It's Nobel Prize season again! You know what that means: It's time for nerds to obsessively speculate and model predictions of which leading scientists will be awarded the coveted Swedish honor. This year, I am pleased to see that Thomson Reuters includes Israel Kirzner on the short list for the economic science prize, due to his paradigm-shifting contributions to the study of entrepreneurship. Whether he wins or not, the prospect gives us an opportunity to talk about his scholarship. If you have heard of Kirzner, it is likely through his association with the modern "Austrian" school of economics and tutelage under another great Nobel-winning economist, F.A. Hayek.
But these Austrians are no ordinary free market guys. Believe it or not, some of their core methodological assumptions are closer to Nobel-winner (and famous free market critic) Paul Krugman than to the "markets-always-tend-to-equilibrium" approach of neoclassical economics that predated John Maynard Keynes' one-man revolution. In his post-recession reverie, "How Did Economists Get It So Wrong?" Krugman diagnoses that "economists were seduced by the vision of a perfect, frictionless market system." Exactly. In fact, his contention is downright Kirznerian, and it echoes the Austrian insight that frictions, imperfections, and disequilibrium do exist in the real world.
What in the world? How could the radical free marketeers of the Austrian school have anything in common with the establishment prophet of economic intervention? The answer lies in deep methodological assumptions that are too often overlooked. Traditional economic models that point to seamless market equilibrium and optimal efficiency are often criticized for relying on unrealistic conditions. Few laypeople are comforted by some economists' earnest guarantees that markets will always work—when accompanied by the heavy caveats that all economic actors know all of the relevant information, that markets are perfectly competitive, and that no inefficiencies exist to increase the cost of trade, that is.
That's, however, where the agreement between Krugman and Kirzner ends. Economists in Krugman's vein argue that this "market failure" requires an "active role for the government" to reduce the market frictions that thwart traditional market theories. In that assertion, he is no different than many neoclassical economists. But where Krugman calls for technocratic intervention, Kirzner embraces the frictions as the trigger necessary to modify behaviors and enact change in practices by way of the market forces that will ultimately reduce imperfections and promote the coordination of plans. In other words, where Krugman see the market process as a "state of affairs" leading to a rigid outcome, Kirzner and his Austrian friends see it as a constantly changing and dynamic process.
In that, Kirzner is no different than other Austrian economists before him like Ludwig Von Mises and F.A. Hayek. They all see the world as an open-ended system fraught with uncertainty and imbalance and constantly in motion. It is precisely the existing imperfections that create the opportunity for changes; it is the existence of frictions and the possibility of improvement that creates the dynamism of the market process.
However, Kirzner's remarkable insight is that this dynamic market process is possible thanks to one special ingredient: entrepreneurs. Now, I should immediately say that we should be careful to understand exactly what Kirzner means by entrepreneurship. Kirzner's work doesn't teach us anything about "applied entrepreneurship," about how to be a successful entrepreneur, or what features set them apart from mere laborers. In fact, speaking at a conference honoring the 40th anniversary of F.A. Hayek's Nobel Prize at George Mason University recently, he noted, "If entrepreneurship can be taught, it ain't entrepreneurship."
Rather, Kirzner focuses on the role of the entrepreneur in the market process as the agent that promotes the coordination of tastes and plans by profitably exploiting the frictions and imperfections that so bedevil the Krugmans of the world. Indeed, economic theory, traditionally defined, does not have an agent of change. A few authors in the last hundred years, such as Joseph Schumpeter and William Baumol, have pointed out the strong limitations of such a view. However, as my friend and economist Frederic Sautet explained to me recently, "[I]t is Kirzner who has developed and presented the most thorough analysis of the role of the entrepreneur in the market system. Without Kirzner's theory, all we have is mathematical relationships describing a dull and boring world."
Without Kirzner's theory, it is hard to explain how the market can resolve the sheer ignorance that exists from not knowing what one doesn't know. For instance, consumers don't usually know that they like ordering cabs from their smart phones before someone actually offers it to them. They don't know that they want to be able to buy everything from groceries to books and clothes in one easy computer click before the service is available to them.
Instead of burying this unfortunate problem under assumptions that preclude its possibility, Kirzner looks to the market process. Entrepreneurs reduce information frictions by remaining alert to changes in prices, tastes, and production among many markets at once to produce the stuff that people didn't even know they wanted.
A world that is continually in a state of optimal equilibrium simply can't explain why the world changes and new products are constantly brought to market. This is why, as George Mason University's economist Peter Boettke wrote recently, we can only hope that Thomson Reuters prediction is correct and that Kirzner's "fundamental work in providing the disequilibrium foundations of equilibrium economics will be recognize" at last.