AUSTRIAN THEORY OF ENTREPRENEURSHIP MEETS THE SOCIAL SCIENCE AND BIOECONOMICS OF THE ETHNICALLY HOMOGENEOUS MIDDLEMAN GROUP
Janet T. Landa
The phenomenon of the ethnically homogeneous middleman group (EHMG) or ethnic trade network – the Chinese merchants in Southeast Asia, the Gujarati-Indians merchants in East Africa, the Jewish merchants in medieval Europe, etc. – is ubiquitous in stateless societies, pre-industrial and in less-developed economies (Curtin, 1984). Neoclassical (Walrasian) theory of exchange cannot explain the existence of merchants let alone the phenomenon of the EHMG. This is because Neoclassical theory of ex-change is a static theory of frictionless, perfectly competitive markets with the Walrasian auctioneer costlessly coordinating the plans of anonymous producers (sellers) and consumers (buyers) so as to achieve equilibrium. There is no role for merchants in the Neoclassical theory of exchange.
Cognition and Economics
Advances in Austrian Economics, Volume 9, 177–200 Copyright r 2007 by Elsevier Ltd.
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ISSN: 1529-2134/doi:10.1016/S1529-2134(06)09007-7 177
178 JANET T. LANDA
Unlike the Walrasian theory of exchange, Israel Kirzner (1973) has de-veloped an Austrian theory of market processes, in which the arbitrager-entrepreneur plays a central role in coordinating the plans of producers and consumers. However, Kirzner’s theory of entrepreneurship is unable to ex-plain the phenomenon of the EHMG because his theory implicitly assumes that entrepreneurs operate in capitalist markets with a well-developed legal framework for the enforcement of contracts. In order to explain the EHMG it is necessary to take account of the institutional environment for entre-preneurship, as well as entrepreneurial studies relevant for less-developed economies where the legal infrastructure is not well-developed. I have de-veloped a theory of the EHMG drawing upon the key concepts of ‘‘trans-action costs’’ and ‘‘institution’’ in new institutional economics (NIE) in the early 1980s as well as an expanded concept of institution drawn from an-thropology and evolutionary biology since then. The aim of this paper is to synthesize Kirzner’s theory of entrepreneurship with my theory of the EHMG via an expanded concept of institution. The expanded concept of institution crosses disciplinary boundaries by linking NIE with the other social sciences and beyond to evolutionary biology and bioeconomics.
This paper is organized into ﬁve parts. In Section 1, I discuss Kirzner’s theory of entrepreneurship and show why his theory is relevant to a cap-italist market economy with a well-developed legal infrastructure and not applicable to markets with poorly developed institutional environment. In Section 2, I discuss the entrepreneurial studies of Glade (1967) and Leiben-stein (1968) relevant for less-developed economies where successful entre-preneurs are found in well-deﬁned foreign ethnic merchant groups. Although Glade and Leibenstein provided important insights explaining the phenomenon of EHMG, their theories lack the micro-foundations for analyzing the emergence of the EHMG from individual traders’ rational choice. In Section 3, I discuss my NIE theory of the EHMG as a club-like institutional arrangement for the enforcement of contracts in an environ-ment characterized by contract-uncertainty (Landa, 1981; Carr & Landa, 1983; Cooter & Landa, 1984; Landa, 2002a). In my theory of the EHMG developed in the early 1980s, institutions are conceptualized in three differ-ent ways: institutions as rules/constraints, institutions as identity signaling devices, and institutions as classiﬁcation. Such an expanded concept of in-stitution crosses disciplinary boundaries to link up with the NIE concept of institution with anthropologists’ concept of culture and classiﬁcation, and with sociologist’s ‘‘embeddedness’’ approach to social networks. In Section 4, I discuss my bioeconomics theory of the EHMG and of Chinese mid-dleman success, using the concept of EHMG as ‘‘adaptive units’’ and the
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concept of ‘‘institutions as group competition’’ in evolutionary biology and in Hayek’s work on cultural group selection. In Section 5, I provide some concluding comments and suggestions for future research.
1. KIRZNER’S THEORY OF ENTREPRENEURSHIP: ‘‘ALERTNESS’’ TO PROFIT OPPORTUNITIES AS THE DEFINING CHARACTERISTIC OF THE KIRZNERIAN ENTREPRENEUR
Neoclassical (Walrasian) theory of exchange depicts markets always in a state of equilibrium brought about by the ﬁctitious Walrasian auctioneer costlessly coordinating the plans of anonymous producers and consumers directly together by clearing markets for the same good at the same price. There is no role for the arbitrager-entrepreneur in such a static theory.
In contrast to the static Walrasian theory, the arbitrager-entrepreneur plays a central role in Israel Kirnzer’s (1973) Austrian disequilibrium theory of market processes. The role of time, ignorance and error, proﬁt expec-tations and subjective perceptions are Austrian elements crucial to Kirzner’s theory of entrepreneurship. Central to Kirzner’s pure theory of arbitrager-entrepreneurship is his relaxation of the neoclassical assumption of markets always in a state of equilibrium by introducing disequilibrium ‘‘market processes’’ that lead to the emergence of price differentials of the same commodity in different markets. The disequibrium is brought about by errors and ignorance of market participants. As soon as price differentials appear, there is the opportunity for the emergence of a new class of market participants: ‘‘alert’’ entrepreneurs who are able to subjectively perceive or discover price differentials and the ability to reap proﬁts from arbitrage.
The deﬁning characteristic of the Kirzner entrepreneur is ‘‘alertness’’ to perceive or discover proﬁtable opportunities. In order to appropriate proﬁt-able opportunities, Kirzner (1973, p. 253) recognizes that planning and cal-culation is needed (see also Koppl & Minnitti, 2003, p. 87). Thus, once an opportunity is discovered, the entrepreneur takes action by which discov-eries of opportunities are translated into proﬁts. The Kirznernian entrepre-neur is a ‘‘Hayekian learner’’ (Butos & Koppl, 1999).
Given that ‘‘alertness’’ is the deﬁning characteristic of the Kirznerian entrepreneur, the concept of entrepreneur does not need to be narrowly interpreted in an arbitrager-proﬁt making framework. As Koppl and Min-niti (2003, p. 87) pointed out, Kirzner’s concept of entrepreneurship can be
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broadly interpreted to include even actions in the non-market sphere. They provided the example of an alert professor who discovers a new round-about route to get to work in order to avoid meeting his dean. Such an action of discovery can be said to be ‘‘entrepreneurial’’ as deﬁned by Kirzner.
At the simplest and most fundamental level, the proﬁt-making arbitrager-entrepreneur stands at the center of Kirzner’s theory of entrepreneurship.1 The arbitrager-entrepreneur is, according to Kirzner, entitled to keep his proﬁts based on the ‘‘ﬁnders-keepers’’ ethic’’ (Kirzner, 1979) because he is the creator or discoverer of what he found i.e. price differentials in different markets. Thus he is entitled to appropriate his proﬁts as his private property. Kirzner’s arbitrager-entrepreneur, seen in historical context is, in fact, the merchant or middleman who played a central role in the rise of markets (Hicks, 1969, Chapter 3), even though Kirzner never used the term ‘‘mer-chant’’ or ‘‘middleman’’ in his theory of entrepreneurship. In Kirzner’s ar-bitrage theory of proﬁt, anyone with the alertness in subjectively perceiving/ discovering price differentials and the ability to seize the opportunity to make proﬁts from arbitrage can, in principle, become entrepreneurs. Pos-session of money or capital is not a pre-requisite for the emergence of the Kirzerian entrepreneur because he can always obtain credit. This, of course, implicitly assumes that entrepreneurs in Kirzner’s theory operate in perfect markets with well-developed infrastructure such as the existence of banking and contract law for the enforcement of contracts. But as some critics of Kirzner’s theory of entrepreneurship have pointed out (see e.g. Burczak, 2002), not all alert individuals are able to obtain credit, even if they are
willing to pay high interest rates.
In addition, not all Kirznerian entrepreneurs are able to appropriate proﬁts as private property, since property rights must be enforced. Kirzner’s notion of property rights, based on the morality of ‘‘ﬁnder’s keepers ethic’’, does not take account of the legal infrastructure of a market economy in protecting private property and enforcing contracts, an idea central to the old institutional economics and NIE literature. In order to extend Kirzner’s (1973) theory of entrepreneurship to take account of the institutional in-frastructure which facilitate entrepreneurship, it is necessary to:
(a) reformulate the Austrian concept of an ‘‘exchange’’ into John R. Com-mons’ concept of a ‘‘trans-action’’ in the old institutional economics literature. This is because in capitalist market economies, all exchanges are transactions involving transfers of titles to goods via legally binding contracts; and
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(b) formulate Kirzner’s concept of entrepreneurial arbitrage activities ex-plicitly in terms of the middleman engaging in a sequence of two bi-lateral transactions across time and space. This captures the notion that transactions via a middleman-intermediary are organized in a complex trade network in which, due to functional specialization and division of labor between producer, middleman and consumer, every market partic-ipant must cooperate and coordinate their plans by honoring their con-tractual obligations. Any breach of contract means that the plans of market participants fail to materialize. A role for contract law is now possible.
Following Landa’s (1976) analysis of the role of contract law in facili-tating middleman-entrepreneurship, let us extend Kirzner’s theory of en-trepreneurship to include a role for contract law. Assume the Kirznerian entrepreneur as the middleman (M) who buys a commodity from a seller (A) at time t at a lower price of $10 and resells the same commodity at a higher price of $15 at time t+1 to the ﬁnal consumer (C) in another market; M’s expected gross proﬁt from the sequence of two bilateral transactions or contracts is $5. Suppose, A opportunistically breaches his contract to deliver the commodity to M at time t, because another merchant offers A a better price, forcing M to breach his contract at time t+1 to deliver the commodity to C. As a result, C will not pay M, and so M’s expected proﬁts failed to materialize; A has imposed a pecuniary ‘‘exchange externality’’ (Landa, 1976) on M under conditions of contract uncertainty. Breach of contract is a source of disequilibrium not accounted for in Kirzner’s theory of entrepre-neurship. Confronted by lost proﬁts from breach, the rational middleman will resort to self-help remedies to reduce risks of breach of contract (Landa, 1976, pp. 914–915) including seeking out trading partners whom he can trust, thus personalizing exchange relations. But all these self-help measures to reduce contract-uncertainty, increase transactions costs of trading. The emergence of the state in enforcing contracts, economizes on transaction costs, hence facilitating middleman entrepreneurship and promoting eco-nomic development by increasing the size and number of markets. Insti-tutions – rules of the game – for protecting property rights and enforcement of contracts are fundamental in promoting entrepreneurship and economic development in a capitalist market economy.
My theory of the role of contract law in facilitating middleman entre-preneurship via its role in enforcing contracts complements the work of David Harper (1998, 2003), who synthesized Austrian theory of entrepre-neurship with NIE by emphasizing the important role of institutions, in
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