The Influence and Significance of Human Action after 75 Years

8

Property Rights and Entrepreneurial Judgment

PETER G. KLEIN

“Private ownership of the means of production,” writes Ludwig von Mises (1949, 678) in Human Action, “is the fundamental institution of the market economy.” Mises is well known for his claim that social cooperation under the division of labor is the essential characteristic of human society. The most advanced form of society—the one that maximizes the well-being of the community, in Mises’s understanding—is the market economy, the system featuring private ownership of productive resources, exchange of these resources via a system of prices and market, and economic calculation in terms of money prices by entrepreneurs and other market participants. Without private property, there are no exchanges, no prices, and hence no means of allocating resources to higher-valued uses—as Mises famously demonstrated in his critique of socialist economic planning (Mises 1990a, 1951). Private property is thus “the institution the presence of which characterizes the market economy as such. Where it is absent, there is no question of a market economy” (Mises 1949, 678).

While Mises’s analysis of socialism is well known, the role of private property in his broader vision of the market economy has received less attention. Indeed, a common critique of economics textbooks is that they take the institutional environment as given and then proceed to analyze resource allocation, first by the isolated individual (e.g., the consumer maximizing utility), then among individuals via barter, then by means of some kind of price mechanism. The notion that private ownership precedes exchange is taken for granted and rarely analyzed or even discussed.And while production and even “firms” (in the form of production functions or production possibilities sets) appear in textbooks, actual business firms and the capitalist-entrepreneurs who create, own, and govern them are almost entirely absent.

Mises’s system places the property-owning, calculation-performing, forward-looking, appraising, and judging entrepreneur at the center of his analysis of production (Klein 2010). Mises’s concept of entrepreneurial judgment, building on work by Carl Menger and other contributors to the Austrian tradition (Foss and Klein 2012; Klein and McCaffrey 2022), has been highly influential in the entrepreneurship literature. However, the connections between private property, entrepreneurship, and ownership deserve further attention. This essay reviews briefly the treatment of property and ownership in the economics and management literatures and shows how different conceptions of property, and the challenges of defining “private” and “public” resources, affect our understanding of entrepreneurship and the entrepreneurial market process.

The Economics of Property Rights

A literature on the economics of property rights emerged in the 1950s and 1960s featuring important contributions by Ronald Coase (1959, 1960), Armen Alchian (1965), Harold Demsetz (1967), Henry Manne (1965), Steven Cheung (1968, 1983), Yoram Barzel (1982), and their students and colleagues. This literature focuses on the costs of defining, protecting, and trading property titles. Coase’s (1960) famous analysis of externality problems, for example, argued that external costs can be internalized via private ownership if rights are clearly delineated and that, moreover, if the costs of exchanging property titles are sufficiently low, the initial allocation of rights doesn’t affect the ultimate use of property. (Often forgotten is that the bulk of Coase’s paper is devoted to cases in which these transaction costs are prohibitively high—in which case he thinks that judges should resolve disputes about external costs by imposing the solution they imagine would have emerged through trade if property rights were tradeable.)

Demsetz (1967) notes that the decision to define and enforce property rights is itself an economic action and is performed only when the anticipated marginal benefits—formal use rights and alienability rights—exceed the anticipated marginal costs of drawing up contracts, recording deeds, building fences, litigating, and so on. This echoes Coase’s (1959) analysis of the US Federal Communications Commission, which documented the emergence of a system of use rights over the electromagnetic spectrum (not full ownership rights, as the federal government was deemed the owner with the ability to license the use of particular frequencies to particular users) at the same time that radio technology and an advertising-based business model were being developed. (Before the invention of commercial radio, parties would not have bothered to devise a system of use rights.) In other words, property rights production can be considered an economic good.

Henry Manne, an important contributor to this literature himself, recalled hearing about these ideas from Alchian, who credited their inspiration to Mises:

Because of my dissatisfaction with what developed as my program at Yale, I began doing considerable reading in areas mainly I’d learned from Aaron Director, works of Hayek, whom I had met at Chicago, and Mises. I always used to joke that I was one of the few people in the world who probably sat down and read the whole of Human Action, Mises’ great work on philosophy and economics, which later on, you’ll see, played a role in my intellectual development. . . .

Just before the ’62 article [Manne 1962] probably the seminal intellectual event in my life occurred. I was invited to a small conference for young professors at Claremont College, in which three very distinguished people held seminars for these young professors. One was John [Jewkes] from Oxford, who had taken a very strong position against British socialism, then the Labour government. Another was Felix Morley, who was a political opponent of Roosevelt during the New Deal, a distinguished journalist and political theorist. The third was a then somewhat young economist from UCLA by the name of Armen Alchian. I mentioned before that the Mises I read at Yale in 1952 or 1953 came back in the early sixties, because Alchian began his seminar by reading a paragraph. It was a paragraph about property, and he asked if anyone in the group could identify it. I was the only one; I recognized immediately that that was from Mises’ Human Action. As he developed that first lecture—which became I think one of the most important economic articles of the twentieth century, “Economics of Property Rights” [Alchian 1965]—it was like a light bulb went off in my head, it was incredible. All of a sudden, everything that I had done intellectually for thirteen years came together, with this one idea of Alchian’s about the real nature of property rights and the Misesian notion of people making choices, with every choice being a tradeoff, meaning that there is a cost—what you give away is the cost of what you get. (Manne 2012, 13–14)

Unfortunately, despite the important work of Alchian, Manne, and the others mentioned above, the relative neglect of property rights issues in mainstream economics remains to this day. To be sure, the “new institutional economics” associated with scholars such as Douglass North and Oliver Williamson takes property, ownership, and governance seriously (Klein 2000; Williamson 2000), and property rights issues have become more important in the analysis of economic development (de Soto 1989; La Porta et al. 1998). A new literature on incomplete contracts within and between firms is sometimes described as the “new” property rights economics (Grossman and Hart 1986; Hart 1995). This literature defines ownership as residual rights of control—as we shall see, this definition is close to Mises’s understanding—and studies the impact of different asset ownership arrangements on firm structure and performance (see Foss and Foss 2022 for an overview).

Property Rights and the Judgment-Based Approach to Entrepreneurship

Property rights are central to Mises’s analysis of the entrepreneur. To see this, note first that entrepreneurship in the Misesian system is characterized by its generality, its emphasis on purposeful action, and the central role given to uncertainty and judgment. Writes Mises (1949, 248): “It is impossible to eliminate the entrepreneur from the picture of a market economy. The various complementary factors of production cannot come together spontaneously. They need to be combined by the purposive efforts of men aiming at certain ends and motivated by the urge to improve their state of satisfaction. In eliminating the entrepreneur one eliminates the driving force of the whole market system.”

What is this driving force? It is the act of bearing uncertainty by taking ownership and control of productive resources in the present and deploying them, in various combinations, with the goal of earning revenues in the future from satisfying consumer wants. If these future revenues exceed the present outlays (taking discounting into account), the entrepreneur earns a money profit, and otherwise, a monetary loss. Hence “the real entrepreneur is a speculator, a man eager to utilize his opinion about the future structure of the market for business operations promising profits. This specific anticipative understanding of the conditions of the uncertain future defies any rules and systematization. It can be neither taught nor learned. . . . [The entrepreneur] sees the past and the present as other people do; but he judges the future in a different way” (Mises 1949, 585).

Mises does not explain in detail the specific means by which the entrepreneur judges the future, but he alludes, both in Human Action and in Theory and History (1957), to a kind of verstehen by which the entrepreneur attempts to understand the motives of the human actors who will determine the success or failure of a business venture (i.e., future potential consumers, rivals, partners, regulators, etc.), just as the historian attempts to understand events of the past—not only by looking at quantitative data, but also by applying praxeological economic theory and by seeking to apprehend the motivations, beliefs, and interpretations of the human actors in question (what Mises calls “thymology”). Hence Mises (1957, 320) refers to the entrepreneur—more generally, acting man in the face of uncertainty—as the “historian of the future” (Topan, McCaffrey, and Foss 2022).

This process of attempting to grasp the uncertain future has been called “intuition,” “gut feeling,” “understanding,” and “appraisement” (in the context of market prices). Mises, like Frank Knight (1921), calls it “judgment,” and thus the strand of entrepreneurship literature building on these ideas has been termed the “judgmentbased approach” (Casson 1982; Klein 2008; Foss and Klein 2012, 2015; Klein and McCaffrey 2022). The judgment-based approach views entrepreneurship as decision-making under uncertainty (what Mises calls “case probability”) without a formal model or decision rule, as would be appropriate for decision-making under probabilistic risk (“class probability”) (Klein 2009). Moreover, the entrepreneur’s judgment is manifest not in acts of pure alertness or discovery (Kirzner 1973, 1997), but in owning, combining, and deploying productive resources under conditions of uncertainty. Thus Mises’s concept of entrepreneurship is inextricably linked to ownership: “A capitalist is always also virtually an entrepreneur and speculator. He always runs the chance of losing his funds. There is no such thing as a perfectly safe investment” (Mises 1949, 254).

What exactly do these capitalist-entrepreneurs own? How do they exercise the ownership function? Are some more effective owners than others? Ownership typically refers to a bundle of legally or socially recognized rights including the right to use assets, the right to exclude others from using these assets, the right to buy and sell (or give away) assets, and the right to delegate use rights to nonowners on a contingent or temporary basis. Note that ownership is thus associated with residual control over resources, which is not the same as proximate control (Hart 1995). Residual control is the right to determine how the resource will be used in conditions not specified by prior agreement. Under probabilistic risk—a situation in which, by assumption, all possible contingencies can be specified ex ante and assigned probabilities—use rights can be partitioned ex ante, and ownership serves no economic function (Klein 2009). Ownership only matters under conditions of case probability (in which events are heterogeneous such that probabilities, as limit frequencies in a series of repeated trials, do not exist) or Knightian uncertainty (in which the set of possible outcomes cannot be specified ex ante).

Mises (1949, 678) describes ownership as “full control of the services that can be derived from a good,” by which he means the human actions that involve the use of the asset or resource. A non-owner can have limited, contractually specified, use rights, but only the owner has the full set of rights (including the right to delegate proximate rights to nonowners). Put differently, under uncertainty, owners exercise “original” entrepreneurial judgment while nonowner employees can only exercise “derived” judgment, that is, can exercise delegated use rights that are derived from the rights of the owners (Foss, Foss, and Klein 2007). In Rothbard’s (1962, 1277) words, “Ownership is the ultimate control and direction of a resource. The owner of a property is its ultimate director, regardless of legal fictions to the contrary.”

Mises’s understanding of the difference between residual control and day-to-day oversight is clear from his critique of market socialism in Human Action. Market socialists such as Oskar Lange, Abba Lerner, and Frederick Taylor, while agreeing with Mises that a price system was necessary for effective resource allocation, argued that the state could own the means of production while tasking hired managers to act as if they were owners of factories, farms, shops, and so on. Mises points out that the market socialists misunderstand the nature of the economic problem, which is not how to set production levels to equate marginal revenue and marginal cost at given prices. “The cardinal fallacy implied in this and all kindred proposals is that they look at the economic problem from the perspective of the subaltern clerk whose intellectual horizon does not extend beyond subordinate tasks.” The owner’s task, by contrast, is “the allocation of capital to the various branches and production” and “altering this structure in order to adjust it to changes in conditions” (Mises 1949, 703). This task takes place mostly in equity markets, in which the allocation of capital across firms and industries, and across capitalist-entrepreneurs, is determined (Klein 1999).

Despite growing recognition in the entrepreneurship, finance, and strategic management (but not economics) literatures of the importance of ownership, less is known about the circumstances under which particular owners will exercise the ownership function effectively. When Mises refers to entrepreneurs judging the future, he means the formal act of exercising judgment (i.e., deploying resources under conditions of uncertainty in pursuit of future monetary profits). This has led to some confusion, as the English word “judgment” often connotes wisdom or prudence or deliberate, systematic analysis (Sarasvathy and Dew 2013; Hunt and Lerner 2018). But judgment includes making sound as well as unsound judgments (Foss and Klein 2015, 591–92). Indeed, when Mises uses the term “market process,” he doesn’t mean the process of converging toward an equilibrium price (the interpretation given by Kirzner); instead, he is referring to the process of competition among entrepreneurs: “If a businessman does not strictly obey the orders of the public as they are conveyed to him by the structure of market prices, he suffers losses, he goes bankrupt, and is thus removed from his eminent position at the helm. Other men who did better in satisfying the demand of the consumers replace him” (Mises 1949, 270). In other words, market competition can be understood as a process in which entrepreneurs compete by acting upon judgments about the uncertain future; those with better judgment will tend to earn profits and expand their operations, while those whose judgments are less accurate will earn losses and eventually be forced out of the market.

The idea of differential judgment ability is also suggested by Alchian (1965, 825), who notes that “people differ in their talents as owners. . . . Ownership ability includes attitude toward risk bearing, knowledge of different people’s productive abilities, foresight, and, of course, judgment.” Building on this insight as well as Mises’s analysis of market competition, Foss et al. (2021) develop a theory of “ownership competence” as distinct from labor productivity or managerial skill.

We argue that owners vary in the competences with which they deploy the right to use, the right to appropriate, and the right to transfer. We call these competences (a) matching competence (knowing what to own), (b) governance competence (knowing how to own), and (c) timing competence (knowing when to own), respectively. We thus define ownership competence as the skills with which asset owners exercise matching, governance, and timing competence. Ownership competence generates economic value via superior skill about what to own, how to own, and when to own. (Foss et al., 2021, 309)

Under uncertainty, ownership competence can be understood as skilled entrepreneurial judgment. In this sense, market competition can be understood as a process of matching actual ownership with ownership competence—more competent owners (i.e., entrepreneurs making more accurate judgments) will earn profits and be able to expand their capital, owning more assets, while less competent owners (entrepreneurs making less accurate judgments) will find their capital stock dwindling as they earn losses.

One manifestation of superior entrepreneurial judgment is choosing the appropriate form of ownership—for business firms, legal forms such as proprietorship, partnership, family business, cooperative, limited liability company, and so on. Each has benefits and costs in terms of organizational efficiency, governance effectiveness, the ability to engage in (or resist) rent seeking and other forms of nonmarket strategy, and so on. Hansmann (2000) identifies the relative homogeneity of interests among the ownership group as the key determinant of the efficient organizational form. In most cases, he argues, the limited liability or investor-owned firm (he calls it a “lender’s cooperative”) has significant advantages in that its owners have no relationship with the firm besides being investors and thus share the same objective: maximizing the market value of their ownership claims. Where owners play multiple roles (for example, a consumer-owned cooperative in which owners are both investors and patrons), differences in objectives lead to substantial collective decision-making conflict. This problem is exacerbated by uncertainty, where a group of owners must coordinate and cooperate to exercise original judgment (Foss and Klein 2018). And talk of an “entrepreneurial state” notwithstanding, it is unlikely that state-owned enterprises, whose “owners” (taxpayers, citizens) are unable to exercise original judgment in a meaningful sense, giving de facto control to bureaucrats and elected officials, will display high levels of ownership competence (Klein et al. 2010, 2013; Murtinu, Foss, and Klein 2022).

When Is Property Private?

If, as Mises claims, private property is the sine qua non of the market economy, how do we analyze systems with fully or partially state-owned businesses and activities, nominally private firms that receive substantial state rewards (or penalties), and other mixed or hybrid institutions? Take colleges and universities, for example. It is common to distinguish formally between public and private universities—the University of Michigan is a public institution, Princeton University a private one. When we look at the details of ownership, control, sources of funds, legal privileges, and the like, however, the situation appears more complicated. In the US, private research universities receive substantial funding—in some cases, the majority of the institution’s operating funds—from federal, state, and local governments. Less research-intensive public universities typically receive less federal research funding than the most research-intensive private universities do courtesy of the National Science Foundation, the National Institutes of Health, and similar entities. On the governance side, public universities are typically controlled by a board of regents or curators, most of whom are political appointees placed there to help the university receive government privileges.

Indeed, contemporary marketlike economies (what Mises classifies as interventionist systems featuring private ownership with “isolated” acts of government interference) include a variety of “hybrid” organizations such as privately owned regulated monopolies (water, gas, electricity, cable), defense contractors and other private firms that mainly serve government clients, publicly owned organizations that mainly serve private clients, various kinds of public-private partnerships, and so on. Are these “private” or “public”? What criteria should we use to determine the publicness of a nominally private institution (or vice versa)? Besides ownership, governance, funding source, clients or customers, and regulation, we might include objectives (profit maximization, stakeholder wealth maximization, manager’s utility, some broader social objectives—which differ in their measurability), whether consumption is voluntary or compulsory, whether competition is allowed, how performance is measured, and other criteria.

In “Confiscation and the Homestead Principle,” Rothbard (1969) suggests that any private organization—he gives the examples of Columbia University and General Dynamics—receiving more than 50 percent of its revenue from the state should be considered, for analytical (and political) purposes, a public entity. This criterion would render many private organizations, including for-profit firms, nonprofit universities, and charities, de facto public organizations. We would then expect that, even if they have nominally private owners (such as a defense contractor’s shareholders), those possessing residual control rights and exercising original judgment are elsewhere—perhaps they are bureaucrats or elected officials.

Mises (1949, 259) points out that public and quasi-public organizations can be considered part of the market to the extent that they purchase inputs and sell outputs on the market, without the ability to confiscate resources or compel purchases. These firms are still “subject to the sovereignty of the market.” The case is different with organizations, public or private, that produce goods and services that are not bought and sold on the market. In Bureaucracy, Mises (1944) argues that these firms, lacking a profit-and-loss test of performance, are compelled to organize and manage their activities with a rigid and hierarchical structure that makes them less able to adapt and respond to changes in market conditions. In terms of effective entrepreneurial judgment, neither case is likely to produce firms high in ownership competence. Organizations with complex hybrid ownership structures suffer from the problem identified by Hansmann, while organizations immune from the competitive market test will not grow or shrink according to governance, matching, or timing competence (Foss et al. 2021; Murtinu, Foss, and Klein 2022).

Conclusion

Both property rights and entrepreneurial judgment under uncertainty are central to Mises’s understanding of the market. Mises makes it clear that private ownership, as decision control over productive resources, is a prerequisite to the formation of markets, exchange, and the prices that facilitate economic calculation. Yet he does not discuss in detail all the “edge cases” involving the definition of specific assets or resources when ownership is ambiguous. Mises generally specifies de facto residual control, rather than titular ownership (as in the case of factory owners under fascism) or day-to-day control (as in the case of hired nonowner managers), as the hallmark of ownership. In other words, privately owned firms that receive substantial government support in terms of subsidies or other privileges (or even compulsory sales or purchases) are still private firms if owners hold residual control rights. At the same time, the meaning of residual control is ambiguous where the state can explicitly or implicitly compel certain behaviors. While there is some excellent work in the Austrian tradition on the behavior of firms under similar conditions (e.g., Rothbard 1970; Higgs 1987; Ikeda 2015; Bylund and McCaffrey 2017; Newman 2021), there is room for more work on the impact of ambiguous property rights on entrepreneurial judgment and the efficacy of the market for ownership nd control of organizations.

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Townsend, David M., Richard A. Hunt, Judy Rady, Parul Manocha, and Ju hyeong Jin. 2024. “Are the Futures Computable? Knightian Uncertainty and Artificial Intelligence.” Academy of Management Review, published ahead of print, January 5, 2024. https://doi.org/10.5465/amr.2022.0237.

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As Armen Alchian (1965, 817) notes,

If we look at the “fields” of economics, say as presented by the American Economic Association’s classification of areas of interest or specialization, we find no mention of the word “property.” Either we can infer that the profession is so obviously aware of the pervasiveness of the effects of various forms of property rights that property rights cannot sensibly be regarded as merely a subfield; or else we can infer that economists have forgotten about the possibility of subjective rigorous systematic coherent analysis of the various forms of property rights. My conviction is that the latter inference is the more valid one.

For various interpretations and treatments of case probability and Knightian uncertainty see Klein (2009); Packard, Clark, and Klein (2017); and Townsend et al. (2024).

Nominal private ownership but de facto state control, as under fascism (“socialism of the German kind”), does not constitute real private ownership, as the nominal owners lack this “total control.” In this system there are “no longer entrepreneurs, but only shop managers” (Mises 1949, 713).

In Ludwig Lachmann’s (1956, 99) terminology, owners are “capitalist-entrepreneurs,” while nonowner managers or employees are “manager-entrepreneurs”; he writes that “the only significant difference between the two lies in that the specifying and modifying decisions of the manager presuppose and are consequent upon the decisions of the capitalist. If we like, we may say that the latter’s decisions are of a ‘higher order.’” Eugene Fama and Michael Jensen (1983) distinguish similarly between “decision management” and the owner’s “decision control,” which involves choosing managers, delegating authority to them, and monitoring their behavior and outcomes.

This is also the way “judgment” is used in the decision-theory and psychology literatures on judgment and decision (e.g., Mellers, Schwartz, and Cooke 1998; Steele and Stefánsson 2020). Judgments can be right or wrong!

Mises (1990b) doubts that cooperatives would exist at all on the free market, attributing their (limited) success to government-granted privileges.

Rothard applies an even looser criterion for private firms that have participated in acts of aggression, giving the example of napalm producer Dow Chemical. “No percentage of sales [to government buyers], however small, can absolve its guilt.”

See Cook and Iliopoulos (2000) for an interesting example in the case of cooperatives.