Wednesday, June 18, 2014

Kirznerian vs Schumpeterian Entrepreneurship, a Review of Knightian Uncertainty: in Which I Pick a Bone with One of My Favorite People

The always-excellent Lynne K reviews Jill Lepore's critique of Clayton Christensen's The Innovator's Dilemma. She delves quite the rabbit hole. I'll do my best to parse the arguments as I see them.

Schumpeter: the entrepreneur advances the possibility frontier of economic production by introducing novel products, new methods of production, or changes to how products are bought and sold. Entrepreneurs disrupt, in other words, existing patterns of production and exchange. [okay, I snuck in a little Arnold Kling in there. I'll cop to it] Entrepreneurs create even as they destroy. This creative destruction ultimately leads to greater abundance as firms are able to produce more output using fewer inputs. [SLW: these are paraphrases, not actual quotes]

Christensen: firms that refrain from sustained disruption, even to their own business models risk ossification and decline. Disruptive innovation is The Spice: it must flow. Try to imagine what the roadways would look like if automobile manufacturers refused to update model specifications year after year. We'd all still be driving the Model A.

It's worse than that, of course. We'd still be going blind in droves from handwashing our clothes using raw lye, frittering hours each week mending (relatively) expensive clothes, and dying early after a short, rough life of backbreaking toil.

Kirzner: saying that the role of the entrepreneur is simply 'to disrupt' misses the whole point of production. The point is mutually beneficial, peaceful, voluntary exchange. The entrepreneur busies himself with the task of discovering new opportunities for exchange. If destruction happens, that's merely a consequence, a side-effect of people finding better ways to enrich each others' lives. This important task of discovering new channels for mutual service is obfuscated by pointing to the aftermath and claiming that it, rather than the action that gave rise to it, is the purpose of entrepreneurial discovery. [SLW: again, these aren't quotes, they are merely my interpretation]

Josh Gans: Kirzner, ftw. Customers ultimately test whether or not an innovation is any good. Disruption on its own tells us nothing about if a new product or service is any good. Firms must take calculated risks under conditions of uncertainty. Ex ante, it could have seemed possible that Crystal Pepsi was a good idea. You don't know till you try. The customers have to sort it out. And even with careful study, risk management, and attentive marketing teams, your customers are almost always sure to surprise you.

Furthermore, what counts as "important" today may not be important tomorrow. Metrics are a locus of attention. Attention shifts.

Frank Knight: the difference between "risk" and "uncertainty" is crucial to understanding the nature of the problem of the firm. Risk governs a probabilistic relationship over a known domain of outcomes. When you randomly draw a single playing card from a standard poker deck, you can calculate the odds that the card will be the Queen of Spades because you know how many cards are in the deck and what each of their values are. If, contrarily, you randomly draw a card from a pile of business cards dropped in an urn by passersby, you lack the ability to calculate the odds, as you don't know what the underlying distribution is. I submit to you that the challenge of productive activity deals far more often in an environment of uncertainty than of risk.

North: when discussing large-scale upheaval, the problems of knowing the underlying distribution are worse than those offered by Professor Knight. To extend the business card-and-urn metaphor, imagine that passersby could drop anything into the urn. Not only does the forecaster lack knowledge of the probability distribution, but the entire domain itself is obscure. The system is non-ergodic. This is to say that if there are patterns in the system, they are incomprehensible thanks to small sampling problems, timing inconsistencies, and the difficulty, if not impossibility of consistently outperforming other actors. Institutional or regime change is best modeled as non-ergodic, meaning that hopes for reliable predictions are futile.

Kiesling: "My epistemic/knowledge problem take on the innovator’s dilemma is that both risk and uncertainty are at play in the dynamics of innovation, and they are hard to disentangle, both epistemologically and as a matter of strategy. Successful innovation will arise from combining awareness of profit opportunities and taking action along with the disruption (the Schumpeter-Knight-Kirzner synthesis)." [SLW: that one is actually a quote]

The economics of energy delivery are particularly salient here. Every now and again, there are big, non-ergodic disruptions to how humans convert heat and light into something useful. The rest of the time, clever folks, ever alert to the importance of mutual, (eu)voluntary production and exchange work to improve, refine, distill this conversion. Prediction is cheap talk (and perhaps impossible). Action is better.

Me: Adam Smith was right. Euvoluntary exchange expands when the entrepreneur retains dignity in an environment of peace, easy taxes, and a tolerable administration of justice. I find rhetoric concentrating on the mutually beneficial nature of entrepreneurship more natural, more accurate, more important than a narrow focus on mere disruption. Side effects are worth acknowledging, but it is the chief effect, that innovation results in mutually beneficial cooperation, that is the real story, the one worth telling loudly and often.

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Do you have suggestions on where we could find more examples of this phenomenon?