Wednesday, February 4, 2015

Types of Entrepreneurial Action and Overcoming Difficulty: Trade Facilitation, Innovation, and Political Entrepreneurship

The manner in which we economists conceptualize entrepreneurship sometimes does a disservice to the complexity and difficulty of entrepreneurial action. Kirzner describes the entrepreneur as being alert to profit opportunities. Kirzner’s entrepreneur brings into existence trades (pure pareto improvements) that would have otherwise not occurred. Schumpeter's entrepreneur brings innovation to markets, with the potential of upsetting entire industries. Baumol’s entrepreneur is not so kind-hearted. She seeks to improve her lot with little regard to some ethical postulate about her nature. She engages in rent-seeking, securing revenue, not by bringing innovation to a market or experimenting with arrangements within the production structure, but by guiding the power of the state to benefit one’s own company or harm competition; all this without regard for the costs borne by taxpayers. What do all these renditions have in common with each other? These brief summaries overlook that the job performed by entrepreneurs is not only filled with uncertainty, but is also difficult. In what follows, I argue that each type of entrepreneurs can use tacit knowledge to overcome difficulty (a phrase I borrow from Scott Page) and secure gain for oneself.

Thus, uncertainty refers to the absence of information about some relevant variable or what some call the state of the world – tomorrow’s weather, to give one example, is uncertain. Difficulty refers to problems that have many interacting variables [emphasis mine]. Developing a workable form of fusion is difficult as is designing an office building or writing a piece of legislation. Difficult problems have many possible solutions and no obvious best one a priori. When faced with a difficult problem, most problem solvers prove incapable of finding the optimum. They must rely on perspectives and heuristics.

Page describes a difficult problem as containing “many interacting variables”, or phrased slightly differently, many interacting elements. These elements may be particular agents or offices of authority or prices or communication lines and so on. Imagine the type of work required by Baumol’s entrepreneur. In order for congress to pass a piece of legislation that benefits a particular firm or set of firms, those firms may need to donate to multiple congressman, launch a campaign that attempts to attract media support, and even work together with other organization, no matter how diverse, in order to build enough support to pass the bill. Any faltering along the way may lead to a loss of a critical ally or some other missed opportunity that prevents all the elements required to accomplish the task from assuming the state necessary for the bill to pass. While these sorts of events might happen by accident, the organization required to take advantage of such an opportunity is probably not formed accidentally. Individual opportunities may arise by surprise, but these opportunities likely require good organization and alertness in order for them to bring an entrepreneur any benefit.

I believe a less technical example will prove to be more salient. Several years ago, Moneyball, a movie starring Brad Pitt and Jonah Hill, showed the story of Billy Beane, a manager of the struggling Oakland Athletics, attempting to find a strategy that might allow the Athletics to at least make the playoffs despite a tight budget. In one of the more intense scenes, Billy Beane yells at his colleagues, “If we try to play like the Yankees in here, we will lose to the Yankees out there!” The previous season, the Athletics had made the playoffs but lost in the first round. To add to this pain, the Oakland Athletics lost some of its best players, including Jason Giambi, after that season. Desperate for a solution, Beane brings in a young economics graduate, played by Jonah Hill, whom he hired out from the Cleveland Indians. The two agree that players need to be chosen by their on-base percentage. The trick was simple. Build a team that has a relatively high on-base percentage given the price tag of each player. Hill’s character describes this team as being discriminated against within the industry like “an island of misfit toys”. These players were undervalued.

The story does not stop there. Beane continues to face problems. The team’s manager, Art Howe, who is played by Phillip Seymour Hoffman, refused to arrange the players as requested by Beane. At first, a frustrated Beane argues with Howe. But he eventually looks for opportunity within the fray. He finds it, trading away apparent party-boy Jeremy Giambi (Jason’s brother) along with a few other players. It just so happens that these players were integral to Howe’s lineup. He has little choice but to play the lineup arranged by Beane in the positions that Beane assigned them. Beane continues to find opportunity throughout the movie. Early on, he bought an aged-but-not-out David Justice. Frustrated that he is part of Beane’s experiment, he does not hide his sourness. Justice was one of the few players on the team with a sense of maturity, but he did not use that maturity to guide the younger, less confident players. Just as Beane’s strategy is implemented, he approaches Justice and encourages him to act as a leader to a team that so badly needs leadership on the field. At the end of the season, Beane’s strategy gained legitimacy as the Athletics won 20 consecutive games.

Although I’m not sure which parts of Lewis’s story and the cinematic adaptation are more true and which are less, I do know that Beane acts as a prototypical entrepreneur throughout the film. In order to help the Athletics earn a playoff bid, he had to alter the state of a handful of elements on the team in such a manner as to increase the overall efficiency, as measured by dollars paid per win during the regular season. Here we have both a case of Hayek’s man on the spot and Schumpeter’s innovator. As a man on the spot, Beane know the ins and outs of the game. He knows the network that he operates within and holds the attitude necessary to operate within that network. He is not surprised at the resistance that he faces from the old guard, so he preps for it. Only experience can build this kind of knowledge and ability. Beane manipulates tacit information to his advantage throughout the movie. Beane also engages in Schumpeterian creative-destruction. After Beane’s team succeeded as what appears to be the result of his adoption of econometric techniques – 20 consecutive wins seems like good evidence of this, though one cannot honestly claim that econometrics was both necessary and sufficient to accomplish this. In any case, Beane was successful enough to convince the Boston Redsox of the strategy. The Sox won the world series only a couple years later (after Beane turned down a handsome offer from them)!

So we have an ontology of entrepreneurial action within the context of markets. Within an equilibrium framework, entrepreneurs find and enable trades that would never be realized otherwise. Important for promoting the health of the system, entrepreneurs constantly transform the marketplace through innovation. More rudimentarily, they even transform agents’ perceptions of the world. Who could have imagined the existence and our dependence on computers over a century ago? Or imagined that Uber could pick me up within 5-10 minutes of my opening the app? Yet now, computers are part of our everyday lives. Computer programs even serve as metaphors of reality. A handy example of this is agent-based computational modeling. Innovation reverberates throughout the market, and almost equivalently, throughout our lives. Sometimes, opportunities for the entrepreneur may lie outside of the market order. (Speaking of Uber, who has been paying attention to the way that the company has “gamed the [regulatory] system,” to use Brian Arthur’s phrase, both through rent-seeking and outright disregard for cumbersome local and state regulations? A new wave of political entrepreneurship may be upon us.) And often, entrepreneurs face complex situations that are difficult to conceptualize and that are ultimately traversed by means of trial and error.

Being an entrepreneur ain't easy, but beneath every difficult problem there is profit to be earned.

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