Why Every Entrepreneur Should Study the Austrian School of Economics
Modern economics is a theory of the economy that leaves no place for the entrepreneur. So where should entrepreneurs turn to improve their understanding? The Austrian school of economics might be the answer.
Over 50 years ago, economist William Baumol noted that economics was a theory of the economy that left no place for entrepreneurship. Economic models, simply put, were "entrepreneur-less." Economics is no better today; in fact, it's arguably worse. It focuses on faceless economic forces in formalized models. Modern economics is to a great extent a theory of equilibrium and efficient outcomes. But it is not a theory of the market.
As economist Joseph Schumpeter argued, entrepreneurs are the lifeblood of the dynamic market economy. They are in the business of creating disequilibrium. They engage in "creative destruction." The new that they create displaces the old and makes us better off. The market economy without entrepreneurship would be static, barren, and boring.
So what can entrepreneurs learn from economics? Not a whole lot. At least not from the highly mathematical modeling that is taught in intermediate and graduate level courses today. But there are other schools of thought that recognize the importance of the entrepreneur.
The Austrian school of economics
So-called Austrian economics, which was founded by scholars at the University of Vienna 150 years ago (hence the name), is an alternative approach to understanding the economy that embraces entrepreneurship and even sees it as the driving force of the market. To "Austrians," as the followers of this tradition call themselves, the market is best understood as a process that is never in general equilibrium.
With entrepreneurship at the core, Austrians only reluctantly use mathematical modeling and statistical analysis. After all, if the economy is a dynamic process of entrepreneurship and innovation, of what use are mathematical equations? Instead, their focus is on value creation, uncertainty, and how producers constantly adjust and attempt to meet changing consumer preferences.
Austrian economics is an economic theory that is much more realistic than equilibrium models. For that reason, it is also much more helpful for entrepreneurs.
Economics for entrepreneurs
Few entrepreneurs have heard of or studied Austrian economics. But my experience is that most entrepreneurs are Austrians without knowing it. They have learned from experience how the economy works and have developed an intuition. Their gut feeling, sometimes referred to as entrepreneurial judgment, is a tacit understanding of the economy as a market process and what this means for entrepreneurship.
Here are four insights from Austrian economics that are part of that entrepreneurial intuition:
1. Consumer sovereignty
Not only is the customer king, but all production aims to ultimately satisfy consumers in some sense by providing them with value. This value is entirely up to the consumer. Entrepreneurs can only provide the means, typically a good or a service, that help consumers become better off. Sometimes this requires educating the customer so that they understand the value of the product. And, typically, the value lies in their complete experience, not just what you sell.
2. Value determines price and costs are a choice
With value being in the eyes (and experience) of the consumer, the price they are asked to pay must be (much) lower. The entrepreneur's job is to figure out at what price their product is attractive, and then choose a cost structure that allows for profit. In other words, the price is a guess based on what value consumers see in the product. The only choice is cost: how to produce at costs below the selling price and, ultimately, whether to produce.
3. Entrepreneurship is about creating tomorrow
Leading Austrian economist Ludwig von Mises noted in his tome Human Action that "the ultimate source from which entrepreneurial profit and loss are derived is the uncertainty of the future constellation of demand and supply.'' What that means is individual entrepreneurs choose costs in the present to produce a product that must be sold in the near or distant future, whatever the market situation might be. That's the uncertainty borne by the entrepreneur.
4. Seek to be a good monopolist
In standard economics models, competition is about offering the same or nearly the same goods competing on price. This is a terrible strategy for entrepreneurs, whose superpower is to facilitate value. Therefore, Austrians think of competition differenlty: It is about figuring out how to provide the best value experience possible. This often involves thinking out of the box and trying something new. Every innovation is by definition a new, unique offering and therefore also a monopoly. What benefits consumers most is entrepreneurs who aim to be good monopolists.
Standard economics has turned its back on and developed models that exclude entrepreneurship. As Joseph Schumpeter, schooled in the Austrian tradition, put it: the market economy without entrepreneurship is much "like Hamlet without the Danish prince." Indeed, entrepreneurs are the main characters in the drama that is the economy. An economic theory that recognizes this not only does a better job explaining the economy -- it is also a useful framework for entrepreneurs.
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