The Fairest Society Is The One Which Most Energetically Promotes The Entrepreneurial Creativity Of All Its Members.

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This post is based on – and utilizes a lot of the language from – The Theory Of Dynamic Efficiency by Jesus Huerta De Soto, an essay that highlights with great clarity some of the essential differences between Austrian economics and mainstream economics.

It seems as though those of us who favor free markets and the unleashing of the creative power of entrepreneurship have lost control of the language.

Take the word fairness as an example. In today’s perceptions of social justice (which, in itself, is an other term we’ve lost to irrational interpretation), fairness is deemed to require equalized outcomes for all. No-one should have more wealth or income than anyone else. Any institution or process or arrangement that tends towards an outcome that can be deemed unequal is unfair. 

Is this way of thinking good for society? There is an entirely different way of thinking, one which will lead to a much more dynamic and productive society that advances with great agility and energy towards a better future for all.

Economist Jesus Huerta de Soto calls this way of thinking “dynamic efficiency”. Efficient is another word that is typically misused in economics. It has been made to mean something like using fewer resources in order to achieve a given output. The point about dynamic efficiency is that output is never given. Thanks to individual human creativity, especially in the form of entrepreneurship, output is always changing, improving, becoming more effective and more useful and more valued by customers. The question should not be how to use fewer resources, but how to use resources in a good way to produce better outcomes.

Neither resources nor technology are “given” in real life. They can vary and actually do vary continually – as a result of entrepreneurial activity. This is the essence of dynamic efficiency – continuous change for the better. When so-called welfare economics calls for redistribution of resources in order to address perceived inequality, it is based on a static view. Interpersonal comparisons of what economists call utility require a snapshot to freeze data in time in order to analyze and decompose It. Meanwhile, time and economic conditions and entrepreneurship and innovation continue apace, and whatever comparisons are made are rendered irrelevant.

Such comparisons completely ignore dynamic efficiency, the capacity to foster entrepreneurial creativity and co-ordination and collaboration, and to seek, discover and overcome any maladjustments or unmet needs in society and among its members. The most important goal is to apply these dynamics and continually shift possibilities to a new higher level.

The driver of this creative and dynamic energy of improvement is entrepreneurship. This can be understood as the typical human ability to recognize opportunities for profit that appear in the environment and to act accordingly to take advantage of them. Entrepreneurs are alert to these opportunities. They are creative in producing new knowledge, new solutions, and new possibilities. The entrepreneurial process never stops or ends. There are always new opportunities to be seized, whether in the form of new ends (things we achieve that we never thought we’d be able to) or new means (better ways to reach goals for which we may have been striving for a long time).

Will there be waste as all these new opportunities are pursued? Probably. Can perfect equality or static efficiency be reached. No – because the dynamic creation and discovery of new outcomes is never balanced, it’s always tilted towards change and towards a better future.

What, then, can we say of the ethics or the social justice of this dynamic and creative economy? We address that question from the perspective that every person possesses an innate creative capacity that enables them to perceive and discover the profit opportunities that arise in their environment, and to act accordingly to take advantage of them. Entrepreneurship is the typically human ability to perpetually create and discover new ends and means. The ethical principle is that each person has the right to the results of their entrepreneurial creativity. Whatever they create, they keep. It’s not a matter of redistribution, but it is a matter of equity. Earn it, keep it.

That’s why de Soto says, “the fairest society is the one which most energetically promotes the entrepreneurial creativity of all its members” – a society in which no authority will expropriate the results, partially or totally, of the creative entrepreneurial process. Social ethics hinge on the private ownership of that which is entrepreneurially created and discovered, based on the voluntary exchange of all goods and services. 

Regulation and state intervention in pursuit of redistribution or restriction of entrepreneurial activity impedes creative action, limits people’s creative capacity , and the new knowledge and innovation that moves society forward. State intervention is both dynamically inefficient and ethically reprehensible.

A dynamic and ethical society under these principles will evolve the institutions that can support them. Entrepreneurial behavior takes place best in emergent common law legal frameworks, and moral frameworks. Taxation policies can undermine entrepreneurship, as can misconceived regulation and economic intervention. The law should be on the side of entrepreneurial creativity.

Social justice concepts such as fairness and efficiency should be re-examined through the lens of economic dynamism and creativity driven by entrepreneurship. All in society thrive most in the entrepreneurial environment.

Economics In The Digital Age Is Different.

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Steve Denning is one of our most important and insightful writers at the intersection of economics, business, and management. He has been in the lead in alerting the business world to the imperative of new thinking about organization, embracing agility and the end of hierarchy, agile processes, and digital transformation. His message: management must change to keep up with technology.

Recently, he turned his attention to economics. His conclusion: economics must change to keep up with technology. Mainstream economics that is; we Austrians may claim a special position, as I’ll argue below.

A school or tradition of economics (such as “mainstream economics”) tends to be defined by stacking dead economists and their theories one on top of another and calling the resulting intellectual edifice a definitive body of work for the filling of textbooks. Later arrivals to the school limit themselves to publishing marginal elucidations. Keynesian economics continues as a set of theories derived from the conditions between the first and second world wars in socialist Britain. Keynesian economists in 2021 continue to insist that these theories still hold, and, in fact, they are the backbone of US Government economic policy today, and the reason it is so disastrous.

In his article Why Mainstream Economists Miss Digital Innovation, Denning drives home just exactly why this backward-looking process of economic theorizing takes us so far off base. Mainstream economists (he quotes Nobel prizewinner Robert Solow) had a very difficult time even recognizing the contribution of digital services to economic value. The “real economy”, Solow opined, was about physical products. Now the largest firms in the world are those delivering primarily digital services. So much for the validity of Nobel rise recognition.

Denning also calls out Robert J Gordon, who asserts that the great innovations occurred before 1970  – innovations such as electricity, household appliances that reduce work, air conditioning that increases comfort and productivity, flushing toilets that improve sanitation and health. Gordon dismisses innovation after 1970 as narrowly focused on entertainment, communication, and information technology. He referred to the arrival of the iPhone as a minor event in entertainment and communications. He failed to realize how a handheld computer in the hands of billions of people radically increases productivity and economic growth, which has been associated with the eradication of poverty, as well as changing how people are educated, given access to healthcare, and put on a pathway to higher aspirations and better lives.

Denning uses this example as an illustration for his conclusion that mainstream economics misses “that digital innovation has changed almost every aspect of human life”. Of what relevance is a field of study that is so oblivious to real life?

Fortunately, there’s a school of economics that understands the dominant role of digital innovation: Austrian economics. There are several points of difference with mainstream economics. One is the understanding that Austrians have of the market as a process and the economy as a constantly changing capital structure. Mainstream economists’ main tool is the study of equilibrium: under what conditions would the economy be perfectly balanced with no more change? Austrians understand that there is no equilibrium, and equilibrium is not a state we desire. The market is a flow of continuous, often dramatic and always accelerating change. Technologies build on technologies and change becomes exponential in terms of impact on growth and improvement. More and more customer value is generated, without limit.

Austrian capital theory recognizes capital in the economy as a flowing river of technology enabling more and more customer value, and constantly changing and improving in response to customers’ never-ending demand for betterment – faster, cheaper, more efficient, more convenient, more comfortable, more productive. Customers demand this continuous change, and technology helps to deliver it.

Another tool in the Austrian economists’ toolbox is the understanding of the role of the entrepreneur, entrepreneurship, and the entrepreneurial method. The entrepreneur has no role in mainstream economics. No one has figured out a mathematical equation to represent this most human of innovative influence. Entrepreneurs are those who look at the world and ask themselves how they can make it better than it is. That’s why Steve Denning can quote an entrepreneur like Marc Andreessen who wrote  “Why Software Is Eating The World” but can’t find any economists to quote.

He could have referred to W. Brian Arthur’s paper, Competing Technologies, Increasing Returns, and Lock-In By Historical Events, where he anticipated exponential growth and the rise of the tech titans. Brian Arthur calls his brand of economics “complexity economics”, which is a strand of Austrian economics. Denning might also have quoted Todd H. Chiles on Organizational Emergence, his theory about how firms and markets advance rapidly through stages of dramatic change and increasing value generation as a result of both technology and changing consumer preferences.

Steve Denning is right to say that it’s imperative that mainstream economics catches up with technology. He should go further and call for the widespread recognition of Austrian economics as the economics of radical economic change. It’s already the go-to theory to explain bitcoin, free software, and the economics of video games. Mainstream will never catch up.

The US Is Compounding Its Shortfalls In Innovation. Make Sure That In Your Business – And In Your Life – You Are Compounding Positively.

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Curt Carlson, the world’s leading authority on innovation and how to implement it, worries that the US is under-performing on this front – badly. 

On LinkedIn, he writes:

Almost all measures of innovative performance today are wanting.  Only 3% of patents recoup their investment; the rest are mostly waste that costs many tens of billions of dollars a year just in maintenance fees.  Only one in ten new venture-backed companies has any real success.  Most venture capitalists lose money, and 5% make 95% of the gains.  Only 20% of university tech-transfer programs break even, and those few are often the result of a new drug.  In our workshops with almost a thousand global teams from leading companies, universities, and government agencies, typically, only 25% of the projects under development would provide any meaningful new customer value if completed.  

This issue profoundly affects civilizational progress and quality of life. Innovation is value-creation and value-creation improves society for all.

Through innovation we address society’s grand challenges, create prosperity and jobs, and provide resources for social responsibility.  Consequently, one of society’s most critical opportunities is to improve our value-creation capabilities.  Improvements in value creation are exponential amplifiers of innovative performance.

He applies the term exponential in a carefully considered way. There is the opportunity for rapid, accelerated advance from where we are today to where we could be tomorrow. Problems can be solved quickly. Conditions we experience as disappointing or even dismal can become uplifting and exciting in a short period of time.

That is, if we are innovating and generating new value.

The opposite is also true, however. Compounding works in reverse. If we fall behind, the distance we have to go to recover becomes exponentially longer. If this year, we realize only 50% of our value creation potential, then next year or in the next relevant period, we’ll have 50% of the resources we would otherwise have had, and we’ll drop to 25% of potential, and so on and so on. The shortfall compounds and our level of performance declines exponentially.

Professor Per Bylund of Oklahoma State University has the same concern about our country’s economic under-performance. He gives a name to the gap between the value that’s actually created by entrepreneurial businesses and what could have been created: The Unrealized. In his book The Seen, The Unseen, And The Unrealized, he describes this value generation shortfall in economic terms, and attributes it to government regulation. Whether in the form of legislation or bureaucratic rule-making, regulation distorts the market, redirecting entrepreneurial creativity into channels favored by politicians and government departments, or curtailing it with enforcement rules, or prohibiting it entirely in some cases. The regulated economy simply can’t evolve and grow in the same way it would if unhampered.

The Unrealized is, similarly, a compounding problem. The number of regulations increases each year, so The Unrealized expands and grows each year. If the economy grew at only 50% of its potential in a base year, then the next year is constrained in the base from which it grows, and this negative compounding extends annually into the future, forever. Since regulation has been with us for a couple of centuries, the compounding of The Unrealized is incalculably high. We simply can’t imagine the dimensions of what could have been. 

Einstein famously said about compound interest that it “is the eighth wonder of the world. He who understands it, earns it…..he who doesn’t….pays it”.

Unsurprisingly, given the source, this is a very important observation. Compounding can work for us or against us. Saving and investing and re-investing can compound in our favor. Interacting more and more with smarter and smarter people can compound in our favor. Iterating a creative idea in critical forums can compound its innovativeness and applicability until it breaks into the market. Exercising and healthy eating every day can compound for us as we age, making us relatively more and more healthy than our age cohort and standard norms. 

The same is true on the negative side. As Einstein said, if we don’t earn compound interest, we pay it. If we get into debt, interest is working against us, especially if we borrow more and more. If we are not continuously engaged with other smart people and iterating our ideas with them, we are less and less likely to make a creative breakthrough. And if we permit ourselves to avoid fitness activities and if we eat an unhealthy diet every day, we are making things worse for ourselves at compounding rates. Every day we are a little less healthy and fit than we could have been – every daily sugar intake, or alcohol intake or cigarette smoke intake compounds, so that, every day, the impact of unfitness and bad diet is a little more harmful on our less-fit body than it would otherwise have been.

Curt Carlson and Per Bylund teach us to concern ourselves with the compounding of The Unrealized in value generation activities. We should bear this in mind – and, at the same time, make sure that compounding is working for us in our personal and family life.

Entrepreneurship is Real. Business Is Real. GDP Is a Fiction. The Government Is The Enemy Of Real.

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When politicians and journalists talk about “the economy”, they generally have an artificial computation in mind, typically either GDP, a computation of the amount of consumption spending in the country, or the percentage rate of change of that computation from one quarter or year to the next.

If there is such an abstraction as “the economy”, it is more properly thought of as all the businesses in the country that are producing goods and services for other businesses or for end-consumers to buy and use and enjoy. Economists refer to this assembly of businesses as the production function, but that, too, is theoretical. These are real businesses using real resources and employing real people to produce real goods and services.

With every act of production, whether a consumer good or a business or capital good, a business utilizes resources, adds value, and sells to a buyer who appreciates that value. Every productive resource has alternative uses and alternative forms of goods and services to which they could be applied, and so the most valuable use is selected. Value comes from the long progression of production and supply. The steel that is produced is dependent on the cost and effort of mining coal and iron ore, building and maintaining a steel plant, the trucks and ships that transport it, and the wages paid to steel mill workers and coal and iron ore miners. The production of everything requires an entrepreneur, natural or produced resources, work, and capital goods. It is these value-facilitating activities that make an “economy” grow and allow individuals to increase their incomes and wealth over time.

And time itself is an important contributor to production. What we produce today builds on production capacity, processes, and experiential learning of years, decades and sometimes centuries. 

This real activity and historical accumulation of capital is almost invariably ignored in the conceptual thinking about GDP, which is a measure of current consumption. 

Individual businesses are run in such a way as to produce more value than was present in the resources used in the production process. And the only way that can occur is if these businesses are operated by entrepreneurs who personally care about whether their businesses are adding value, because each individual entrepreneur’s own income will depend on whether their business earns a profit.

Actual entrepreneurs with their own personal incomes on the line worry about revenues, costs and profits. This can’t be said of government bureaucrats, regulators, and politicians. Their personal incomes are not on the line.

The real “economy” is driven from the supply side, that is, by businesses and the entrepreneurs who operate them, according to their judgment about whether or not a particular form of good or service that they produce will earn a profit. 

And this “economy” can only exist in a moral and political order in which individuals are permitted to start, run and manage businesses that make a profit, and in a reality where profit-making is not envied or resented or criticized by governments and their partisan voters. 

The “economy” can only thrive where governments do not confiscate profits and incomes through excessive taxes, don’t plunder value-adding businesses, and don’t constrain them via over-regulation, and don’t try to replace them by producing their own goods and services. The “economy” advances when it is widely recognized that everyone’s prosperity depends on allowing businesses to function as freely as they can to earn profits, in a market where the price mechanism operates without government interference and tariffs and trade taxes do not limit global competition to provide optionality and competition.

Businesses and production are real, using real resources to produce real goods and services for real buyers. Politicians and regulators don’t operate in this real world. They operate in their own conceptual world. The best illustration of this truth is their idea that the “economy” is consumption and can be measured as consumption, in the form of GDP. The computation of GDP includes government spending as a major contributor to total consumption. This false logic leads to the conclusion that increased government spending can lead to increased GDP and can therefore boost the “economy”. It has come to the point that the politicians will claim that any and all government spending, from welfare to nuclear bombs, drives economic growth.

This is, today, the state of government economics. It goes by the name of Keynesian economics. What that means is that the “economy’ is treated as an abstraction, a computation of consumption, and a numerical target at which unlimited government expenditures can be aimed without any thought of production, investment, or value.

In this sense, government is the enemy of reality. When the economy is understood as production, with real businesses producing real goods and services for real customers under conditions of real competition, then government spending and regulation is the opposite of production. It is extraction. It undermines production. It diverts and destroys. 

Politicians and regulators have no sense and no appreciation of the real-life entrepreneurs and real-world businesses sourcing and assessing real resources to run real enterprises at a real profit.

The Emerging Middle Class Of Business Is Characterized By Entrepreneurial Venturing.

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Americans have associated their concept of the middle class with virtues and positive values. Members of this group were seen as hard-working ethical achievers, succeeding on the terms set by the economic system of entrepreneurial capitalism, where the cultivation of specialized skills enables individuals to make their distinctive contributions to socially shared goals.

The proxy metric for membership of this admired group was family income. Statisticians defined the range that they decided was middle class – not the richest, not the poorest. But the concepts of income and class don’t gel particularly well. Class refers to bounded structural tiers that restrict entry and exit. A member of the peasant class can’t become a member of the aristocracy. The point about the middle class is that it is open to all who are willing to play by the rules of hard work, specialization, and collaboration.

Disastrously, the use of income statistics to define social class has had the unintended effect, in the entitlement society in which we now live, of triggering envy and anger. Income statistics become comparative, and comparisons engender hatred (https://www.phrases.org.uk/meanings/Comparisons-are-odious.html). Consequently the middle  class – once a realm of admiration for achievement – becomes a war zone of social conflict.

The concept of the middle class as the backbone of an economically dynamic and philosophically vibrant society remains fundamentally important, especially when the twisted and distorted entitlement jealousies of the welfare state threaten to sour all social relationships and to undermine the natural collaboration of free markets. How can we recover the appreciation of the virtue and ethic of the middle class?

Professor Deirdre McCloskey, in her Bourgeois Trilogy, did, in fact, define the middle class by its virtues: prudence, justice, courage, temperance, faith, hope, and love. All of these can be interpreted as including an economic component: the courage to innovate, the prudence to take affordable risk, the justice of honest trading and avoiding extractive and exploitative behavior, and the temperance of meritorious behavior. 

Professor Saras Sarasvathy goes much further, changing the thinking about the middle class and its positive role in society via an entirely new perspective. The middle class, she says, should be a middle class of business – those firms and corporations that are not the biggest, such as the Fortune 500, and not the smallest, such as individual contractors, but ventures between 5 and 300 employees. These ventures are founded, led, managed and staffed by people, bound together by a sense of belonging, both to the collaborative company to which they contribute, and the larger community in which the company is embedded. 

Size is important: there is value in the “middle” in middle class, says Professor Sarasvathy. In society, the middle class follows the impetus to bridge the chasms of unequal opportunity to arrive at a shared level of economic experience, escaping from the distasteful consequences of not producing and not participating. In the realm of business, there are also distasteful consequences at the extremes. When companies grow too large, they tend to become monopolistic and predatory, and they sidle up too close to government in the shared corruption of government lobbying and agency influence. Similarly, economies with the largest number of individual and small-employment ventures tend to be poor communities where entrepreneurship is due to necessity rather than opportunity.

Professor Sarasvathy’s preferred classification is not based on size but on endurance and stability. This embraces growth, but not of the unstable type that aims to produce only unicorns and gazelles. Growth is increase in size over time, but not at breakneck speed. Small firms add vitality through the diversity of innovations they introduce into the economy. Growth need not require the churn of creative destruction, a game of competitive innovation involving large numbers of losers with few winners.

Endurance can deliver a more deliberate and conscious kind of innovation, including the innovation of new ends – reconceptualizing what is worth striving for, and co-creating new possibilities beyond the traditional notions of market and government. 

Ventures can endure without stagnation. They can provide local stability, especially employment stability, but also technological stability and community stability. Individuals and families and communities can thrive while harvesting the productivity gains from deliberate innovation and the social gains from human well-being. The pursuit of well-being involves more than income and prosperity. It involves the freedom to choose what is worth pursuing in the first place. 

The guides on this journey to considered growth, stable communities, and advancing well-being are entrepreneurs. Not all will be founders. Many will be co-founders, team members, managers, employees, or value partners in multiple network roles. The commitment of entrepreneurship is to the generation of value for all, with multiple players in multiple roles of mutual support. The prospect of defining the middle class of business by entrepreneurial venturing promises a future of shared growth and shared well-being in a value generation network rather than an envy-tinged calculation of income levels.

What Is This Wonderful Institution We Call Entrepreneurship? It’s A Force For Social Good.

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What exactly do we mean when we use the term entrepreneurship? The theoretical definition is the intentional pursuit of new economic value. Intentional means people – entrepreneurs – do it, either as individuals or teams or in an institutional setting like a firm, or a business or a corporation. Value means that there are other people who benefit as recipients, and become better off. Pursuit means that the people who conduct the process are not guaranteed a successful outcome every time, and may take a while to establish the right recipe and the best practice. New means continuous innovation and improvement for those recipients of value. And economic means it’s an ever more efficient use of the resources available to us, free from politics, that mean and vicious fight over dividing the pie that the entrepreneurs have so generously baked. 

Yet, beyond this definition that comes from economics, there is something even greater and more expansive. Entrepreneurship is a social force for good – the greatest such force that has emerged from the long and checkered history of civilization. And if we employ the entrepreneurial method that makes it a force for good, we can achieve greater and greater levels of community, collaboration and societal advance.

Innovation and improvement

To continuously improve people’s lives, we need new things. We need people to invent things that haven’t been thought of before. And we need innovators, people who improve those things and find new purposes for them or new ways of producing and distributing them. And we need entrepreneurship, the marshalling of resources to produce these better things faster and more efficiently and get them into more people’s hands.

Entrepreneurs are those unique people who organize the marshalling of resources, and who risk their own capital and their investors’ capital in this pursuit of a better future for all.

Cascading Development

When entrepreneurs undertake this act of discovery, and especially when they succeed, they trigger cascading development. One innovation and entrepreneurial initiative leads to another. They are all aimed at making people’s lives better – easier, more convenient, more affordable, more efficient. And, eventually, knowledge spreads, and people’s lives are transformed, so that Indian peasant farmers can check produce prices on their smartphone and get the best offer from the market. Development cascades from individual to individual, firm to firm, market to market and country to country. It’s never-ending improvement.

Long termism and ethical behavior

The outcome is long term uplift and benefit for all. Entrepreneurs are long term thinkers. They are focused on the lifetime of their company and their products, and perhaps to passing them on to the next generation. (Politicians are the opposite – they can only think in election cycles.)

Entrepreneurs don’t want to just make a short term profit and then leave the market. They want long term revenues and long term profits. That means creating reliable, returning customers who love the entrepreneur’s product. That requires delighting those customers, serving them impeccably, never letting them down or breaking a promise. There are few, if any, institutions that are constituted in this way.

This long termism is ethical. Entrepreneurship is ethically driven.

Internationalism

A small firm can trade on a global stage, and if they can, they will. It’s easier than ever before in the digital era. New and better ideas quickly spread around the world. But it has always been the case, since the earliest of times. Politicians establish borders to divide people, and then violate them in invasions and wars. Entrepreneurs see no borders between people. Political borders can’t divide markets. 

Social good

Entrepreneurship achieves more for social good than any other institution. Entrepreneurial innovation in goods and services enhances life and opens up new possibilities. Customers flock to entrepreneurs because of the tremendous service they deliver. The constant improvement delivered by entrepreneurs constitutes civilizational progress. The competitive pressure to improve quality and utilize resources more efficiently generates more and more value for the world. 

It’s an error to see business as extractive – extracting and using up resources. Business is generative, putting life-changing inventions at the disposal of the global population. What’s seen is the dirt and smoke left over from mining or manufacturing. What’s not seen, and often unappreciated, is the huge amount of good that comes into the world via entrepreneurship.

Entrepreneurship is the application property rights at every scale

It’s another error to think of entrepreneurship as small business or young and immature business. Ray Kroc of McDonald’s was a great example of an entrepreneur who worked out how to operate a hamburger restaurant at global scale with continuous improvement. Entrepreneurship requires property rights; people need to have control over their property in order to transform it into marketable innovations and services. But that does not limit the scale of entrepreneurship. Property rights are a principle that supports global scaling.

The entrepreneurial method

Probably the best way to define entrepreneurship is as a process or a method. It’s akin to – and as important to civilization as – the scientific method, but different. They both involve trial-and-success, coming up with ideas and testing them. The scientist tests against reality, looking for a law, a repeatable outcome that will never vary. The entrepreneur tests against consumer approval, looking for acceptance that might be repeatable until conditions change, such as new competition arriving. Entrepreneurs can’t predict the future as scientist can, and they can’t exert control in the form of unchanging laboratory conditions. Yet they still are challenged to build  a business that lasts.

Can we nurture this institution?

Yes. In school, via literacy and entrepreneurially-oriented education, teaching young people about profit, and uncertainty and the requirement for supportive environmental elements such as property rights and flexible labor laws, and the value of trying multiple different initiatives before discovering a winning proposition. We might not be able to teach successful entrepreneurship, but we can create the conditions for learning.