the case. Unfortunately, neither group has offered much evidence for its conclusion.

What a cop-out. This really is shameful of these two celebrated economists. They acknowledge the entrepreneur as being the lifeblood of dynamic capitalism, but will not venture an opinion on how taxation affects entrepreneurship. Even worse, notice how Baumol and Blinder use general business taxes and taxation of entrepreneurs interchangeably. First they discuss the dynamics of capitalism depending upon the innovation of entrepreneurs, then shift the focus to critics of big business, those who argue that profits can be taxed at high rates, as long as what remains is at least as high as what can be earned by investing in Treasury bonds. The critics of big business and big business lobbyists "unfortunately" do not offer much evidence in either direction!!! Baumol and Blinder, of course, have to fudge on this issue, although they advise their college students that the matter can "threaten the very lifeblood of capitalism." Why? Because they hope to make a profit with their textbook and know that most economics professors and faculties would not use a textbook that argued for lower tax rates on entrepreneurial capitalism.

Note also that Baumol and Blinder make no mention of the capitalist in this dynamic process. As far as they are concerned, the tax issue involves "profits [which] are necessary to attract people into entrepreneurial roles..." The authors, of course, know that entrepreneurs are not necessarily driven by the desire for financial profit. On p. 381, they highlight a quote of Robert Knapp, who says: "If money should not be the primary reason for starting a business, what should be? Love. The love of a challenge — of creating and building something; of scaling the mountain, not reaching the peak; of traveling the road, not resting at the inn at the end. Successful entrepreneurs are driven to express and prove themselves, be the best they can, beat the competition, break the rules, disprove the odds. And they love the game."

Where money enters the picture, it is via the capitalist, who is not interested in love, challenges, achieving the best, etc. The capitalist has resources to put at risk and wishes nothing more than a return to compensate for the risk, if the enterprise in which he is investing is successful. The issue of taxation is of little concern to the entrepreneur, who naturally will proceed with his idea as long as he can find a capitalist to bankroll him. If the capitalist observes that the entrepreneur's success will produce returns that will be taxed away by government, there will of course be no investment. Baumol and Blinder certainly know this, but it would be politically incorrect for them to put it in their textbook, or their students might get the wrong ideas.

In Human Action, von Mises does discuss the role of taxation as big business uses its influence throughout history to suppress entrepreneurial talent that might challenge its pre-eminence. None of the other textbooks listed here come close to understanding the dynamics of entrepreneurial capitalism and most are far worse in their presentations than Baumol and Blinder. We will kick them around in the weeks to come.

* * * * *

Lipsey, Courant, Purvis, Steiner; Economics (Tenth Edition), 881 pp. Harper Collins, 1993.
Campbell R. McConnell, Stanley L. Brue; Economics: Principles, Problems, and Policies (Twelfth Edition) 782 pp. McGraw-Hill, 1960.
Roger LeRoy Miller; Economics Today (Eighth Edition), 822 pp. Harper Collins, 1994.
Michael Parkin; Economics (Updated Second Edition) 1,057 pp. Addison-Wesley, 1994.
Paul A. Samuelson, William D. Nordhaus; Economics (Fourteenth Edition), 727 pp. McGraw-Hill, 1992.
Ludwig Von Mises; Human Action: A Treatise on Economics (Third Revised Edition), 885 pp. Contemporary Books/Henry Regnery Co., 1966.