This is an article about Entrepreneurship. It is an economic article intended to briefly explain the organization of production and how the central role in this process belongs to the Entrepreneur, the men and women who invest in "capital." Additionally, we discuss a few misconceptions about the processes utilized by the entrepreneur in assembling the various means of production, especially in the area of capital formation. Included are comments on corporations, the stock market, and government intervention in the market.
Before going much further into this explanation, it is important to point out that although everyone is a consumer, not all people produce. As simple examples, an infant does not produce. The elderly or otherwise incapacitated, do not produce. Also, in our particular day and time, we have an enormous and increasing number of people that are retired, or very soon to be retired. These folks, most often, do not and will not produce either. The ranks of the growing unemployed do not produce. Then we have an element of our citizenry that parasitically extract their total means of support from government agencies, therefore, we can say with certainty that there is no production occurring within this expanding sector of the population. Nevertheless, in spite of these facts, there are continually varying tastes and wants of people at work in the market. And, no one knows this better than the entrepreneur. Though the numbers of them are smaller than ever, entrepreneurs are still there, always on the alert for areas where they can earn more than the going rate of interest.
"Human action is purposeful behavior. Or we may say: Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego's meaningful response to stimuli and to the conditions of its environment, is a person's conscious adjustment to the state of the universe that determines his life."
The term entrepreneur is derived from the French word which means "one who undertakes to carry out an enterprise." More specifically, his role is that of the individual who brings together the various means of production to their final useful end, i.e., consumption. In essence he takes the elements of production which are land, labor and capital and arranges them in such a way that a product or service is the result. Therefore, the entrepreneur can be a great industrialist or he can be a farmer operating on a parcel of land.
"The most efficient organization in the world is not any group of people but a single person. A normal person can conceive a plan, figure out how to carry it out, and communicate the orders to do the task to his faculties instantly, with minimum likelihood they will be misinterpreted and without uttering a word, move his idea into action. Moreover, an individual who owns his own material, has put up the investment for an undertaking, and stands to gain whatever profits arise from the enterprise must have the greater incentive to do the job well."
Clarence B. Carson (2)
Even so, undertaking production of a product or service is a risky business. There is no certainty that the product or service will sell well, even though there may be a history of good sales in the past. Guaging people's wants and needs is calculated guess work; quantities to produce may be overestimated. Undertaking production may be on borrowed money or credit and interest rates may rise; and what about competition? All of these factors are uncertainties; therefore, the entrepreneur is a risk taker. To the outsider the entrepreneur appears to be a person of great independence with power to wield over an organization. In reality the entrepreneur is at all times keenly aware of the perilous risks he must take in making his decisions. For this reason the role of the entrepreneur is performed in any organization by one person. He may have assistance from an army of advisors, boards of directors, accountants, attorneys and the like, but at the end of the day, it is he who makes the final decisions. He is the one person who has the final say.
"The entrepreneur is not creating uncertainties for the fun of it. On the contrary, he tries to reduce them as much as possible. The uncertainties he confronts are already inherent in the market situation, indeed in the nature of human action; someone must deal with them, and he is the most skilled or willing candidate."
Murray N. Rothbard (3)
Every Entrepreneur invests in a process of production because he expects to make a profit; however, it is an error to think of the economy in which he operates as being made up of only profits. In reality it is a "profit and loss" economy. A loss occurs when an entrepreneur has made poor judgments in estimating his future prices and sales. He understands that a free market rewards its efficient entrepreneurs and penalizes its inefficient ones and his goal is to be efficient. However, his biggest problem is that profit and losses are intertwined with the going interest returns. It is this rate of interest, especially when artificially manipulated, which ultimately creates the greatest danger and threat to him, though he may be unaware of it or not understand how the artificial manipulation occurs.
Austrian Economists have seen for decades that businessmen are driven out of the entrepreneurial role altogether by regulatory intervention of government in the marketplace and unprecedented interest rate manipulation by the Central Bank. This is a trend that escalated here in the United States in 1913. It is a trend that is the direct cause of every economic recession since then, right up to today's worst financial panic on record.
"Inflation and credit expansion always precipitates business maladjustments and malinvestments that must later be liquidated. The expansion artificially reduces and thus falsifies interest rates, and thereby misguides businessmen in their investment decisions. In the belief that the declining rates indicate growing supplies of capital savings, they embark upon new production projects. The creation of money gives rise to an economic boom. It causes prices to rise, especially prices of capital goods used for business expansion. But these prices constitute business costs. They soar until business is no longer profitable, at which time the decline begins. In order to prolong the boom, the monetary authorities may continue to inject new money until finally frightened by the prospect of a runaway inflation. The boom that was built on the quicksand of inflation then comes to a sudden end."
Hans F. Sennholz (4)
Today, the prospect of never again being able to live in a prosperous economy is more certain than ever. Increasing monetary inflation and government regulation on our present economic system defies explanation. The incentives to be in business or to go into a new business have been dealt a crushing blow. Why the present administration cannot see this, or refuses to see this, is beyond all rational thinking. Today's entrepreneur must not only be an astute risk taker, but he must understand economics contrary to the way main stream economists tend to teach it and the government puts into practice. If he is to succeed in his endeavors, today's entrepreneur must understand the Boom and Bust Cycle Theory as advanced by the Austrian School of Economics or his goals may be thwarted.
Point No. 1: How Entrepreneurs Raise Money
Partnerships: Most people think of capital simply as money used in the production of goods, however, capital is actually equipment and technology. Also, it is important to realize that savings always precedes capital. And, although it is true that sometimes an individual may save the money to invest in capital, it is difficult to put enough money aside to invest in even a small business enterprise. In this century, entrepreneurs must organize in order to raise enough money to go into business. Creativity has spawned various forms of investment banking activities or formulas in order to pool together the required funds, however, the most common way is to partner with others who have money to put up for capital. This method, however, immediately presents a problem for entrepreneurs because, as noted earlier, an organization must have only one head. Since full partners share in the profits and at the same time are personally obligated for all of the debts of the business, the partnership works well only when each partner is a working member of the firm, has a common background with the others, and is known and trusted by the others. For these reasons, the partnership concept is limited in the ability to raise money for large undertakings. Although limited partners can be allowed to invest in the enterprise and share in the profits, partnerships typically work best for small undertakings such as stores, law firms or medical clinics.
Corporations: The most widely used method for raising money for a business enterprise is the corporation. Its greatest attraction is that the liability of its investors is limited, most often to the extent of the amount invested. In other words, if the corporation should go bankrupt, the investors can just walk away without any harm to their reputation or personal pocketbook. A stockholder, if he is not an officer or director, may not even need to concern himself with the business enterprise at all or what and how it produces its product. For that reason many investors can and do own shares of stock in corporations.
At one time, corporations were instruments of the King. Later they were basically devices used for the formation of towns and cities under a state. It was not until the mid 19th century that corporations began to be used as instruments for capital formation. In the early beginnings, ownership of corporations was a very special privilege of powerful families or politically connected individuals.
Two types of stock are generally offered to the public, preferred and common, whereby, preferred stock does not convey ownership, but rather a preferred status in the sharing of profits. Also, the management of a corporation is not necessarily tied to ownership. The stockholders choose a board of directors who, in turn, select managers to run the day to day affairs of the business enterprise. Although the CEO of a corporation many times owns the controlling shares of stock of a corporation, it is not necessary, and managers generally only own a small portion of stock shares, if any at all. Additionally, we should point out that because of the manner in which stock shares are owned, there is an overly concentrated emphasis on the "bottom line" above anything else. To the stockholder the dividend per share and the price each share will bring in the market is the main concern. These accentuated profit-making goals are combined with the stockholders limited liability provision and from time to time cause questionable economic ramifications.
Corporations can also raise money through the issuance of debt instruments, such as bonds or loans from lending institutions. These types of securities, as well as the shares of stock, can be transferred at will. There has been an enormous growth in the activity of securities since the corporation has become the dominant force for raising money. In more recent times, corporations have grown into giant enterprises with millions of stockholders, none of whom may participate in the actual production of the product, nor actually care about the day to day affairs of the business. There could be thousands of employees in a corporation, most of whom are there to draw their pay and keep their job. Many times the employees never even see the finished product and certainly do not participate in profit sharing. There is a sort of dual disconnect, a distance between the owners and the actual process of production that even flows down to the workforce where the desire to do a good job is most often an artificial idea. One wonders how these giant organizations survive and successfully compete in the production of goods in the market place, especially against the business enterprise that is overseen by one person, the entrepreneur, who is both owner and manager. What makes the difference? What helps these large corporations survive and thrive over the smaller business?
Capital and Economies of Scale: The Corporation overcomes its inherent problems of size, its bureaucracy, lack of work motivation and remoteness in ownership on the part of its owners by its ability to attract capital. And, as has been mentioned before, capital is equipment and technology. It is this "know-how" and equipment that gives the larger business the edge over the smaller. Additionally, purchasing power and production power, as a result of economies of scale are what distinguish large and growing businesses from the smaller declining ones. In essence, the equipment and technology, which are the defining difference in production power, are just too expensive for the small operator. In one sense, it is the market's process of "selection" in rewarding good producers of consumer goods and penalizing poor ones proportionally.
Point No. 2: The Stock Market
A strange phenomenon is the belief Americans hold that the stock market is the driving force behind corporations and American industry. Many believe declining stock prices on the New York Stock Exchange or NASDAQ and other exchanges signifies that the entire national economy is declining or that rising stock prices indicate that prosperity is ahead. This is indeed a strange reaction to the stock market in that most Americans do not feel that way about other products and services when they go up or down in price. Why should stocks be any different? Clearly it is the manner in which the media reports the financial news which is much to blame, however, a large part of the answer lies in the incorrect manner in which the Stock Market is viewed and what it actually does.
The New York Stock Exchange, the NASDAQ and the several other stock exchanges in the United Sates, including those abroad, are just that, "exchanges." These exchanges, especially from the point of view of the entrepreneur, do not actually constitute the "stock market." The entrepreneur would more properly refer to it as the "used stock market" because that is all that is offered for sale, "used stock." New stock issues are not offered on these exchanges. The IPO, the "initial public offering," is when the actual wealth or capital is being provided for the corporation. This is what the head of a corporation is after. This is the true stock market for the corporation and it is located wherever IPO's are put together and offered to the public for sale. Some financial firms specialize in these securities, but the point here is that the stock exchanges, as in the New York Stock Market or the NASDAQ, for all the daily trading they do, provide no capital whatsoever for American industry.
Another glaring area of confusion is in the way those who buy stock are referred to as "investors." Remember, they are only buying and trading shares. Although they may be purchasing a return in dividends, their real motivation to buy a stock is to be able to sell at a profit when prices rise. In effect, they are really "speculators." They are primarily focusing on the "exchange value" of the commodity as opposed to its "use value" in consumption, i.e., the end result of production. This is the main reason that purchasers of stocks only want "bull markets" or rather price increases. On the stock exchanges, speculation is rewarded by the rising price of a stock. When prices fall, all those who bet on the increase will lose. It is this "anticipatory" element that defines speculation. For example: On Monday, October 19, 1987, also known as "Black Monday," $500 billion vanished into thin air because it existed only in the quoted price of the stocks on the stock exchange. In what is an overly simplified explanation, but certainly a true one, that is the extent of what happened on that particular day even though it spread economic panic everywhere. At best, the redeeming value of that day is that it corrected prices to where they really needed to be. This is why in many ways the buying and selling of stocks is seen as having no worthwhile purpose, certainly not to the extent it is often given, except to enrich some and impoverish some. Quite often these are the same people at different times. It merely represents an interpersonal shift in wealth, but in and of itself has nothing to do with the formation or consumption of capital. Additionally, false signals are sent into the economy by either overvaluing or undervaluing particular stocks. When prices start to rise, trading tends to become irrational and naturally people panic when prices fall. Much of the liquidity crisis created during the Crash of 1929 was that the irrational thinking created by skyrocketing prices made a lot of stock speculators borrow on credit (margin) in order to buy stocks. Buying stocks on credit has the potential to achieve greater gains, however, as prices plummeted, speculators who did not get out in time, scrambled for cash to meet their obligations. Of course the cash was nowhere to be found. More recent crashes in the stock market, or any other markets for that matter, are no different.
One wonders why people do it. What makes people speculate on stocks the way they do? What is the attraction? Basically, it is the same thing that makes buying shares of common stocks from corporations so attractive. Principally, it is the limited liability provision. The risk is a known quantity when liability is limited. Also, a growing trust in the "professional trader" who has the ability to profit on prices going up or down and can exit the market quickly, has increased the participation in the stock market. Nevertheless, because it is still speculation and no one can predict with accuracy each and every time, many have discovered that speculation in stocks can be an extremely risky endeavor, especially if your entire life's savings are totally vested in it. This financial disaster occurs most often to the general populace who is driven into the stock market via their employment benefits disguised as their retirement savings. These good people, who for the most part are living from pay check to pay check, are unknowingly taking very speculative risks with their life's savings. In this fast game of musical chairs, these speculators most often loose.
Point No. 3: The Real Market
Of course, anywhere two or more people meet to engage in buying and selling is a market. Economists refer to "the market" as a concept, knowing at all times that markets exist everywhere in great varieties and numbers with things in common to each. The variety and kinds of products and services in a nation such as ours is complex and extensive. It boggles the mind to try to determine the demand for such products and services against existing or non existing supplies. In addition to the variety and complexity we speak of, there is an even greater complexity in the great range of prices for all of these products and services. This leads to a question economists have wrestled with for centuries - who or what determines price? The cost of production will certainly play an important role in pricing, but since people acting in the market tend to buy the highest quality goods at the lowest prices possible, cost of production is always subordinated to supply and demand. In effect, cost of production is irrelevant to the buyer. And then, of course, all markets will invariably have competition. A successful product or service will quickly have many imitators and competitors that can run away with much needed sales. This phenomenon is most clearly seen in fads, trends, and styles that can create windfall profits for certain producers while completely destroying others. It is this arena - this marketplace, that an entrepreneur enters and astutely calculates the pros and cons of his planned innovation. It is the action he takes that starts the whole ball rolling. It is a most courageous undertaking which many would think foolish. It is an environment filled with uncertainty. Upon careful contemplation, the entrepreneur innately knows that, in the end, the market, and not he, will always have the final say.
"Entrepreneurial activities are derived from the presence of uncertainty. The entrepreneur is an adjuster of the discrepancies of the market toward greater satisfaction of the desires of the consumers. When he innovates he is also an adjuster, since he is adjusting the discrepancies of the market as they present themselves in the potential of a new method or product. In other words, if the ruling rate of (natural) interest return is 5% and a business man estimates that he could earn 10% by instituting a new process or product, then he has, as in other cases, discovered a discrepancy in the market and sets about correcting it."
Murray N. Rothbard (5)
All things being equal, the unhampered market has always been seen by classical natural law theorists as a mighty and efficient instrument of social order. For example: with regards to prices, the market itself eventually dictates the "going price" because a price in a free market is the amount a willing seller will take and willing buyer will pay. In other words, prices are arrived at by agreement between buyer and seller. Even the simplest purchase involves an unspoken agreement. This market price is the result of the interplay of a changing supply and demand because these elements are dynamic. Nothing in the free market stands still for long. And as far as competition goes, it and it alone can be said to be the stimulant to market efficiency, both in price and quality. It is competition which keeps producers from charging exorbitant prices. It is actually the friend of the consumer. Therefore, in what can only be explained as a true marvel, the free and unhampered market operates like an "invisible hand" as Adam Smith described it. For 100 years, first in England and then in the United States, the entrepreneur flourished under this glorious type of market environment, creating a wealth and a standard of living for the world unlike anything ever before witnessed in the history of mankind. The physiocrats of the late 17th century described their prescription for bringing about this state of affairs as "laisse faire"--- that government should stay totally out of the market and let this natural order emerge. And, this is actually the idea the framers of the Constitution had in mind for the government of the United States when they first formed it.
"The "free market" creates a delicate and even awe-inspiring mechanism of harmony, adjustment, and precision in allocating productive resources, deciding upon prices, and gently but swiftly guiding the economic system toward the greatest possible satisfaction of the desires of all the consumers."
The sad truth is that our federal government has never allowed the market to operate totally free from intervention. The ink on the paper on which our Constitution was written on had hardly dried before the government's desire to tamper with the market began to exert itself. Tampering more excessively with the market began at the start of WW I, with an all out assault on it during the Roosevelt "New Deal" years. At that particular time, the Constitution itself was dramatically and dangerously altered. However, even that fact pales in comparison to what we see government doing today. Today the federal government is clearly after total control. Daily we see evidences of this by the sheer fact that money inflation and spending is done with impunity. Today government not only completely monopolizes our money and directly manipulates interest rates at will, but they are nationalizing our financial institutions and even parts of American industry. The irrationality of it all has reached such a level that would indicate that government's main goal is hyperinflation and total economic collapse. Does anyone care? Can anything be done? Is it all just too big and complex to bother with?
Message of Hope:
"Tu ne cede malis" These words from the poet Virgil became the motto of the most central figure of the Austrian School of Economics, Ludwig von Mises. They are well chosen words for a man, who by all historical indication lived them. These words are his legacy to us, a reminder of the moral obligation we all have to society which is to"not give in to evil," but to move boldly against it.
How should this motto be taken and mobilized into action? Quite frankly, it means simply that each of us should take this message to our neighbor. We must speak up and tell our neighbor what we see happening and express our discontent. The more neighbors we can reach, the more we can change public opinion. We do not have to convert the entire population of the United States in order to change public opinion, only 10% will do. The problem is that we do not yet have the 10%. The good news is that we are getting there. We are no longer alone in this intellectual battle. There are today literally tens of thousands of us through out this land and worldwide. Individuals everywhere are coming to recognize that ignoring the Austrians is what got us into this financial mess in the first place.
Today these lovers of liberty are speaking publicly, writing economic articles and publishing books. Independent Libertarian Think Tanks are flourishing everywhere. Scholarly conferences and seminars are being held regularly and many young students are being taught Austrian Economics in Universities. Evidence in the progress being made is in the fact that just last year, well known Austrian Economist Ron Paul was a candidate for President of the United States. There will be others following in his footsteps soon. Yes, there is much progress, but we must continue the momentum. There is still much to be done.
Finally, let's never forget this: Though these classical natural law theorists wrote long ago, their truthful message about what constitutes a free market is as fresh today as ever. Murray N. Rothbard, Mises' student (1926-1995), declared that the idea that Austrian Economics would take us back to the "horse-and-buggy" days is preposterous! This cliché assumes that growth in government is required by the advances of technology. Since 1776, our technology has been progressing. Why should an increase in technology require a change in the Constitution, or in our morality, or values? "The fundamental relations of men--their need to mix their labor with resources in order to produce consumer goods, their desire for sociability, their need for private property, to mention but a few - are always the same, whatever the era of history. Jesus' teachings were not applicable just to the ox-cart age of first-century Palestine; neither were the Ten Commandments somehow outmoded by the invention of the pulley." (7)
When it comes to holding on to our freedom, we the people still have the final say!
L. Carlos Lara is President of United services and Trust Corporation, a Management Consulting Firm specializing in Business Consulting, Corporate Trust Services, Corporate and Private Seminars and Speaking Engagements. Visit him or contact him at www.usatrustonline.com.
(1) Ludwig von Mises, Human Action, 3rd revised edition, Contemporary Books, Inc.
(2) Clarence B. Carson, Economics Text Book, Basic Economics, Second Edition 1988, American textbook Committee 3105 Fourth Avenue, Phoenix, Ala.,Boundary Stone Publishers
(3) Murray N. Rothbard, Man, Economy and State, Published by the Ludwig von Mises Institute, 518 west magnolia Avenue, Auburn, ALA 36832-4528,www.mises.org Copy right 1962 by The Volker Fund
(4) Hans F. Sennholz, the Freeman Publication, Article: October 1969. Foundation for Economic Education, New York
(5) Murray N. Rothbard, Man, Economy and State
(6) Murray N. Rothbard, Man, Economy and State
(7) Murray N. Rothbard, the Freeman Publication, Article: "Clichés of Socialism", 1962, The Foundation for Economic Education, New York