Organizations and Markets

| Peter Klein |

When explaining the returns to factors of production economists often define wages as the payment to labor, interest as the payment to capital, rent as the payment to land, and profit as the payment to entrepreneurship. Treating entrepreneurship as a factor of production, earning a return we label profit, poses some challenging problems, however. Does entrepreneurship have a marginal revenue product, corresponding to a firm’s profit? Is there an upward-sloping supply curve for entrepreneurship (more of it is offered to the market when profits rise)? Are there diminishing returns to entrepreneurship?

The answer given by the classic contributors to the economic theory of entrepreneurship such as Cantillon, Say, Schumpeter, Knight, Mises, Kirzner, and others is clearly no. They treat entrepreneurship as ubiquitous, an attribute of the market mechanism that can never be absent. This came out in John Matthews’s paper, “Rents versus Profits: What Are the Appropriate Goals of Strategizing?”, presented Wednesday at the CCSM.

John shared this quote from the French economist Jean Marchal, writing in the September 1951 American Economic Review:

[E]ntrepreneurs obtain remuneration for their activity in a very different manner than do laborers or lenders of capital. The latter provide factors of production which they sell to the entrepreneur at prices which they naturally try to make as high as possible. The entrepreneur proceeds quite otherwise; instead of selling something to the enterprise he identifies himself with the enterprise.. Some people doubtless will say that he provides the function of enterprise and receives as remuneration a sum which varies according to the results. But this is a tortured way of presenting the thing, inspired by an unhealthy desire to establish arbitrarily a symmetry with the other factors. In reality, the entrepreneur and the firm are one and the same. His function is to negotiate, or to pay people for negotiating under his responsibility and in the name of the firm, with two groups: on the one hand, with those who provide the factors of production, in which case his problem is to pay the lowest prices possible; on the other hand, with the buyers of the finished products, from which it is desirable to obtain as large a total revenue as possible. To say all this in a few words, the entrepreneur, although undeniably providing a factor of production, perhaps the most important one in a capitalist system, is not himself to be defined in those terms. (pp. 550-51)

Marchal expresses, in strong terms, the view propounded by Nicolai and myself in several papers that entrepreneurship is embodied in asset ownership (i.e., in the creation and operation of the firm). The entrepreneur is not merely an idea man, but rather an owner, who exercises judgment over the capital assets he owns and manages. (This contrasts with Kirzner’s analytical device of the “pure entrepreneur” who owns no capital.)

Here is an interesting quote from Mises (Human Action, 3rd ed., p. 293) on the ubiquity of entrepreneurship:

The entrepreneur is also jeopardized by political dangers. Government policies, revolutions, and wars can damage or annihilate his enterprise. . . . If all entrepreneurs were fully convinced that the total victory of Bolshevism was impending they would nevertheless not abandon their entrepreneurial activities. The expectation of imminent expropriation will impel the capitalists to consume their funds. The entrepreneurs will be forced to adjust their plans to the market situation created by such capital consumption and the threatened nationalization of their plants and shops. But they will not stop operating. If some entrepreneurs go out of business, others will take their place — newcomers or old entrepreneurs expanding the size of their enterprises. In the market economy there will always be entrepreneurs. Policies hostile to capitalism may deprive the consumer of the greater part of the benefits they would have reaped from unhampered entrepreneurial activities. But they cannot eliminate the entrepreneurs as such if they do not entirely destroy the market economy.

This nicely illustrates Mises view that the entrepreneurial act is, as Joe Salerno writes in an email, “a non-marginal and purely intellectual decision.” The marginal or factor-of-production approach holds that entrepreneurs enter and exit the market for entrepreneurship based on (exogenous) profit rates. For Mises, Knight, and — as illustrated by the passage above — Marchal, it is entrepreneurship that creates profit.

Part of the reason many people speak of the supply of entrepreneurship and the marginal return to entrepreneurship is that they conceive “entrepreneurship” as an occupational category, as self-employment. An entrepreneur is a person who starts his own business, as opposed to an employee who works for someone else. In this sense it makes sense to talk about entrepreneurship as a factor of production with an upward-sloping supply curve. As profit opportunities increase, relative to wages, more individuals will choose self-employment over employment.

If, on the other hand, entrepreneurship is treated as a function, process, or attribute, rather than an employment category, it cannot be treated as a factor of production and is exercised, as in the Mises quote above, even in the worst market conditions.