The Use of Knowledge in Entrepreneurship
In a recent episode of the Economics for Entrepreneurs podcast, I interviewed Steve Mariotti, who has spent a lifetime teaching entrepreneurship to kids from difficult and troubled backgrounds in the US, as well as the sons and daughters of parents who lived through the USSR and Vietnamese communist regimes. He portrayed entrepreneurship as an escape from poverty and oppression for these young people, one they embraced with excitement and enthusiasm.
Mariotti found a guiding light for his teaching, and for the young people searching for their pathway out of poverty, in F.A. Hayek’s "The Use of Knowledge in Society." He cited in particular paragraphs ten and eleven, where Hayek underlines “the importance of the knowledge of the particular circumstances of time and place” and bemoans the fact “that this sort of knowledge should today be generally regarded with a kind of contempt” compared to theoretical or technical knowledge. In other words, academics and institutional economists don’t understand or appreciate how entrepreneurs generate revenue and make profits as a result of their specialized individual knowledge.
Steve Mariotti’s insight prompted me to reread Hayek's famous 1945 American Economic Review article through the lens of entrepreneurship. Here is a compressed paraphrasing of it.
We wouldn’t need entrepreneurs if we possessed all relevant economic information, if we knew every detail of customers’ preferences, and if we had complete knowledge of all the means by which customers could realize their preferences. But this is emphatically not the case.
The peculiar role of the entrepreneur is determined by the fact that this knowledge of customers’ ends and their available means never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all separate individuals possess. The economic problem that entrepreneurs address is the utilization of knowledge that is not given to anyone in its totality to secure the best use of available resources for ends whose importance only other individuals know. We can label this “knowledge of the particular circumstances of time and place,” i.e., the specific and unique local knowledge accumulated by entrepreneurial individuals as they work particular jobs, acquire specific skills, gain knowledge of particular industries and markets, become aware of alternative uses of resources, observe particular transactional inefficiencies, and gain an understanding of particular individuals’ goals and dissatisfactions.
Academics, government regulators, scientists, and experts do not grant this kind of knowledge the economic significance it deserves. Nor do they sufficiently respect the entrepreneur who profits from the application of this kind of knowledge. Those entrepreneurs are not using the latest scientific discoveries or the best technology.
Moreover, scientists and experts do not fully appreciate the reason why this kind of knowledge is important for economic growth. It is important because the economic problems that entrepreneurs solve arise always and only in consequence of change. Expert economists and their models are insufficiently equipped to deal with constant change. They deal with statistical aggregates, which show much greater stability than the movements of the details that entrepreneurs deal with.
The experts don’t have the practical experience of the businessperson who maintains constant vigilance to keep up with changes in the environment, to maintain the continuous flow of goods and services via constant deliberate adjustments made every moment in light of new information and new circumstances not known the day before. This kind of knowledge can’t enter into statistics and can’t be conveyed in statistical form.
The economic problem that the entrepreneur deals with is rapid adaptation to changes in the particular circumstances of time and place. The only people who can deal with these changes are those who are intimately familiar with these circumstances, who know of the relevant changes and know the resources that are immediately available to meet them. The knowledge of particular circumstances of time and place must be promptly used. There is no waiting for experts to process the information. The entrepreneur acts on the information that’s available—admittedly incomplete—and makes the best business decision possible based on the relative importance of the particular things with which he or she is concerned.
The price systems is a particularly important knowledge tool for entrepreneurs. When the price of inputs rises, or the price the customer is willing to pay declines, the entrepreneur makes adjustments in response to the new information. This adjustment may rapidly spread throughout the whole economic system and effect major changes in supply and demand, but the individual entrepreneur does not concern himself or herself with the system, just with the actionability of local and specific knowledge that they regard as essential even if it is, in theory, imperfect.
It is a marvel that this imperfect, limited information is utilized in economic action by individuals that results in so much good for society. There is no human design or conscious direction in this mechanism of economic growth. In fact, the actions and adjustments of the entrepreneur in relation to prices and to the subjective values of customers are implemented, in a sense, without a great degree of conscious thought. The action is often instinctive. This is of profound significance. Entrepreneurs build upon habits and practices—and institutions such as the price system—which have proved successful, thereby availing themselves of the benefits of knowledge that no single individual possesses.
The system of entrepreneurial use of knowledge and market signals was not designed and can’t be planned. It makes possible the specialization and division of labor without which we would not have been able to develop our modern civilization.