In a market economy, the entrepreneur serves the function of using resources to create finished goods and services. It is through his work that the raw materials taken from the earth are eventually transformed step by step into products ready to be sold to consumers. In other words, he oversees and organizes production. As such, he is the bedrock of the economy; all creation and innovation are a product of his efforts.
In the entrepreneur’s toils to bring goods and services to market, he must utilize two factors of production: capital and labor. Labor is not owned, but rather, rented out by the entrepreneur for his production processes. However, his capital stock, all of the machines and equipment utilized by the entrepreneur, is owned by him. In order for him to produce goods and services, investment in capital is necessary; without it, any complex production process would never be realized.
Given the close nature of entrepreneurs and capital, the economic theories used to describe them will necessarily be closely related. Any theory of capital must take into account its usage by entrepreneurs, and theories of entrepreneurs must take into account their usage of capital. Although this fact is often overlooked in economic literature, the two topics and necessarily intertwined. To theorize about one is to implicitly theorize about the other. As a consequence, to view one of these concepts incorrectly is to view them both incorrectly. An erroneous theory of capital will necessarily lead to flaws in a theory of entrepreneurship. An unsound theory in one area is tantamount to unsound theories of both.
This is no better example of the interdependent nature of these two topics than the Neoclassical and Austrian approaches to capital/entrepreneurship theory. The Austrian view of these topics is significantly different than the Neoclassical conception, but both the Neoclassical and Austrian views of capital/entrepreneurship are consistent within their own respective schools of thought. Consequently, this means that, as we stated above, the errors in one will flow over into the other. To clearly illustrate this, we will examine the Neoclassical and Austrian theories on both of these topics in turn and examine how the Neoclassical errors affect both their theories of capital and entrepreneurship.
The Neoclassical view of capital is quite simple; capital is reduced to a single variable of k. All shapes and sizes of capital are amalgamated into one variable. Entrepreneurs add to their capital stock of k by investing in more units of capital. They will continue to invest in capital until it reaches the optimum quantity as determined by the capital’s production function within that particular production process. At this optimum quantity, any further investments in units of capital would result in a decrease in total profit, so the entrepreneur halts any further investment projects and sustains his current capital stock.
This view of capital translates directly into the Neoclassical understanding of the entrepreneur. The task of the entrepreneur in the Neoclassical view is to find the optimum combination of both k and L to generate the most amount of profit possible. Utilizing the production functions of labor and capital, he determines exactly how much of each should be used to be able to generate the maximum amount of profit. As such, the problem of achieving profit is one of math and algebra. As a result, the Neoclassical view of entrepreneurship is of linear production processes; the entrepreneur does his best to estimate his production function, and utilizes those estimates to maximize profits.
The Austrian view of capital is nearly antipodal of the Neoclassical view. Austrians view capital as being a radically heterogeneous structure. Different types of capital cannot be summed all together into one variable. Hammers and trucks are both capital, but they serve very different purposes. As such, capital is not interchangeable, but rather, various capital goods serve various purposes in production processes. Different capital goods will work on goods and services at different times and in differing ways. The various tasks and jobs that these capital goods perform result in a capital structure where goods in process flow down this structure, being worked on by various capital goods as they go, until the come out of the structure as finished consumer goods.
This view of capital directly flows into the Austrian theory of the entrepreneur. Because of the complexities of capital, the job of the entrepreneur is not nearly as simple and straightforward as the Neoclassical conceptions. Because of the radically heterogeneous structure of capital, any investment decisions by an entrepreneur must take the capital structure into account. His investment decisions are based on what particular capital goods his production process requires. As such, his function in the market economy is very dynamic and fluid. To carry out production, he must constantly be watchful of not only his own capital stock, but also of the capital elsewhere in the capital structure. If there appears to be an opportunity elsewhere in the capital structure that may be filled, it may benefit him, and by extension, society as a whole, for him to transition out of his current production process and invest in a new one.
From an Austrian perspective, the Neoclassical theories on both capital and the entrepreneur are wholly mistaken in their analysis. Austrians completely reject the idea that capital can be summed up with a single variable of k. Different capital goods serve radically different purposes in production processes, and to attempt to homogenize capital will inevitably result in that fact being excluded from our analysis. A single variable cannot expressly the complex and heterogeneous nature of the capital structure.
These errors in the Neoclassical theory of capital carry over into the theory of the entrepreneur. If capital cannot be accurately summarized in k, then the job of the entrepreneur consequently becomes much more complex. Investment decisions are not just a matter of how many units of capital are needed; they are a matter of determining what particular capital goods are needed and in what quantities. Without k, the production decisions of the entrepreneur become much less linear. Capital cannot be invested in as units, but rather, in specific capital goods that carry out specific tasks. The capital stock of the entrepreneur has its own structure, as well as fitting into the broad capital structure of the entire economy.
Even though they are often treated as two entirely different areas of thought, capital theory and entrepreneurship theory are joined at the hip. The Austrian and Neoclassical theories both illustrate this point very clearly. As a result, if one theory is incorrect, then the other will be incorrect as well. It is impossible to have an unsound theory of capital and a sound theory of the entrepreneur. The two are interwoven in their analysis of the market economy.
The interconnections of entrepreneurs and capital dictates to us to importance of sound economic theory in all areas of thought. A failure to correctly develop or describe any aspect of the market economy is likely to result in contradictions at best, and a total collapse of economic theory at worst. Any fallacies in economic matters have an inevitable contagion effect; wherever we find an unsound theory, more are sure to be just around the corner. If we wish to construct sound economic theory, no element of our theoretical construction can be ignored.
As Ludwig von Mises said:
“The economist must never be a specialist. In dealing with any problem he must always fix his glance upon the whole system”.
