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Why Austrian Economics Is The Economics You Need For Entrepreneurial Success.

Jeff Deist, President of the Mises Institute, recently penned a metaphorical comparison of Austrian economics to the punk rock bands of the 70’s and 80’s who composed, created, and played but were denied recognition because they were locked out by the music industry establishment. They developed a do-it-yourself ethic when it came to publishing and touring and promotion; they referred to their own music as unheard. Jeff’s metaphor is that Austrian economics is unheard today, locked out by the neo-classical mainstream and its academic and publishing establishment.

Jeff pointed to specific areas of economic theory where Austrians are unheard, but have the chance to be vindicated when outcomes confirm Austrian insights: money and monetary policy, malinvestment resulting from bad monetary policy, misallocation of resources as a result of socialist welfare policies, the bureaucratic mismanagement of the interventionist state, and economic distortions that favor a political elite.

This is all macroeconomics. There is a field where Austrians are being heard and where Austrian theory is tremendously influential, and that field is dynamic entrepreneurial capitalism.1 To be sure, this is not a locus of government policy. Neither government nor mainstream economics recognizes the role of the entrepreneur in the economy. The Austrian school, on the contrary, defines that role, and builds a cogent theory of innovation, economic growth and individual and social betterment on entrepreneurship. Austrian economists build a necessary bridge between economic theory and strategic and organizational management studies.

There are elements of Austrian economics that are uniquely suitable for building this bridge, including:

Individualism

The unit of analysis for the Austrian school is the individual, both as producer and as consumer. The consumer is sovereign, the captain of the economic ship. The entrepreneur is the helmsman,2 steering toward the goal that the sovereign consumer sets. Each role is aimed at improving the individual’s circumstances. The two roles interact with the result of betterment for all. Mainstream economics start from a different place, with the focus of analysis on false aggregates, like GDP, money supply, the price level and even “gross” supply and demand. Austrian economics can help individuals make better decisions, both as producers and consumers, and that recognition is beginning to dawn.

Subjective Value

Austrian value theory is unsurpassed in its ability to help producers with the critical economic task of value creation. Value is a consumer perception, and occurs exclusively in the consumer’s mind. Therefore, it is the consumer who creates value. The descriptive adjective “subjective” means that value is personal, emotional, idiosyncratic, and inconsistent. It most certainly can not be modeled or “formalized” in any way, which places it well outside the boundaries of modern economics. Yet value creation is central to civilizational progress, economic growth, and the success of firms. Austrian economics holds the exclusive key to the understanding that guides these processes, a key that is highly prized in the business community, if not by government and its economists.

Entrepreneurship

In Austrian economics, the role of the entrepreneur is to sense, through the application of empathy, the dissatisfactions of consumers — the signal that they are not experiencing the value they seek — and to rearrange resources into a solution that addresses that dissatisfaction. Because value is subjective in the consumer’s mind, and because the future is unpredictable, entrepreneurs exercise what Austrians call judgement: the commitment to action required to bring their new solution to market for the consumer despite the uncertainty of a profitable outcome. Mainstream economics is unable to comprehend entrepreneurial judgment. Why do 9 out of 10 entrepreneurial initiatives fail? Because, explain Austrians, such a high failure rate is to be expected as a consequence of high levels of uncertainty, consumer subjectivity, the limits on present knowledge. These cause entrepreneurial initiatives to be experiments in new knowledge creation, and the rivalrous actions of multiple entrepreneurs conducting contemporaneous experiments so that the sovereign consumer can choose the best one. Entrepreneurship is the dynamism of the unhampered economy, as more and more people are beginning to understand.

Austrian Capital Theory

In the real world, as opposed to the world of economic models, Austrian capital theory (ACT) provides a guiding light to entrepreneurs on how to assemble, organize, and manage their companies. In Austrian economics, capital is called heterogeneous. That means, every unit of capital is different, and entrepreneurs can combine these units in innumerable ways, reflecting their own knowledge, preferences and experience, and the results of their previous experiments. They can continue to reshuffle and recombine assets in dynamic adaptation to market signals, so that the resultant capital structure can be viewed as unique. The value of the capital structure is based on its ability to facilitate the experience of value by the consumer, so that the entrepreneur-assembled capital structure reflects consumer preferences. This is all anathema to neo-classical economics and its static concept of the production function. For entrepreneurs, ACT guides them toward dynamic and flexible capital structures and new forms of organization which facilitate that dynamism. Modern “virtual” organizations and new commercial processes such as Direct-To-Consumer are reflections of the insights of ACT.

Innovation

Modern mainstream economics lacks a theory of innovation, primarily because there is no role for the entrepreneur. The field has been left to business writers who attribute it to creativity in the “design process,” and promote innovation processes and innovation workshops. In Austrian economics, innovation emerges as the result of consumer sovereignty, subjective value, and entrepreneurship. Austrian economists can help businesses to innovate not through process and tactics, but through understanding the mind of the sovereign consumer (via insights tools such as the means-end chain), capacity development, and dynamic resource allocation accelerated by consumer-response capabilities.

In addition to these principles, entrepreneurship is also a decentralizing process. Knowledge is highly distributed, and because entrepreneurial initiatives stem from individual entrepreneurs’ empathic knowledge of a small number of consumers’ dissatisfactions, so is entrepreneurial action. Entrepreneurial specialization will tend toward increasing narrowness in the search for unique capabilities and unique capital combinations. This decentralization runs counter to the centralizing tendency of government regulation and intervention and of crony capitalist and globalist corporations. In this sense, the dynamic entrepreneurial capitalism of Austrian economics represents not only a route to personal and societal betterment, but also a better route to freedom than political action.

1.See, for example, The Theory Of Dynamic Efficiency, Jesus Huerta de Soto, https://www.jesushuertadesoto.com/the-theory-of-dynamic-efficiency/

2.Bureaucracy, Ludwig von Mises, p226 https://mises.org/library/bureaucracy

20. Dr. Keith Smith on How Austrian Economics Helped Me Innovate

Dr. Keith Smith is an anesthesiologist and founder of both the Surgery Center of Oklahoma and the Free Market Medical Association. Surgery Center of Oklahoma has innovated in healthcare with a completely free market offering of transparent pricing with no hidden fees, with a radically patient-centric organization and different and better patient and doctor relationship protocols. Free Market Medical Association is a movement to encourage medical practitioners throughout the country to pursue a similar pathway of radical innovation. Dr. Smith took inspiration from Austrian Economics principles. Here are the seven principles he talks about on the Economics For Entrepreneurs podcast:

1. Subjective Value

This was the first Austrian principle that Dr. Smith learned from reading Menger and Mises. He applied subjective value thinking to the healthcare industry by asking, “Who is the customer?” and “Are health care industry participants focused on creating customer value?”

He realized that, since the patient is not paying the anesthesiologist or the surgeon, then there was no value exchange between the customer and the service provider. Therefore, there is no market relationship. The customer was not in a position to evaluate the quality and efficiency of the medical service that Surgery Center Of Oklahoma and its surgeons provided.

When a third party payer is paying the fees, the patient is not acting as the customer. The fee from the third party can never represent the right price — the one that properly reflects customer preferences — and much of what is dysfunctional in the health care system stems from this arrangement. The industry can not accommodate the fact that patients who wish to consume medical services value different aspects of the service in different ways. Some will pay any price to experience the value of immediate service: surgery today. Some will defer service to a later date to pay a lower price. Some want a surgeon that spends a lot of time with them before and after surgery. Some prefer speed and efficiency. All individuals create value in their own minds, and should be able to decide what price they will pay for that value. Subjective value theory guides Dr. Smith to run his surgery center to serve patients’ preferences.

2. Preference Rankings

The idea of preference rankings may sound theoretical, but Dr. Smith has found a practical way to make them a tool for building an organization.

When the patient and the surgeon are both customers of the surgery center, it can be hard to align the interests of both without conflict. Dr. Smith calls this desired outcome “accommodating all interests with boundaries”. Both the surgeons and the patients can make unreasonable demands that can’t both be accommodated in the service of good care. How to accommodate both? Just ask them what their preferences are and how they rank them. Many times, just having the conversation is a revelation — it reveals considerations to the patient or surgeon they had not appreciated before. For example, if a patient demands a local anesthetic and the doctor reveals a preference against it, the reasons for the surgeon’s ranking may bring new information to the patient and may change their preference.

Preference ranking provides an organizational tool to help Dr. Smith build his team of surgeons. A surgeon that frequently shows up late, or habitually takes an excessively long time for a procedure, may be revealing a preference for revenue over patient quality. By observing behavior, it becomes easy to identify a doctor (or a hospital) that is revenue focused compared to one that is truly focused on value, taking the long-term view and making every value exchange mutually beneficial. If a surgeon is observed acting in a way that is not in the patient’s best interest, Dr. Smith does not want him or her on the team. Asking preference ranking questions — what is important to you and how do you rank it? — is a good way to get to know someone you are considering for your team. It’s a troublesome thought process for some, and an enlightening one for others.

3. Self-Examination

Preference ranking can be applied in self-examination. Dr. Smith says, “I scour myself for inconsistencies”. He found one when he realized he was filing Medicare insurance claims that were paid with government funds which, he declares, is like “receiving stolen goods”. That, he realized, was inconsistent with his free market principles. And so he abandoned the practice and now treats Medicare patients at no cost. The acceptance of the market is the determinant of his business success — “to hug us or crush us”. Dr. Smith’s preference is to be consistent in his commitment to free market practices.

4. The Errors of Interventionism

The refusal to accept government money was just one step in expunging the corrupting and distorting effects of government intervention in the health care market. Dr. Smith examines every element of government intervention in the market and attempts to eliminate it from his business, to make sure his business does not benefit from it. He scrutinizes one situation after another and attempts to eliminate them all.

5. Dynamic Flexibility.

Austrian Capital Theory — and the Resource-Based View of the firm that derives from it — prescribes extreme flexibility of capital assets and resources to enable shuffling and recombining in response to changing consumer preferences. Dr. Smith describes the process of continuously looking for more knowledge, more learning and more flexibility as “radical entrepreneurship”. He looks for texts like Peter Klein’s The Capitalist And The Entrepreneur to provide new ideas and new initiatives. Continuous learning is part of Dr. Smith’s recipe, and he is always searching out readings that will change his mind.

6. Time Preference

Time preference is a core concept in Austrian economic theory. Entrepreneurship takes time. It requires patience, and the elevation of long-term goals over short term goals. It also requires foregoing present opportunities in order to pursue future benefit. What are you willing to forego in order to be an entrepreneur?

Dr. Smith found the most striking discussion — “jaw-dropping” in Dr. Smith’s words — of time preference in Hans-Hermann Hoppe’s Democracy: The God That Failed (i.e., the relevant passage starts at the very beginning of Chapter 1).

He found an immediate application in the business model for Surgery Center Of Oklahoma. As surgeons get older, their time preference changes. They want to monetize their ownership position in the partnership — to “cash out”. This often leaves junior surgeons “holding the bag”, because the partnership (or an intervening VC) may buy the departing surgeon’s position, but this is paid for out of the future earnings of the remaining partners. Through his understanding of time preference, Dr. Smith was able to anticipate this situation and organize his surgery center like a law firm — no partner pays anything to join and receives no exit payment when they leave. They also don’t own the real estate. So there is no opportunity to monetize on exit, which “saved SCO as a business” and brought stability by de-fanging an activity that doctors are known for.

7. The Austrian Way of Thinking

As important as any principle of economics is the Austrian Way of Thinking: rigorous reasoning based on logic and a priori axioms; being aware of assumptions and always examining them; respect for how others value things; understanding the difference between risk and uncertainty, and looking uncertainty in the eye; and generally exerting more logic and less emotion in conducting business.

Economics is the study of human behavior. Humans move from A to B because they prefer B to A. Understanding the logic of human action — and the motivation behind it — provides a lens through which to observe what is going on around you and to see it more clearly, obscuring distractions and perceiving conflicts of interest you might not see without the lens. The Austrian Way of Thinking brings confidence, decisiveness and calm. Physicians — and anyone — can benefit.

 

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17. Yousif Almoayyed on How Austrian Economics Can Make You A Better Businessperson

Yousif Almoayyed runs a concrete business based in Bahrein, part of a family conglomerate of businesses. It’s a complex business, requiring the procurement of raw materials both locally and imported, the manufacture of products to exacting standards, the provision of on-time and efficient service and deliveries, relationship management, and cash flow management. The business involves high-cost capital goods and careful economic calculation of the revenue flows from those capital goods in an environment of fluctuating costs and market prices.

His university education was in engineering: math and computer science. He declined the opportunity for a business degree in order to learn on-the-job. Part of his self-directed business education was the reading and thoughtful analysis of Austrian Economics texts, and the practiced application of the principles gleaned from non-stop reading. Some highlights from our conversation:

By reading Austrian Economics texts and thinking about how to apply the learning, It’s possible to develop an “economic way” of seeing and thinking. Yousif’s reading plan was eclectic and broad-ranging. He first discovered Irwin Schiff’s How An Economy Grows And Why It Doesn’t (we thought about providing an amazon or Abe Books link, but the originals are now priced at over $90 online). Then he found Bastiat, and heard Ron Paul mention Austrian Economics, so he signed up for Mises University, which he listened to in his car via iTunes U. Since then he’s read all the great texts, many downloaded free from mises.org. His reading gave him principles, economic logic, and clarity and precision in vocabulary.

Looking through an economic lens results in a better understanding of people, their goals and motivations and the purpose of their actions. Now it is possible to look at people and understand why they do what they do. Economics teaches empathy – putting yourself in other people’s shoes to understand their motivations and therefore their actions. This analysis applies to customers, colleagues and employees. Yousif declared himself “surprised and shocked” at why he had not been taught this before.

For entrepreneurs, the core of economics is subjective value. Many people use the term “value” mistakenly and imprecisely. They equate money prices with value. But Austrians do not make this mistake, and by analyzing the subjective value preferences of customers and employees, it is possible to be more effective at motivating. To a customer, on-time delivery and operational efficiency have a value that can be reflected in higher price or longer cash flows through relationship strengthening. To an employee, convenient parking and recognition for extra effort can have more value than a pay raise. Your tennis coach tells you, “Keep your eye on the ball”. In business, it’s “Keep your eye on each individual’s subjective value preferences”.

Austrian economics provides a uniquely helpful perspective on pricing. Pricing is a particularly challenging subject for entrepreneurs. The Austrian perspective recognizes that, at any given moment, price is a kind of average of what many involved actors think it should be, i.e. it’s subjective. Some think it should be higher, some lower; some think it’s going to drop, some think it’s going to go up. At a point on time, all the actors settle on a number. Austrian economics teaches you to observe what all the actors are doing or hoping to do in the market at the time, and to analyze what’s motivating them. Many things influence price actors – including the supply and demand for the product or service, but also the supply and demand of money – but always in the specific market of your local set of exchanges and local actors.

Prices tell the truth. A lot of people won’t accept market prices. They deny the truth. If prices contradict what’s in the news, the news is fake. If a building owner fails to lower the rental prices of apartments because he thinks that would be going too low, and the building becomes one-third unoccupied, it is the prices that are telling the building owner the truth.

In Austrian economics, prices determine costs. The entrepreneur has some discretion to manage costs, but must meet the market price. Entrepreneurs must meet the market price in order to sell, and find ways of keeping costs below that level to make a profit. The entrepreneur can have some influence over costs e.g. via negotiating contracts based on volume, or speculating, or finding new suppliers.

Importantly, if market prices change, the entrepreneur’s cost must change. Subsequently, it’s important to understand that accounts look instantly different. What you did in the past is no longer an accurate indication of what you can do today. You can’t repeat old arrangements when future prices change. Prices change the way your accounts look in the past, present and future.

As a consequence, traditional accounting is mostly useless for entrepreneurs. Accountants do not really measure anything, at least not accurately. Many of their numbers are aggregated figures, or averages over arbitrary periods of time like quarters or months. Accounting takes something inherently dynamic and simplifies it and puts it into numbers for purposes of stewardship over capital. Accounts were originally simplified snapshots for owners who look periodically at what their managers are doing. Entrepreneurs who are actually running a business need to understand what is going on dynamically under the numbers. We need economics to understand “underneath the numbers”. Austrians are very careful with assumptions and are sensitive to the many assumptions in accounting.

For example, asset prices may fluctuate. They are accounted for via straight line depreciation, which is calculated for deduction from income tax, and therefore is not necessarily accurate regarding the real world.

Austrians examine the ends of the people who devised the accounting systems.

Knowledge of Austrian Economics is the foundation for confidence and decisiveness. An entrepreneur can never have complete data or complete information. Austrian economics enables the entrepreneur to make confident decisions under these conditions of uncertainty. That’s because the Austrian lens focuses not on data but on more qualitative understanding. Austrian entrepreneurs utilize the principle of distributed knowledge from F.A. Hayek. Talk to salespeople. Talk to cab drivers. Observe behaviors. Derive indications. If those indications are pointing in a certain direction, reach a conclusion. Confidence, of course, comes from being right. So keep practicing the formation of entrepreneurial judgements. Call things before all the information is in. Review the outcome based on results. If there is contradictory information, don’t be hasty. Economics helps you build a picture of what all these indicators mean.

Supplementals: Yousif mentions accounting as a field where Austrian Economics gives entrepreneurs a different perspective. Here is a link to Thomas C. Taylor’s Accounting In The Austrian Tradition and another link to an interview with him on mises.org.

For a general view of Austrian Economics for Business, you might like this video by Peter Klein.