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This is an Accepted Manuscript of an article published by Taylor & Francis in the
Journal of Economic Issues 56 (3), 741-757. The published article is available at
https://www.tandfonline.com/doi/abs/10.1080/00213624.2022.2079934
The entrepreneurial function as an element of the institutional framework of
capitalism – The enterprise, not the pure entrepreneur, is relevant
Eduard Braun1
Clausthal University of Technology
Institute of Management and Economics
Julius Albert Str. 2
38678 Clausthal-Zellerfeld
Germany
eduard.braun@tu-clausthal.de
The enterprise is a part of the institutional framework of capitalistic societies. It is a fictional
agent created by accounting and sanctioned by law. It is based on capital and its purpose is to
yield monetary profit. This paper demonstrates that in capitalism, the entrepreneurial function is
not fulfilled directly by pure entrepreneurs, but indirectly through enterprises. By situating the
entrepreneurial function in the enterprise, this paper fruitfully combines the gist of the theories
of the pure entrepreneur with that of the institutionalist approach. The applicability of the main
point of the paper is demonstrated by reference to three basic approaches to the theory of the
entrepreneur. It is the institutional framework of capitalistic societies that allows for the
entrepreneurial function, regardless of whether the entrepreneur is defined as (1) the one who
brings about equilibrium, (2) the one who destroys equilibrium and thus creates development
and progress, or (3) the one who bears the uncertainty which prevails in disequilibrium. By
factoring in the role of institutions, the paper demonstrates that the theory of the entrepreneur
does not have to be a mere dynamic add-on to otherwise static economics. Instead, the
entrepreneurial function is necessary for the existence and coordination of production factors,
and therefore for economic theory itself.
Keywords: Entrepreneurship; Enterprise; Capitalism; Institutions
JEL Classification: D50, L26, P12
1 Eduard Braun is Privatdozent (associate professor) at Clausthal University of Technology
(Germany). He was previously research assistant at the University of Passau (Germany). He
earned his PhD at the University of Angers (France).
1: Introduction
John Stuart Mill (1848, p. 89) famously warned his fellow economists from getting
distracted by the existence of money. They should be careful not to make the mistake of
attending “only to the outward mechanism of paying and spending” and should instead
focus on the “realities of the phenomena.” That is, they should pay attention to the
tangible elements of wealth production, particularly to the factors of production: land,
labor, and the produced means of production. The “mechanism of paying and spending”
is but a veil that hinders us from seeing the more relevant events and relationships.
Economists adhere to Mill’s advice more or less to this day. The Arrow-Debreu
general equilibrium models are constructed accordingly. “[M]oney can play no essential
role” in them (Hahn, 1971, p. 417). Neither do the more recent Dynamic Stochastic
General Equilibrium models incorporate money in a meaningful sense (Laidler, 2015,
pp. 19f.).
However, it must not be forgotten that Mill’s mechanism of paying and spending
is not only about money as such. This mechanism comprises the whole institutional
framework of the market economy, all the institutions that help in organizing the
production process in capitalistic societies. Next to the institution of money, this
framework presupposes also: (1) markets as such, (2) agents who perform the
entrepreneurial function, (3) capital that grants those agents the authority to dispose
over the production factors, and (4) the institution of financial and managerial
accounting that allows for monitoring the profitability of the way capital is and has been
invested. A better term for the mechanism of paying and spending than the well-known
“veil of money” is therefore the broader term “veil of capitalistic organization.” By
ignoring monetary transactions, economists ignore the fundamental institutions that help
to organize the economy under capitalism.
The economists’ habit of ignoring the veil of capitalistic organization has also
led most theorists of the entrepreneur to disregard the institutional underpinnings of the
entrepreneurial function. The institution-less general equilibrium framework of
neoclassical economics is still the benchmark. As static equilibrium models do not need
the entrepreneur, the economic theories of the entrepreneur arise only under “dynamic”
analysis (Ikeda, 1990). It is either maintained that the entrepreneur is the one who
brings about equilibrium (Kirzner, 1973), the one who destroys equilibrium and thus
creates development and progress (Schumpeter, 1911), or the one who bears the
uncertainty which prevails in disequilibrium (Knight, 1921; Mises, 1949). In any case, it
is supposed that the specific dynamic task of the entrepreneurs is, in general, “to deal
with economic disequilibria” (Schultz, 1975, p. 828).
By distinguishing between static and dynamic analysis, economists have found a
way to deal with the entrepreneur in a way that is on par with neoclassical economics.
Entrepreneurs are often defined, explicitly or implicitly, as the “fourth group” in the
factors of production (Baumol, 2010, p. 188) – the one that deals with disequilibria –
and thus they are put on an equal footing with the technical production factors of labor,
land, and the produced means of production. Entrepreneurs are reduced to another
tangible “reality” in Mill’s sense, and are not a part of the veil of capitalistic
organization.
As a consequence, the place of the theory of the entrepreneur in economics is a
peripheral one, orbiting the autonomous static general equilibrium models. Once the
veil of capitalistic organization, i.e., the institutions of capitalism are made visible,
however, it can be shown that the entrepreneurial function is not only “embedded” in
the market’s existing structure (Bylund & McCaffrey, 2017, p. 463; Khoury & Prasad,
2016), but constitutive for the existence and coordination of the factors of production
and, by implication, for economic theory as such. In this way, Veblen’s (1904, p. 8)
claim that “no single factor in the cultural situation has an importance equal to that of
the business man and his work” becomes reinforced.
In this paper, I outline the institutional underpinnings of the entrepreneurial
function in the market economy. This function is fulfilled by the enterprise, which is
part of the institutional framework of capitalism, and not by a pure entrepreneur of some
sort. I further demonstrate that the flaws of Knight’s and Mises’s theory of the
entrepreneur, as recognized by Hébert and Link (2009) and Foss and Klein (2012),
disappear once the institutional character of the entrepreneurial function is accepted and
made explicit. The entrepreneurial function as developed in this approach is even shown
to be constitutive for economics because it is the reason for the existence of stable factor
markets. By bearing the uncertainty that is involved in producing for the market, the
capital-based enterprise provides (relative) certainty for the wage earners and other
factor owners. I indicate also that Schumpeter’s and Kirzner’s approaches to the
entrepreneur profit if the institutional character of the entrepreneurial function is taken
into consideration.
2: The Veil of Capitalistic Organization
2.1: Survey of the Literature
As Barreto (1989) notes, in the history of economics Say (1803) is the best-known
representative of the idea that the entrepreneur is not just another factor of production,
but, instead, the one factor of organization, the necessary precondition for the other
factors to participate in the production process in the first place. The entrepreneur is the
one who combines them and thus makes them collaborate in the attainment of a
production goal.
Schumpeter (1954, p. 645) regretted that Say’s idea was not absorbed by the
mainstream of economics. However, the idea that the entrepreneurial function is
historically specific to capitalistic societies, that it is situated at the organizational level
of capitalism, and that it is therefore constitutive of the factors of production can be
traced to the writings of several adherents to the historical and institutional schools. As
an early example, Riedel (1839, p. 2) recognized clearly that the factors labor, land, and
produced means of production are totally unproductive on their own. By founding
enterprises, man places himself above those factors as “the originator and founder of
their combination.”
We find a similar idea in Biermann (1904, p. 6) who contrasts the technical
factors of production with the only “organizing” factor – the entrepreneur – who
combines the former in order to produce output. Labor as such, without an organizing
and disposing entrepreneur, is but a grand army without a commander (Biermann, 1904,
p. 11). Veblen (1904, p. 8) makes the related point that the “business man” is “the only
large self-directing economic factor.” Brentano (1907, pp. 15f.) considers the
entrepreneur as the representative of the human spirit that gives direction to the
otherwise inactive production factors. Brentano (1907, p. 20) clearly adds the idea that
it is impossible for the entrepreneur to make contracts with those factors and to combine
them without owning capital. This is why we should not talk about the pure
entrepreneur but about the “capitalistic enterprise” – which he also calls “fertilization of
capital by intelligence” (Brentano, 1907, p. 20).
Streller (1926, p. 171) even explicitly criticizes those theories of the
entrepreneur that strive for “universal” definitions of the entrepreneur and “do not start
from the hypothesis of the capitalistic economy.” Quante (1935, pp. 146ff.) adds that we
must therefore not separate in our explanations the “logically necessary […] connection
between human spirit and capital that creates entrepreneurial income.”
Plenge (1926, p. 121) clearly recognizes the role institutions play in the
organization of production. He states that without an organizational factor, “the factors
of production do not come together.” Produced means of production would then be but
“old iron,” land would be but “nature that takes its course,” and labor would be a mass
of “cluttering people.” The organizational factor in capitalism, however, is not a pure
entrepreneur of any sort, but the capital-based enterprise.
Capital, i.e., money that is utilized on the market to make more money, has […]
the function of combining the forces of production in the manner wished for by
the organizing agent [i.e., the enterprise] (Plenge, 1926, p. 121).
Kleinwächter (1923, p. 215) also states that it is the function of the enterprise to use its
money (i.e., capital) “to make its workers collaborate harmonically.” This view is
perhaps best expressed by Heller (1941, p. 394) who clearly recognizes that
capital is not on the same level as the factors of production, but on a par with
another means of power, namely with the power of disposition that a communist
state would use to organize the division of labor. It is obviously not capital itself
that organizes the economy, as capital is an impersonal factor, but the
organization is accomplished by those persons who command capital, i.e., the
entrepreneurs.
To summarize, in the market economy it is the institutional framework allowing for
capital-based enterprises that constitutes the existence of land, labor, and produced
means of production as factors of production.
According to Hawley (1927), the factors of production do not combine but
rather are combined. “The entrepreneur is the only combiner of the three subsidiary
productive factors” (Hawley, 1927, p. 417). In Hawley’s words, the entrepreneur
“dominates the whole productive process” (1927, p. 414) and “is necessarily the
governing factor in economic activity” (1927, p. 415). The other factors “only become
economic when their results are combined by the entrepreneur to serve his own
purpose” (Hawley, 1927, p. 415). However, Hawley (1927, p. 419) clearly and
explicitly separates the entrepreneur from the possession of capital. He does not
mention that the function of combining the factors of production imperatively
necessitates the power to do so – in capitalism, this would be capital. Although Hawley
thinks along similar lines, he does not acknowledge the institutional framework of the
market economy but tries to construct an institution-free theory of the entrepreneur.
Stauss (1944, p. 216) made an important step when he realized that the idea of
an entrepreneur as an identifiable individual is “a holdover from the classical era of
political economy.” The entrepreneurial functions – for Stauss these were especially
managing and risk-taking – are nowadays performed by the firm as an entity of its own.
So he acknowledges implicitly that economic theory cannot deal with the entrepreneur
without introducing the institutional framework, particularly the firm or enterprise.
Biondi’s (2007) theory of the firm combines the institutional framework
discussed by the Historical School with the idea of the enterprise as an entity proposed
by Stauss (1944). Biondi (2007, p. 248) argues that the “firm-entity combines the parts
in such a manner as to give the parts purpose and meaning.” But he does not discuss the
effect of his view on the economic theory of the entrepreneur. The same holds for
Gindis (2009, 2016) who criticizes several theories of the firm for their lack of
institutional underpinnings, but does not touch upon the theory of the entrepreneur.
Jo and Henry (2015) and Jo (2019) have recently updated the institutionalist
theory of the business enterprise, whereas Giminez-Roche (2016, p. 711) has pointed
out that “without entrepreneurship there is no market process to be described in the first
place.” It is the purpose of the present paper to make a connection between these two
lines of argument and link the theory of the entrepreneur with the institutional
framework of capitalism.
2.2: The Production Process as Organized in the Market Economy
The factors of production – labor, land, and the produced means of production – are a
necessary part of all production processes. They are universal and general technical
inputs to all human production in all thinkable forms of societies, no matter whether we
look at Stone Age, Soviet communism, or modern capitalism. The definition of these
factors of production can therefore rest on rather technical criteria, e.g., their durability
or the mode of their reproduction. With the entrepreneur, however, economists try to
add someone to this picture who is not a universal factor of production. The
entrepreneur does not belong to the sphere of production but to the sphere of
organization which is not universal but which depends on the institutional framework.
Following Hodgson (2003, p. 163), institutions are here understood as “durable
systems of established and embedded social rules and conventions that structure social
interactions.” The argument that each epoch of history is characterized by a particular
way of organizing the production process has been stressed by Karl Marx, the American
Institutionalists, and the German Historical School. The production process – the
technical collaboration of production factors in the creation of the product – never
stands by itself. It is always embedded in a sphere that is located on a different level and
gives meaning to it. Robinson Crusoe combines the factors because he wants to provide
for his personal subsistence. A socialist planning board does so because it pursues social
objectives, be they the provision of the citizens according to their needs or the victory in
an arms race. In modern capitalism this is done by enterprises whose purpose is to breed
money out of money by investing it in input factors, combining them, and selling the
resulting product on the market.
I now analyze the principle according to which the production process is
organized under the institutional framework of capitalism. Further below I explain why
I chose to call the central agent ‘the enterprise,’ not ‘the entrepreneur,’ which seems to
be an undue anthropomorphism; yet there are institutional reasons for this step as well.
The gist of the way that enterprises organize the production process shines
through in Marx’s formula
Money – Commodity – Money’
The be-all and end-all of a typical profit-oriented enterprise in capitalism is the
proliferation of money (Veblen, 1904, p. 16). Actions in the organizational sphere of
capitalism start with an investment of a certain amount of money and end, if everything
works out as planned and hoped for, with money revenues exceeding investment.
Marx’s formula captures why the production factors of land, labor, and produced means
of production – which are nothing but the “commodities” – are set in motion in
capitalism: they are bought for money in order to make more money, i.e., they are part
of business.
How do these monetary processes accomplish the organization of production?
Zwiedineck-Südenhorst (1930, p. 1069) elaborated on Marx’s formula in order to better
illustrate the logic of capitalism and described the production process therein with a
scheme that was recently elaborated on by Braun (2017, p. 313).
This scheme illustrates the way production is organized in the market economy.
Enterprises do not combine the factors of production in order to merely produce output.
These technical events are but means to a superordinate end. Enterprises are ultimately
interested in the processes that occur in the organizational sphere which frames the
production process. For them, the purpose of production is to allow for money revenue
in excess of money investment (Veblen, 1904, p. 19). The standard by which the success
of production is measured and in respect of which it is organized is profitability – the
relationship between these two monetary magnitudes. The question for an enterprise is
not whether production has been successful, or whether the combination of land, labor,
and produced means of production made sense from a technical point of view, but only
whether its money investment has paid off (Liefmann, 1928, p. 11). In line with this, the
accounting system of enterprises does not calculate profits and dividends in relation to
some technical features of the production process, but to the money figures which
belong to the institutional framework.
Figure 1: The Logic of Production under Capitalism
Land
Labor
Produced means of
production
Investment of money Product Money revenue
2.3: The Enterprise as the Institutionalized Organizing Agent in the Market Economy
In the last subsection, I called the agents who organize the production process in the
market economy ‘the enterprise,’ and not ‘the entrepreneur.’ This is a procedure against
which Jensen and Meckling (1976, p. 311) warned. For them, the personification of the
firm is “seriously misleading” because “[t]he firm is not an individual.” Behind what is
called the firm there is a “complex process in which the conflicting objectives of
individuals […] are brought into equilibrium within a framework of contractual
relations.” As Gindis (2009, p. 27) notes, the contract and the transaction are generally
considered to be the basic unit of analysis and the essence of all forms of economic
organization.
I do not maintain that the enterprise is a rational and conscious entity that acts in
and of itself. The enterprise consists of a network of contracts between real persons (or
organization that themselves consist of real persons) who have various claims on its
capital and its profit. As a system of individual acts it can (and arguably must) be
analyzed on the basis of methodological individualism (Teubner, 1988, p. 132).
Even Jensen and Meckling (1976, pp. 310f.) admit, however, that enterprises
are treated as individuals before the law. Legal practice has sanctioned the idea that an
enterprise can be regarded as an entity by assuming a fictional legal personality. And
even though the enterprise may only be a fictional entity, it should be clear that the
enterprise is not an artificial construct by some economic theorists. It is an
institutionalized fiction that is sanctioned by law in capitalist societies (Commons,
1924, pp. 144f.). Hansmann et al. (2006, p. 1336) point out that economic activity in
modern societies is “dominated not by individuals, but by firms that own assets, enter
contracts, and incur liabilities that are legally separate from those of their owners and
managers.”
The reason, then, why I chose the institution of the enterprise as the central
agent, and not the entrepreneur, is that the well-known theories of the entrepreneur are
actually theories of the enterprise and its institutional underpinnings. Once the
institutional framework of the market economy is taken into account, it is difficult to see
how an individual agent called “the entrepreneur” could be conceptualized. As was
shown above, the starting point of any action in this sphere must be money; money with
which production factors can be purchased so that they generate profit from the
(expected) sales on the market. A person in itself – a “pure” entrepreneur so to speak –
is not enough to decide the fate of any production factor. Without the power to move the
factors according to one’s wishes, one cannot start any business. The power to purchase
goods and services, therefore, is a necessary requirement for agents who want to act in
this sphere and cannot be separated from other entrepreneurial functions (Schloss, 1968,
p. 230).
In this regard, it is important to note that the proliferation of money via the
investment of money is nothing but the circulation of capital. Capital, in this sense, can
be defined as all business assets which are destined for acquisition and evaluated in
terms of their (actual or estimated) historical money costs. As money can be a business
asset, too, the definition comprises all stages of the process described in figure 1 (with
“labor” referring to labor services only, not laborers). It should go without saying that
this definition of capital deviates from the usual ones in that it does not consider capital
to be a production factor (Hodgson 2014, 2015; Lewin & Cachanosky 2018, 2019).
So a different way of saying that money is the starting point of action in business
is that capital is and must be at the basis of entrepreneurial action. In capitalism, capital
is the power that allows agents to organize the technical production process and to move
the factors of production. And here we see why it suggests itself to pick the enterprise
as the organizing agent of the market economy: the enterprise is an agent that is actually
based on and unthinkable without capital (Weber, 1922, p. 91). It is an artificially
created institution whose purpose is to yield profit on the money – the capital – that has
originally been invested in it.
As Biondi (2007, p. 249, 2013, pp. 397, 404) explains, an enterprise is created
by artificially separating capital from its owners by financial accounting. The enterprise
is an institution, a fictional, capital-based person; it has also been termed an “accounting
entity” (Stauss, 1944, p. 230; Liefmann, 1928, p. 14). In the words of Werner Sombart
(1919, p. 101), the enterprise “assumes a separate existence” and becomes “an entity
which emerges as a subject conducting individual economic acts and which leads a
separate life, outlasting the life of individuals.” Sombart (1919, p. 119) adds that the
creation of a separate fictional actor is one of the main purposes of double-entry
bookkeeping which “accomplishes the ultimate separation of the sum of money invested
acquisitionally, i.e., in order to make profit, from all natural purposes of subsistence.”
As I concentrate on the enterprise as an institutionalized entity, it is not
necessary to distinguish between equity capital and borrowed capital. From the point of
view of the enterprise and its accounting system, both forms of capital are involved in
acquisitive activities as “entity capital” (Biondi, 2013, p. 397).
Two points must be made in an effort to bring clarity to the idea that the
entrepreneurial function is fulfilled by enterprises and not by (pure) entrepreneurs:
First, what about companies with incomplete asset partitioning? This is the case
with unlimited companies whose creditors can have recourse to the personal assets of
the companies’ owners or those whose assets are not shielded against the personal
creditors of the companies’ owners (Hansmann & Kraakman, 2000). An example would
be sole proprietorships. Companies without entity- or owner-shielding may be distinct
accounting entities, but their capital is not completely separate from the private wealth
of their owner(s). So far as this is the case, it is fine to speak of those real people who
share into the capital risk of the enterprise as actual “entrepreneurs.” These are people
are directly connected to their enterprise by shouldering a portion of the losses that
might be involved in the business actions of the latter. Even in such cases, however, the
people are only entrepreneurs to the extent that they constitute part of the enterprise –
that is, to the extent that their private wealth can be seized to cover the liabilities of the
enterprise. Like enterprises, actual entrepreneurs are, therefore, not part of the sphere of
production. They may be so in their capacity as laborers if they perform labor in their
own enterprise, but the entrepreneurial role is still situated on a different level. As
entrepreneurs, they personify their enterprise; they buy and organize the factors of
production in order to generate profit.
Second, what about enterprises that have started measuring (and publishing)
success not only in terms of money but also in terms of corporate social responsibility –
enterprises that have, therefore, implemented social or environmental accounting? As
long as the respective enterprises only add these new accounting processes to their
traditional financial accounting, and as long as they do not give up the profit motive,
they fulfill the entrepreneurial function, as understood in this paper. However, those
instances in which the profit motive is overridden by social or environmental objectives
are not covered by the entrepreneurial function depicted in this paper. This is also the
reason why non-profit enterprises are excluded from the discussion.
3: The Uncertainty of Capitalistic Production
3.1: The Pure Entrepreneur as Decision-maker under Uncertainty
The enterprise does not belong to the sphere of production, but to the institutional
framework of capitalism. The profit-oriented enterprise is an historical phenomenon
specific to capitalism which is either not at all or only tangentially present in other
economic systems (like socialism). Economists, however, have tried to find a concept
that captures the idea of an organizing agent but still fits into the universal and
ahistorical models of economics. They tend to define the entrepreneur in a universal
way, as an agent who is on the same level as the factors of production, or even a fourth
factor of production (e.g. Baumol, 2010, p. 188), and who therefore has a certain
function that is not only relevant in the market economy, but everywhere humans live
and act. Schultz (1975, p. 832), for example, bemoans that the concept of the
entrepreneur is restricted to “businessmen” and wants it to include all individuals who
are “in the act of reallocating their resources;” he mentions laborers, housewives,
students, and consumers.
The attempts to put a “pure entrepreneur” next to the three other factors of
production blur the fundamental role of the institutional framework, described above,
for the entrepreneurial function. I exemplify this argument by means of the theory that
associates entrepreneurship with the bearing of uncertainty as developed by Knight
(1921) and Mises (1949).
Mises (1949, pp. 253f.) is well aware that the pure entrepreneur as used in
economic theory is only a “methodological makeshift.” Mises tries to isolate, with this
makeshift, the element of uncertainty in all human actions. The term entrepreneur refers
to “acting man exclusively seen from the aspect of the uncertainty inherent in every
action” (Mises, 1949, p. 254, emphasis added). Mises distinguishes his theoretical
construct of the pure entrepreneur clearly from the factors of production. He also
emphasizes that the pure entrepreneur “does not own capital” and “remains
propertyless” over the course of the production process (Mises, 1949, p. 254).
Mises defines the entrepreneur without referring to the institutional framework
of the market economy. In principle, everybody is an entrepreneur as the outcome of
every action is inherently uncertain. In his treatment of the entrepreneur, which
otherwise resembles the one by Mises, Knight (1921) comes closer to acknowledging
explicitly the institutional underpinnings of the entrepreneurial function. Although
Knight (1921, pp. 236f.) also considers uncertainty to be prevalent in all human actions,
his entrepreneurs do not bear all uncertainty in the economy. Rather they deal with a
specific form of uncertainty, namely the uncertainty of producing for a market (Knight,
1921, p. 241). Still, Knight does not want to link the entrepreneur with the institution of
the capital-based enterprise. He concedes the possibility, though “rare and improbable,”
of a pure and property-less entrepreneur who contributes nothing but the responsibility
for the ultimate decisions to the production process (Knight, 1921, pp. 299f.).
Mises’s and Knight’s approach is carried forward by Casson (2003) and Foss
and Klein (2012) who explicitly link the uncertainty-bearing by entrepreneurs to
resources that are put at risk. This literature scraps the idea of a pure and penniless
entrepreneur altogether. Ownership and entrepreneurship thus cannot be separated and
entrepreneurial judgment always “implies asset ownership” (Foss & Klein, 2012, p. 20).
This way, an institutional element of the market economy – property rights – seems to
be introduced into the definition of the entrepreneur as the bearer of uncertainty.
Without any further qualification, however, the mere presence of property rights
as such does not explain sufficiently how entrepreneurs bear uncertainty and thus
perform their function. After all, property rights over resources are presupposed in the
analysis of all human decision-making. Even otherwise property-less workers own
scarce resources – their time and their working power – and therefore their choice
between leisure and labor is nothing but the allocation of scarce resources in the face of
uncertainty. That according to the view in question the entrepreneur is still a universal
phenomenon and all people must be considered to be entrepreneurs shines through in
Casson and Wadeson (2007, p. 286) for whom the mere fact that entrepreneurs have
opportunity costs – the commitment of time – suffices to demonstrate that
entrepreneurship is based on the ownership of resources. Foss and Klein (2012, pp. 40,
98f.) also comprise more or less all human actions within their definition of
entrepreneurship. When they state that it is the entrepreneur who ultimately decides on
the utilization of resources, they would have to include the worker, the land owner, and
the capitalist who are all ultimate decision-makers in this sense. Their universal
definition does not isolate the entrepreneur from the owners of the factors of production.
The distinctive feature of the entrepreneur gets lost if all decision-makers are
considered to bear uncertainty in the sense that they have to bear the consequences of
their choices.
3.2: Capital as a Precondition of Bearing Uncertainty
We have seen that Knight (1921) came close to acknowledging the institutional
background of his approach to the entrepreneur. But also Mises (1949, p. 255) brings in
institutions through the backdoor. The pure entrepreneur is not only the agent dealing
with uncertainty but also the one who “earns profit or suffers loss.” Loss, however,
cannot fall onto anyone who is property-less. Mises (1949, p. 254) himself states that
losses only affect the entrepreneur in so far as he owns funds; otherwise, “they fall upon
the lending capitalists.” Mises (1949, p. 254) even admits that the pure entrepreneur is
actually “an employee of the capitalists.” Mises’s pure entrepreneur is, in other words,
not exposed to uncertainty. This means that his pure entrepreneur is not able to perform
the entrepreneurial function as defined by Mises himself – to take on the uncertainty
involved in human action – without becoming or associating with a capitalist who owns
funds. Apparently, Mises’s pure entrepreneur cannot be separated from the institutional
framework of the market economy with its capital-based enterprises.
In their actual discussions of the entrepreneurial function, the authors in this
tradition do not deal with all decisions on the utilizations of resources – as they should
according to their definitions. Instead, they nearly exclusively focus on the enterprise in
the market economy. The uncertainty they are concerned with is not the uncertainty a
laborer bears in the face of massive lay-offs during an economic crisis. What they are
investigating, along the lines of Knight (1921, pp. 240f.), is the uncertainty that is
involved in producing not for oneself or on order, but for the general market. The
investment of actual money – or resources evaluated in money – in the production
process has uncertain outcomes, and it is this kind of uncertainty that entrepreneurs
shoulder: whether they get back what they have invested before. At one point, Foss and
Klein (2012, p. 39) indeed limit their approach to a “market setting” and state that they
“are mainly interested in a specific kind of uncertainty-bearing, namely the deliberate
deployment of resources in anticipation of financial gain.” In short, what is at issue is a
historically specific phenomenon, the uncertainty that is implied in the formula Money
– Commodity – Money’ describing the institutional framework of capitalism.
Once this is recognized, it is possible to extend this approach to an analysis of
the working of this framework. It becomes obvious then that the enterprise and its
institutional underpinnings are not just another factor of production; rather they are
constitutive for the other factors, and therefore for economic theory as such.
3.3: The Enterprise as Generator of Certain Income for the Owners of Production
Factors
The question remains why the owners of the production factors allow profit-oriented
enterprises to decide upon the use of these factors. And here we can see the gist of
Knight’s and Mises’s approach to the entrepreneur. After some mild reinterpretation,
this approach helps to understand the rationale of the organization of production in
capitalism.
As was shown above, all actors, not only enterprises (or entrepreneurs), bear
uncertainty. What demarcates the enterprise from other actors is that the uncertainty it
bears arises because it provides (relative) certainty for others. This becomes obvious in
Knight’s (1921, pp. 271ff.) discussion of the non-contractual character of profit. Profit
is a residual income. Its height is not and cannot be fixed in advance. In contrast, wages,
rent, and interest are contractual incomes. Their recipients are freed from the necessity
to produce for an uncertain market as they receive a fixed remuneration from an
enterprise independently of the ultimate outcome. This does not mean that they do not
have to face any uncertainty. For various reasons, their contracts might unexpectedly be
terminated, or not prolonged, or even defaulted on by the employing enterprise. Also,
there are different kinds of wage contracts. Some provide fixed hourly or daily wages;
others offer pay based on piece work, which implies a much less certain stream of
income for the laborer. The point, however, is that as long as the contracts hold,
recipients of fixed remuneration are exempt from the uncertainty of producing for the
market, which is regularly accompanied by losses. Inasmuch as an enterprise pays
wages, rent, and interest, that is, contractual income, it assumes uncertainty for others
by creating a kind of certainty that otherwise would not exist.
So the reason why production is conducted by capital-based enterprises is that
enterprises grant factor-owners some kind of insurance by paying them a periodic
income which is, at least to some degree, independent of the outcome of production
(Streller, 1926, p. 176). In the formula Money – Commodity – Money’, the first
“Money” (the costs) is advanced by the enterprise to the factor owners (or to other
enterprises) at a time where the amount of the second “Money’” (the revenues) is still
uncertain. This idea was stressed by the classical British economists in their wages fund
theory but was forgotten by economists during the marginal and Keynesian revolutions
(Braun & Howden, 2017). Enterprises do not bear a universal form of uncertainty, but a
special form that only emerges where there is production for the market. In order to be
able to do so, they must be based on capital out of which income can be paid without
there being a guarantee of recovering it later. The capitalistic institutions around the
capital-based enterprise provide income payments to the factor owners that are not
subject to the uncertainty of the market – at least in the short run.
Without capital-based enterprises bearing the uncertainty of producing for the
market, the category of wage earners – who choose the amount of labor they want to
supply to the market according to their utility function – would not even exist. The same
holds for the category of interest. Their might be some occasional wage or interest
contracts even without enterprises organizing the production process; still, the
production process at large would have to be organized in a different way, making the
labor market and the capital market obsolete, and with them neoclassical economics
which presupposes these institutions.
If we do not brush the veil of capitalistic organization aside, Knight’s and
Mises’s theory of the entrepreneur throws some light on the rationale of the production
process under capitalistic institutions. The entrepreneurial role as performed by
enterprises is not but an add-on to economic theory but is one of its institutional
preconditions.
3.4: Consequences for the Economic Theory of the Entrepreneur
It is generally taken for granted that the entrepreneur does not fit into the equilibrium
framework of neoclassical economics. According to Baumol (1968, p. 67),
entrepreneurs do not have a place and are simply not necessary in standard neoclassical
micro. The standard model is basically an instrument of optimality analysis of well-
defined problems. Households and firms determine their optimal decision values
simultaneously. Households, in setting their supply of the factors of production, fully
take into account the firms’ decision on the production of consumer goods and vice
versa. The instant coordination of the simultaneously set decision values implies that the
income of the households, i.e., of the factor owners, generates itself. Income is paid as a
direct, simultaneous – and optimal – reaction to the households’ decision on the amount
and the direction of consumption which itself, of course, depends on the households’
income again. In this model, the firm provides no room for entrepreneurship, however
defined. It is taken to perform mathematical calculations in an environmental vacuum in
order to yield optimal results for its decision values (Jo & Henry, 2015, p. 31). Firms
and households are simply assumed to know the utility and production functions and to
be capable of calculating from that the demand and the supply schedules and their
optimal choices (Leibenstein, 1966, p. 397). Their behavior is considered optimal in that
they regain equilibrium instantaneously (Schultz, 1975, p. 829). No separate acting
person or entity like the entrepreneur is necessary in this model.
It has been argued in addition that, after the neoclassical theory of the firm had
been completed in the 1930s, the entrepreneur even had to be dropped because
otherwise the internal consistency of the theory would have been jeopardized (Barreto,
1989).
It is for this reason that economists who tried to integrate the entrepreneur into
economic theory came up with the distinction between dynamic and static analysis. In
mere statics there was no place for the entrepreneur so that the dynamic state had to be
introduced in order to be able to add the entrepreneur vaguely to the picture ex post. If
we locate the entrepreneurial function in the institutional framework of economics,
however, it is no longer necessary to make this distinction in case we want to discuss
the role of the entrepreneur. The issue of the organization of the production process is
prior to both dynamics and statics. The veil of capitalistic organization is not something
that could be added ex post; it must be discussed ex ante. The institutions of capitalism
are the preconditions of economic theory as it is presented in microeconomics
textbooks. We have seen that the categories of wage-, rent-, and interest-earners exists
on a large scale only because capital-based enterprises assume the uncertainty that is
involved in producing for the market. By extending the theory of the entrepreneur to a
theory of the veil of capitalistic organization, we are able to pinpoint the institutional
assumptions of economic theory. They provide the context and mark out the scope of
current economic models. In this way, the discussion of the entrepreneurial function
gets rid of its peripheral status and becomes constitutive for economic theory.
4: The Institutional Underpinnings of other Theories of the Entrepreneur
4.1: Entrepreneurship as Alertness to Unexploited Opportunities of Profit-making
In order to demonstrate that the veil of capitalistic organization is not only behind
Knight’s and Mises’s theory of the entrepreneur, I will indicate shortly that the same
institutional underpinnings can be detected in Kirzner’s and Schumpeter’s approaches
as well.
According to Kirzner (1973), the most important feature of entrepreneurship is
the alertness to so far unexploited opportunities to profitable actions (Shaffer et al.,
2000, p. 127). He emphasizes the entrepreneur’s ability to discover profitable
opportunities already existing but not detected. The entrepreneur exploits these
opportunities and thus makes them disappear. In more technical language, the
entrepreneur spots disequilibrium and generates a tendency towards equilibrium.
Kirzner is well aware of the hypothetical character of his association of alertness
with a special class of people, i.e., the entrepreneurs. Kirzner explicitly approves the
point of view according to which each human action contains an entrepreneurial
element, and he (1973, p. 31) emphasizes that, therefore, also each acting human
displays a certain amount of alertness. It is a mere theoretical construction when Kirzner
isolates the element of alertness and assigns it to persons he labels the “pure
entrepreneurs.” Kirzner (1973, p. 33) assumes that all decision-makers but the pure
entrepreneurs are passive, optimizing price takers who simply optimize against the
background of assumed data. Only the pure entrepreneurs carry the entrepreneurial
element, that is, alertness. It is important to stress that Kirzner does not mean that the
entrepreneur is an accounting or legal fiction that is actually used in real life, like the
enterprise. Rather he takes the entrepreneur as a theoretical makeshift that allows
economists to grasp the entrepreneurial function.
Like his mentor Mises, Kirzner (1973) tried to isolate the entrepreneurial
function from the factors of production, but also and especially from capital, understood
as financial power. As a result, however, Kirzner provides a theory of entrepreneurship
that is incomplete (McCaffrey, 2014; Hébert & Link, 2009, p. 88; Foss & Klein, 2012,
p. 66). He has to assume a perfectly certain state of the world so that his capital-less
entrepreneurs do not have to bear any losses. Yet, in a perfectly certain world alertness
– the essence of entrepreneurship according to Kirzner – is redundant.
Kirzner’s theory only makes sense once we introduce the institutional
framework of capitalism where capital-based enterprises organize the production
process, and not pure entrepreneurs of any kind. Enterprises are able to bear at least
some of the losses that might result from alert decisions, and so they are fit to perform
the entrepreneurial function à la Kirzner.
That Kirzner’s theory is not a theory of the pure entrepreneur but of the working
of the veil of capitalistic organization becomes clear even by what he writes himself as
long as he does not discuss the theoretical construction of the pure entrepreneur itself.
Then, Kirzner refers to the alertness as an historical phenomenon that is not present in
all human actions but depends on the institutional framework (see esp. Kirzner, 1973,
pp. 39f.). Kirzner (2000, pp. 264f.) summarizes this idea in the following statement:
It is markets, under institutional arrangements which include especially the
possibility of buying at a low price in order to resell at a higher price, which are
responsible for the initiation of those systematic processes of error-correction
which we understand as making up the process of equilibration. While
interaction between alert human beings can be expected to result in some
relevant gradual mutual discovery under any institutional circumstances, the
speed of such discovery processes within markets is clearly of an entirely
different order of magnitude than is conceivable outside markets.
Although it is not visible from Kirzner’s definitions, his approach clearly presupposes
the institutional framework of the market economy.
4.2: Entrepreneurship as Creative Destruction
The same is true a fortiori for Schumpeter’s theory of the entrepreneur. In principle,
Schumpeter does not describe a fundamentally different process than Kirzner. What he
does do is to tell the story the other way round. His entrepreneurs also try to exploit
profitable opportunities. Yet, in order to do so, they have to destroy the existing
equilibrium, not to generate it (Cheah, 1990, p. 342). If they want to make profit, they
have to establish new combinations of the production factors. The function of
Schumpeter’s entrepreneurs is to be the leaders in this process of creative destruction.
They pull the production factors out of the combinations where they have been
integrated before and put them into more profitable ones.
Similar to Kirzner (1973), this description of the functions of the entrepreneur
omits the problem of uncertainty (Kanbur, 1980; Barreto, 1989, p. 30; Hébert & Link,
2009, p. 74). Schumpeter’s entrepreneur does not have to bear losses. There is no
negative counterpart to the profit the entrepreneur makes. Profit is paid for the new
combinations of production factors, for the development the entrepreneur creates
(Schumpeter, 1911, p. 235), but losses do not have to concern the entrepreneur. That is
not to say that Schumpeter overlooks the uncertainty of these actions altogether; yet,
uncertainty is not taken on by the entrepreneurs qua entrepreneurs, but by the capitalists
who fund them and who, in the end, also carry the losses (Schumpeter, 1911, p. 217).
Schumpeter’s pure entrepreneur, like Kirzner’s, does not own capital (Foss & Klein,
2012, p. 32).
It is easy to see that Schumpeter does not succeed in his attempt to isolate the
entrepreneur from the capitalist. The entrepreneurs’ function to break the production
factors out of their present employment and to newly combine them presupposes that
they possess these factors so that they can dispose over them. But in the capitalist
system, the power to do so, according to Schumpeter (1911, pp. 165ff.), is provided not
by the entrepreneurs themselves, but by the capitalists or the banking system in the form
of purchasing power (Metcalfe, 2004, p. 165). In the market economy, creative
destruction can only be accomplished by combining the entrepreneur – the leader – with
the capitalist who provides the necessary purchasing power. More importantly, this
destruction results in profit or loss. To argue, like Schumpeter does, that the
remuneration for creative destruction goes to the entrepreneurs when it is positive, but
to the capitalists when it is negative, surely begs the question of whether it makes sense
to speak of two separate functions. The entrepreneur and the capitalist cannot be
separated in the explanation of creative destruction. Again, it is the enterprise, not the
“pure” entrepreneur, which performs the function attributed to the entrepreneur.
Unlike Schultz (1975, p. 833) maintains, Schumpeter does not confine the
entrepreneurial function exclusively to the veil of capitalistic organization, but considers
more or less all economic players to behave entrepreneurially (Demsetz, 1983, p. 276).
Yet he pays due attention to the way the market economy is organized which is why it is
easy to extract from his own writing how his view dovetails with the institutional
framework of capitalism (McDaniel, 2005, p. 486). Schumpeter discusses in detail the
questions as to how entrepreneurs are able to enforce the new combinations in the
economic system of capitalism and why they actually do it. In this discussion
Schumpeter obviously embeds the process of creative destruction in the institutional
framework of the market economy. His entrepreneur needs money in order to pull the
production factors out of their current assignment, and the ultimate goal of this process
of creative destruction is to earn money. Obviously, Schumpeter’s story corresponds
perfectly to the role of the enterprise as a part of the institutional framework of
capitalism. As against the pure and property-less entrepreneur, however, the enterprise
can actually perform the function of creative destruction as it has, in its entity capital,
the financial power to bear the losses that might result because of the uncertainty
involved. Like Kirzner’s, Mises’s, and Knight’s approaches to the entrepreneur,
Schumpeter’s approach is not about pure entrepreneurs, but about how capital-based
enterprises embedded in the institutional framework of capitalism organize the
production process.
5: Conclusion
This paper has demonstrated that in order to find the place of the entrepreneur in
economic theory we must distinguish two levels: the level of production and the level of
organization. Whereas production is a universal technical phenomenon, the organization
of production is historically specific. In the economic system of capitalism, production
is organized by enterprises which calculate in money and try to maximize their profits
by buying low and selling high on the market. They are a part of the institutional
framework of capitalism. Their actions are basically oriented by what Marx has grasped
in his formula Money – Commodity – Money’. Economists usually ignore the
institutional underpinnings of the entrepreneurial function because they try to see
through what I have called the veil of capitalistic organization.
In this paper I have developed the institutional framework of the market
economy in so far as it relates to the entrepreneurial function. Then I have demonstrated
that the theory that defines the entrepreneur as the decision-maker under uncertainty
fails to properly isolate the entrepreneurial function. It cannot do without implicitly
introducing the ownership of capital as a necessary precondition for those who perform
the entrepreneurial function. Based on this result, I have demonstrated that this theory
only makes sense when it is applied to the enterprise within the institutional framework
of capitalism. It then becomes an explanation of how the category of production factors
is created in capitalistic societies. Enterprises bear the uncertainty of producing for the
market and in this way create certainty for the factor owners. This provides the
incentive for these owners to grant enterprises a right of control over their factors.
In order to support my point that the entrepreneurial role belongs to the veil of
capitalistic organization, I have added some short remarks on the institutional
underpinnings of Schumpeter’s and Kirzner’s theories of the entrepreneur.
I have concluded that the entrepreneurial role can be shown to be not only a
mere add-on to economic theory. The institutions that are behind the entrepreneurial
role are rather constitutive for economics, and they should be treated in this way by
economists.
If economists recognized the business enterprise as an important institution and
as part of the veil of capitalistic organization, their ability to understand and comment
on far-reaching reforms of corporate regulations would be strongly enhanced. The
recent reform of accounting rules is an important example. Neoclassical and, therefore,
institution-free economics served as the basis for the argumentation of the proponents of
so-called fair-value accounting. One could think that neoclassical economists, with their
coherent yet abstract theories, had difficulty convincing politicians concerning this
highly practical matter. However, their opponents, endorsing the traditional historical
cost accounting, could not even advance a coherent theory. An approach explaining the
role of the enterprise (and its financial accounting system) within the institutional
framework of capitalism remained wanting. As a consequence, the fair-value side won
easily, and accounting rules worldwide have become such that they hamper market
coordination instead of promoting it (Braun, 2019a).
Another example would be the institution of limited liability. Several important
economists have warned against the implementation of limited liability for profit-
oriented enterprises because of the propensity of gravely distorting competition (Braun
2019b). As long as entrepreneurship is interpreted as the fourth factor of production,
however, and not as part of the institutional framework of capitalism, there is no
theoretical basis for discussing this important and complicated issue. The concept of the
production function, after all, is independent of prevailing liability rules. By situating
the entrepreneurial role in the institutional framework of capitalism, the present paper
provides a basis for discussing this and similar issues.
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