The Eternal Sunshine of the Entrepreneurial Mind

Tyler Cowen points to an interesting article on how entrepreneurs think, and quotes the following passage:

That is not to say entrepreneurs don’t have goals, only that those goals are broad and—like luggage—may shift during flight. Rather than meticulously segment customers according to potential return, they itch to get to market as quickly and cheaply as possible, a principle Sarasvathy calls affordable loss. Repeatedly, the entrepreneurs in her study expressed impatience with anything that smacked of extensive planning, particularly traditional market research. (Inc.’s own research backs this up. One survey of Inc. 500 CEOs found that 60 percent had not written business plans before launching their companies. Just 12 percent had done market research.)

…Sarasvathy explains that entrepreneurs’ aversion to market research is symptomatic of a larger lesson they have learned: They do not believe in prediction of any kind. “If you give them data that has to do with the future, they just dismiss it,” she says. “They don’t believe the future is predictable…or they don’t want to be in a space that is very predictable.”

While I have some quibbles – for example, many failed entrepreneurs share this frame of mind, and there are other characteristics joined with this one that tend to characterize successful entrepreneurs – the gestalt of this is, in my experience as a technology entrepreneur, exactly right.

At root, what’s so fascinating to me here is the distinction between risk and uncertainty. By “uncertainty,” I mean non-quantifiable lack of predictability. For example, we could roughly say that there is a 50% risk of getting heads if I flip this quarter, but that the probability that Egypt will experience a military coup this month is uncertain – somebody might venture to place odds on it, but it is not reliably quantifiable in the same sense.

I think that this distinction points to a fundamental cleavage in worldviews in economics that turns on the role of the entrepreneur. This meaning of the term uncertainty is, in fact, often referred to as “Knightian” uncertainty, after the great early twentieth century American economist Frank Knight, who used it to try to explain the role of the entrepreneur.

Entrepreneurs choose to operate in sectors in which uncertainty dominates. This is inherent to what entrepreneurship is. The kind of predictive tools that work well for the U.S. aluminum market don’t work very well when you’re inventing the Software-as-a-Service business model. What works better is trial and error learning, or more formally, experimentation. As an entrepreneur, you throw yourself into an evolutionary competition, and use whatever resources you have to succeed. You don’t believe that you (or anybody else) can predict the multi-step game in advance.

There is a heterodox tradition of economists who focus on the centrality of these issues for the long-run growth of the economy. Frank Knight, Joseph Schumpeter, F.A. Hayek, Vernon Smith and Douglas North are obvious examples. This focus leads to an emphasis on uncertainty, experimentation and evolution, and stands in contrast to the currently-dominant paradigm within university economics departments of risk, quantification and equilibrium.

I believe that entrepreneurship, broadly defined, is central to economic growth, and that determining public policy using economic models that inherently under-emphasize this is a very bad idea. Professional economists, in my view, have a class interest in obscuring this. One that is as powerful as the class interest of entrepreneurs in conflating luck and skill.

(Cross-posted at The Corner)

P.S. As commenter Jeff Singer points out, blogger / economist / entrepreneur Arnold Kling writes about this kind of thing all the time, and with great insight. If this topic interests you, you should be reading his blog.