Chapter 14: Entrepreneurship
Christian Economics: Student's Edition
For now we see in a mirror dimly, but then face to face. Now I know in part; then I shall know fully, even as I have been fully known (I Corinthians 13:12).
Only God is omniscient. Only He knows the future perfectly. No creature should ever aspire to possess knowledge equal to God's. Such a goal is inherently demonic. Nevertheless, it is wise to seek to understand better what is likely to affect you in your areas of responsibility. You do not want to be blind-sided by some event that sets your plans back a year or a decade. You cannot foresee such an event, but you may be able to buy insurance to compensate you if a similar kind of event upends you. Insurance is one of the great discoveries in history. Take advantage of it. Just don't pay more than you have to.
Insurance is possible only because there are statistical patterns in life. Certain kinds of events take place on a mathematically predictable basis. These mathematical laws are referred to collectively as the law of large numbers. Some events that are unpredictable individually are part of a class of events whose frequency is predictable collectively. Statisticians who are called actuaries understand these patterns. This knowledge enables them to advise insurance companies on how to design policies that can be sold profitably to people seeking a way to minimize the economic impact of such an event.
The insurance industry rests on a knowledge of risk. The industry insures against the economic effects of certain classes of events. It does not insure against events that are not part of a class of events that are subject to the law of large numbers. Most events are not part of such a class. Therefore, most events cannot be insured against. But most of the individually devastating ones can. These are events that are common to mankind and nature.
What about events that cannot be insured against? They are part of life's innumerable uncertainties. Economists distinguish between risk and uncertainty. Risk is subject to the law of large numbers. Uncertainty is not. This analytical distinction goes back to a 1921 book by a young economist named Frank H. Knight: Risk, Uncertainty, and Profit. This insight on the difference between risk and uncertainty is considered conventional among economists.
This brings us to the topic at hand: entrepreneurship. There is an analytical distinction between an entrepreneur and a manager. Both of them must deal with an unknown future in a business enterprise. An entrepreneur deals mainly with uncertainty. A manager deals mainly with risk. An entrepreneur forecasts events that are not part of a class. A manager forecasts events that are part of a class. An entrepreneur cannot buy insurance policies to hedge against the economic effects of events. A manager can. They may be the same person in a small business, but if this is the case, then the person must take care to distinguish between the two types of forecasting. They are not the same. The tasks of entrepreneurship are far greater than the tasks of management. Not many people are good business entrepreneurs. The skill is limited in society.
Nevertheless, everyone who makes responsible decisions must be an entrepreneur. No one sees the future clearly. Uncertainty is universal. We must all deal with uncertainty. We cannot buy an insurance policy to deal with every bad event that might happen to us. Even if such policies were available, we could not afford to buy all of them.
The free market rests on the decisions of entrepreneurs who specialize in forecasting future supply and demand. Without entrepreneurs, most of us would die, and most of the survivors would live in what today would be regarded as extreme poverty.
Point one of the biblical covenant is God's transcendence, yet also His presence. How does this relate to entrepreneurship?
God is omniscient. No other being is. Omniscience is a non-communicable attribute of God.
The fact that God knows everything and exercises power over everything offers this comfort to covenant keepers: life is not a threat to them. It is an opportunity. Paul wrote this:
And we know that for those who love God all things work together for good, for those who are called according to his purpose. For those whom he foreknew he also predestined to be conformed to the image of his Son, in order that he might be the firstborn among many brothers. And those whom he predestined he also called, and those whom he called he also justified, and those whom he justified he also glorified (Romans 8:28--30).
The entrepreneur must be an optimist regarding the outcome of his ventures. No one commits time, money, and emotion to a project that he thinks will probably fail. He thinks he can beat the odds. Besides, there are no odds in a truly uncertain endeavor. If there were odds, then there would be statistics on similar outcomes. There would be evidence of the law of large numbers. The project would then be mostly managerial, not entrepreneurial.
A covenant keeper presumably thinks that God is calling him to pursue some venture. He ought to believe that God is both omniscient and omnipotent. He should not think that God is a cosmic deceiver, let alone a cosmic trickster. He thinks that God has a wonderful plan for his life. So, he is willing to take what are commonly called risks, but which are not risks. They are uncertainties.
Sustaining a covenant-keeping entrepreneur internally is faith: optimism. He does not think that he may get lucky in the latest venture. He thinks that he is operating in a providential world in which the cosmic battlefield tipped in his favor.
Point two of the biblical covenant is hierarchical authority. It asks: "To whom do I report?" How does this apply to entrepreneurship?
God knows the future perfectly. Man is made in God's image. Man can also make judgments about the future, but imperfectly. Man is supposed to think God's thoughts after Him. This ability is the basis of accurate forecasting.
The heart of entrepreneurship is forecasting. An entrepreneur seeks a profit from buying low and selling high. But how can he buy low? If the free market is competitive, why can anyone buy low? Why isn't there a single price for every asset in a class? Doesn't competition lead to equalized prices? No, it doesn't. That is because people are not omniscient.
An entrepreneur thinks that he knows better than his competitors regarding future customer demand. Maybe he thinks that customers will pay more for what he wants to sell, or maybe he thinks that they will buy far more units if he lowers the price. His competitors do not share his estimate. They have not entered the markets for labor, raw materials, and warehouse space. They have not bid up prices. So, he thinks there is an opportunity for buying low and selling high. He enters specific markets for production goods and starts buying, hiring, and leasing. If he is correct in his forecast, he will reap a profit. If he is wrong, he will reap a loss.
Because men are not omniscient, there is great uncertainty regarding the future. The entrepreneur comes with a unique forecast. He puts his money or his investors' money or his lenders' money where his forecast is. He re-organizes existing producers' goods to create new opportunities for future customers.
Economists have the same task that all scholars have. They must make sense out of the constantly changing world around them. They must impute order to what seems to be chaos. We do not live in chaos. There are continuities in life. There are familiar patterns. Theorists attribute these regularities to laws. They offer different theories about how such laws operate. They offer rival theories of how such laws even exist. They attempt to link together stable economic laws and the flux of historical events. They face what physicist Eugene Wigner pointed to in his 1960 article, "The Unreasonable Effectiveness of Mathematics in the Natural Sciences." Any correlation between the laws of human logic and the regularities of the external world is unreasonable. But scholars keep trying to discover even more reasonable unreasonable correlations.
Economists compare their theories' accuracy with a fixed standard. There are two main standards for economic causation. One standard is omniscience. The other is randomness. The standard of omniscience is called equilibrium. There are neither profits nor losses under the assumptions that are said to govern the utterly hypothetical world of equilibrium. The concept of equilibrium is nonsense. If there were omniscience, no one would hold money. People hold money because they are uncertain about the future. But if no one held money, all money prices would be infinite. Money would not function. There could be no price system under equilibrium. But there is no scientific economic theory without money pricing. So, any economist who uses equilibrium conditions as a standard is faking it. It cannot exist. How useful for understanding the real world is a theoretical model that cannot exist even in theory?
The rival procedure is to identify deviations from pure randomness as evidence of causation. This also has major problems. First, pure randomness does not exist. There is always some orderly deviation from randomness. Second, the model presupposes a world without any structured causation. This is not God's world. So, statistical deviations from pure randomness do not prove anything definitive. Economists rely on statistical correlations to explain causation. But, as critics always insist, statistical correlation is not causation. This criticism is correct.
Then why is there cause and effect? Because of God's providence. How can anyone make sufficiently accurate predictions to produce a profit? Because man is made in God's image. Man is responsible to God: point two of the biblical covenant.
Point three of the biblical covenant is law. It asks: "What are the rules?" How does this apply to entrepreneurship?
The Bible mandates the private ownership of property. There is a prohibition of theft (Exodus 20:15). There are rights of property. These are legal rights to exclude. This leads to a conclusion: the right to own property is necessarily the right to disown property, i.e., sell it.
How does someone sell an asset in a free market economy? He places a price on it. This is the first step in making an offer to sell it. Then he finds a way to communicate to potential buyers his offer to sell at a specific price.
He faces competition from other sellers. They also are making offers to sell. Sellers compete against sellers. On the other side of these offers are offers to pay. This usually means payment in money. We call people "buyers" if they are willing to pay money. Buyers compete against buyers. Out of this system of competition--sellers vs. sellers, buyers vs. buyers--comes an array of prices for goods and services.
This system of competition is best described in terms of an auction. Most people can understand an auction. People with money come to an auction. They want to bid for one or more items. The auctioneer shows an item. Then he calls for bids. The bids begin. He is paid on a commission basis: a fixed percentage of the sale price of each item. The higher the bids, the more money he makes. So, it is in his interest get potential buyers bidding against each other. He uses familiar techniques to keep people bidding. "Do I hear a thousand?" He wants to hear this. Then he wants to hear a higher bid.
There is only one item offered for sale in each bidding session. Bidders compete against bidders. Who will take it home? The person who bids the highest price. Here is the rule of all auctions: high bid wins. All over the world, auction participants understand this rule. It is easy to understand. When the person making the highest and therefore the final bid hears the word, "sold," he is happy. When others who made bids hear this, they may be happy or sad. Maybe they think, "That person paid way too much. I'm glad I stopped bidding." Or they may think: "Maybe I should have stayed in the bidding." But no one thinks this: "It's just not fair." Everyone knows the rule: high bid wins. Everyone also knows that only one person will leave the auction as the new owner.
If there were only one auction, there would be only one seller. But there are many auctions going on at one time. Auctioneers compete against auctioneers. They advertise. "Come to my auction on Saturday." Each auctioneer wants a large crowd: more bidders. More bidders mean higher prices.
Who sets prices in any bidding session? The bidders. The auctioneer can beg. He may try to humiliate bidders. He has time-proven techniques to keep bidders bidding. But he is not in control. Why not? Because bidders own the most marketable commodity: money. Money talks. Money screams. High bid wins.
This is how the free market works. Critics of this process of production and distribution complain, "It's just not fair." Why isn't it fair? Is an auction inherently unfair? In what way?
Point four of the biblical covenant is sanctions. It asks: "What do I get if I obey? Disobey?" How does this apply to entrepreneurship?
The entrepreneur has an idea of what customers will buy, at what price, and in what quantities. I have already covered the economics of entrepreneurship under "Forecasting." The issue here is the system of accounting. We call it double-entry bookkeeping.
The entrepreneur makes a judgment regarding the future. This is a forecast involving economic value. What will customers value in the future? At what price? There is a relationship between economic value and price. What is it?
Economic value is imputed subjectively by buyers and sellers. Each person has a scale of values at any time: first, second, third, etc. He first satisfies the want that is highest on his list, if he can afford it. Price will determine this.
Prices are the result of the auction process. They are objective: exactly this much money for this item. These prices may be public. Today, prices are more public on the Web than at any time in history. The ignorance factor is shrinking constantly.
The businessman uses accounting techniques to assess either profit or loss. These techniques have been widely known since around 1550. Businessmen have great familiarity with double-entry bookkeeping. If they do not have this, they had better get it.
The businessman is held to a numerical standard. He must reap a monetary profit. The success or failure of the business is made in terms of a monetary standard: black ink (profit) vs. red ink (loss). There may also be a minus sign to mark losses, or parentheses. The point is, others besides business owners can accurately assess profit or loss. There has been a huge expansion of the number of people who can read a profit-and-loss statement and a balance sheet. This means that others can exercise judgment.
The entrepreneur wants to make profits. These are monetary profits. A business may have intangibles of value, but these rarely count for much in the price of the shares of a company. Investors look at profit and loss in the immediate past. They look at the trend. Then they make judgments about the share price in the future. Then they buy, sell, or hold. Out of today's orders to buy or sell emerges a price for the shares.
Point five of the biblical covenant is inheritance. It asks: "Does this outfit have a future?" How does this apply to entrepreneurship?
If an entrepreneur makes a discovery that leads to above-average profits, he will get imitators. Through imitation, productive techniques spread around the world. The once-unperceived advantages of a particular production technique become a common practice. The initially high rate of profit gets lower and may even disappear. Customers benefit.
A successful entrepreneur dares not rest on his laurels. He must find new ways to repeat his success. New techniques become old, fast. They cease to generate profits, fast. Imitation removes the initial advantage.
The free market order is inherently innovative. People seek to better themselves through voluntary exchange. Competition is continual. Producers must find new ways to meet future customer demand. This process of innovation is intensely future-oriented.
The result of the quest for profits is economic growth. The compounding of economic growth is the result of innovation. It is not sufficient to reinvest profits. This is necessary, but not sufficient. Profits will decline as the result of imitation and competition. For a business to have profits to reinvest, it must discover new, previously unrecognized ways to please customers in the future. The carrot of profits and the stick of losses promote innovation.
There is nothing automatic about profits. Profits result when an entrepreneur sees what others do not perceive. He works to reduce uncertainty. He is not a manager. He is not dealing with risk. He is dealing with uncertainty. He cannot reduce uncertainty by applying known risk-reduction techniques in familiar ways. The law of large numbers does not apply to uncertainty.
At the heart of the biblical economy is the entrepreneur. He attempts to reduce the costs of uncertainty by means of innovative techniques of production and distribution. He imagines the future, and he estimates demand. Then he attempts to meet this demand at a profit. He buys low in order to sell higher. He can buy low because he imagines what competing entrepreneurs do not imagine or else reject. So, they do not bid up the prices of production assets in this limited market niche.
There are opportunities for profit because God is omniscient. He can see the future perfectly. Men cannot. God has granted to some people a remarkable ability to see the economic future. If men could all see the future as God does, there would be neither profits or losses. There would be no unexploited opportunities for profit. There would be no errors that would produce losses. This is the general equilibrium model. It assumes that human omniscience is the best way to explain economics in a world of ignorance. This model is not merely useless. It leads to major conceptual errors. The main one is this: an incommunicable attribute of God is supposedly a legitimate standard of performance for man. It would make as much sense to establish the standard of God's omnipresence as the ideal for computerized digital monitoring.
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