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Ludwig Von Mises

The societal function of loses

So far we have placed an increased emphasis on profits, but what about loses? Loses are the counterpart to profits. One cannot exist without the other. They point out to market participants the places where ineffectiveness and waste have occurred. This serves the function of advertising the fact that investing capital in such endeavours is not profitable and also that there may be an opportunity should the product or service be improved or its cost lowered. Loses is what makes Catallactic competition work because they are undesirable outcomes. Entrepreneurs (just like any other human) work hard to prevent undesirable outcomes. The market -through loses- punishes ineffectiveness and wastefulness in the same manner in which it rewards effectiveness and efficiency through profit. Both are proportional to the capacity of the entrepreneur to satisfy people's needs.

Capitalism is a profit and loss system where one drives the other. Capitalism is not a profit-only system. This is clearly ridiculous!

Entrepreneurs again

At the beginning of this article we provided a general definition of entrepreneurship. However, in the realm of a free market, we can produce a more specific definition which relates to money. As such we define:

Entrepreneurs are people who risk their capital (money) with the goal of achieving a profit by acting in a free market. They do so by speculating about an uncertain future using economic calculations.

How entrepreneurship functions

In general terms, entrepreneurs decide the most appropriate market structure. What this means is that entrepreneurs decide how to use capital to get the most effective production factors and capital goods. Entrepreneurs use their own capital or savings (other peoples' capital) that were provided to them by other entrepreneurs. They do so hoping that the final consumer good or service will sell for more than the value of the used capital, thus making a profit. In this sense the goal of an entrepreneur is to make a profit but the only manner in which this is possible in a free market is through the satisfaction of consumer needs in the most effective manner.

An entrepreneur is always looking for products that will present this discrepancy between manufacturing costs (i.e. the use of capital) and prices consumers are willing to pay. Take Thomas Edison the first patentee of electric light bulbs in USA (no, he wasn't the only inventor of the electric light bulb). Edison realized that the difference between the capital (his and his investors') that he advanced to his employees (in the form of wages) plus the capital he spent on manufacturing machines will be far lower than the price consumers will be willing to pay to have electric light. Edison was right and thus he obtained large profits. Customers signalled that electric light bulbs were a desirable product by accepting Edison's high prices. However, soon after, other companies became aware of this discrepancy thus they also created their own production systems for light bulbs through the use of their capital. However, in order to be able to ensure their light bulbs (and not Edison's) will be purchased by consumers; they had to offer added satisfaction. They did so by lowering the sale price. In other words, they engaged in Catallactic competition. But the process of Catallactic competition is always the decrease of prices and thus de decrease of profits. It is for this reason (the desire to have high profits) that entrepreneurs are always looking for opportunities where prices of goods and services will be far superior than the invested capital. In a free market entrepreneurs cannot just sit still with their products because through Catallactic competition other entrepreneurs will diminish their profits until they become loses.

At the core of entrepreneurship is the capacity to anticipate what people want and the capacity to perform economic calculations to determine if there will be a difference between invested capital and prices. But neither of these capacities are guaranteed or even objective. They are always subjective and operate within the realm of uncertainty. It is for this reason that entrepreneurs are speculators.

Speculators

We now have to make a small detour and qualify the term "speculator". This term has been used by communist and socialists with negative connotations through their propaganda machines with such a success that its use is now denigrating. People associate a "speculator" with somebody profiting using less than ethical means or even through illegal ones. However, this cannot be further from the truth. If we look at the etymology of the word, we see that:

  • It originates from the Latin word speculatus which means contemplation or observation.
  • It also means intelligent contemplation, consideration or the act of looking.
  • Also, to observe, to look at, to view.
  • Also, the pursuit of the truth by means of thinking.

This is the correct description of what a speculator is. It is simply a person that is better at observing what people need and willing to put that observation to the test through market actions.

Speculation and entrepreneurship

As such, entrepreneurship has two different and distinct properties:

  1. The capacity to anticipate what people want. This is the personal view and opinion of the entrepreneur. As this is personal and subjective it cannot be replicated or taught.
  2. The capacity to make economic calculations. This has two parts. The first one, the manufacturing cost, is almost trivial because it can be placed in the hands of technicians (such as accountants, engineers, statisticians, manufacturing experts and so on). The second one, the estimation of the price consumers will be willing to pay not so much.

The end result of these two characteristics is that entrepreneurship is a constant trial-and-error process. Entrepreneurs engage in this process through their human actions in the market. This trial-and-error process originates in the uncertainty of future demand and supply. If there would be no uncertainty, then there would be no market inefficiencies thus no opportunities for new entrepreneurs. This would be so because entrepreneurs would be able to calculate the maximum price that other entrepreneurs can afford to pay for the means of production, and this maximum price would be limited by the maximum price that consumers would be willing to pay for those goods and services. In other words, there would be no difference between the cost of production and sale prices, thus no profit. But if entrepreneurs would be able to do so, to calculate the maximum retail price, this would mean that entrepreneurs would know the needs of all customers at all times and into the future, which is clearly ridiculous. If we would be able to anticipate the future, then today's prices would fully reflect tomorrow's needs which would prevent any price differential thus eliminate any possible profit.

The goal of an entrepreneur is to exploit market inefficiencies and do so by anticipating future market conditions more accurately than other entrepreneurs.

Entrepreneurship, education and capital

It is clear by now that in order to achieve maximum satisfaction of our needs we need to have a maximum number of entrepreneurs engaged in Catallactic competition. The question then shifts to whether or not we can produce entrepreneurs and the answer is yes. Even though entrepreneurship has a clear component of art, or intuition or predisposition this than can be taught just like any other art (e.g. painting or poetry writing). However, what cannot be taught is its effectiveness. Just like with any other subject, the distribution of effectiveness in a group of entrepreneurs will approximate a Gaussian curve. There will be a few very effective entrepreneurs, a great deal of mediocre entrepreneurs and a few very ineffective entrepreneurs. And this is a natural limitation which we cannot breach. We can only increase the number of good entrepreneurs by increasing the total number of entrepreneurs. In this sense, increasing entrepreneurship education would help.

But this is not the only limitation. The second limitation is capital. If entrepreneurs lack capital there is nothing they can do regardless of how brilliant they may be. It is for this reason that any limitation in free capital produces devastating consequences to our standards of living; because it prevents entrepreneurs from executing their art.

Our standards of living are tied to the supply of things we need. Removing suppliers from the productive system only leads to a reduced supply. This is what happens in communism (and to a lesser degree in socialism) where there is either outright elimination of entrepreneurs and capital sources or severe limitations placed onto them. The elimination of entrepreneurs only leads to lower supplies. This elimination is being heralded (by socialists) as an increase of freedom and equality but in reality it produces neither.

Wages and profits

As previously mentioned, the goal of an entrepreneur is to make profits. Profits are the prize entrepreneurs receive for taking risks with their capital. But profits are tied to the accuracy of entrepreneurs' forecasting ability which means that profits are uncertain. They fluctuate over time and in different economic conditions.

Worker's wages on the other hand, are not only certain but they are not tied neither to their ability to forecast the future state of markets nor their need to risk their capital.

We must also never forget that entrepreneurs are always exposed to loses, while workers are not (with the exception of losing their jobs).

Yet another thing we must consider is the attrition effect of loses. Many entrepreneurs are removed from the market due to their ineffectiveness and wastefulness. This means that surviving entrepreneurs tend to be those who are far more effective and efficient. This creates an image problem. All the time in the media we hear about super-rich entrepreneurs but we never hear about the risk that these people were exposed to, risk that destroyed many more entrepreneurs. Furthermore, successful entrepreneurs are so because they are effective and efficient at satisfying our needs. They don't receive higher wages because they have become "the evil empire" but because of the opposite. They are making our standards of living higher with higher effectiveness and efficiency than any other entrepreneur.

What all this means is that worker's wages will be lower than entrepreneurs' wages and for a very good set of reasons.

Note: please see the Glossary if you are unfamiliar with certain words.

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