The Role of the Entrepreneur
by Faustino Ballvé
Entrepreneur and consumer. Economic calculation. The data of the market. Factors and means of production. Comparative cost. Marginal utility. Diminishing returns. The time factor. Risk.
We have seen that the market is the pivot around which the whole of economic life revolves. We can say just as well that the market revolves around the entrepreneur.
The entrepreneur is the person, natural or juristic (i.e., individual or collective), who enters the market with the object of making a profit, that is to say, of getting more than he gives. In this sense, all those who go to the market are entrepreneurs, buyers as well as sellers, since anyone who buys a cow for two hundred dollars does so because he considers that, for him, the cow is worth more than the money he pays for it. Otherwise he would keep his two hundred dollars. However, in economics one who enters the market in order to obtain what he needs for his own use is not called an entrepreneur, but a consumer. Strictly speaking, the entrepreneur is anyone who goes to the market to sell or anyone who goes to the market to buy, not for his own consumption, but to resell what he has bought.
The entrepreneur aims at making a profit, and to this end he is obliged to resort to appropriate means. He thus has to exercise his power of choice twice: he has to choose the end, and he has to choose the means of attaining it. For both he has to make use of his judgment, of his own powers of reasoning. This is called economic calculation.
The first thing that must be done by whoever considers himself an entrepreneur and desires to enter the market to offer for sale something that will yield him a profit is to decide on the kind of thing he is going to trade in. It may be something entirely produced by him, or something he has transformed from what it was when he acquired it; or it may simply be in the same physical condition as it was when he got it, but improved in his estimation by his having kept it until the consumer needed it or by his having transported it from where it was not useful to where it is; or perhaps he has just broken it up or accumulated it in quantities acceptable to the consumer. To come to such a decision, he must study the market, that is to say, he will have to be guided by what in economics are called the data of the market. He has to take into account what is already in abundant supply in the market and what therefore it is not advisable to offer for sale; what is in short supply and consequently will easily find ready purchasers; what the qualities are that are predominantly in demand; whether it is expedient to offer one quality or another; and finally, what the future prospects of the market are, i.e., what promises to prove profitable, not now, but when he enters the market and even after that. This applies as much to goods as to services: nobody will undertake today to sell things that are out of fashion, nor will anybody offer the services of an ostler on a modern automobile highway. It is rather to be supposed that at the present moment some entrepreneur is calmly preparing to enter a business connected with the peaceful uses of atomic energy.
Having chosen the end, i.e., the kind of speculation he is going to embark on, the entrepreneur has next to concern himself with the means by which he is to carry out his project. These are called, in general, means of production, even though they may not involve the production of material things, but simply the rendering of services. A producer is not only one who makes shoes; he is also one who distributes them, one who transports them. All produce, in the last analysis, commodities; that is to say, they accommodate the consumer by satisfying his needs and desires.
These means of production can be divided into two categories: the factors of production and the techniques of production.
The factors of production are essentially capital and labor. The former is divided into fixed and circulating capital. Fixed capital consists of land, buildings, machinery, tools, means of transport, and other permanent factors needed to produce the goods and services that the entrepreneur will offer for sale in the market. For a textile factory, these would be the looms and other machines needed in the various stages of preparing the yarn, processing it, and producing the finished cloth. For a distributor, they would include warehouses for storing the merchandise, as well as scales for weighing it, packing materials, and other apparatus to enable him to distribute his wares. An enterprise engaged in journalism must invest in facilities for gathering the news, whether by cable or wireless, as well as typewriters, duplicating machines of all kinds, etc., in its various branch offices; and the fixed capital of the agriculturist consists of the soil, grist mills, olive presses, tractors, and ploughs.
Circulating capital is the money needed for the purchase of the raw materials, lubricants, composts, seeds, wages and salaries, rent, light, etc., that enable the entrepreneur to go on producing and to keep his business in operation. As part of the costs of production, this is a factor that enters into the sales price of the product.
Labor consists in the services of all those engaged in the enterprise, beginning with the entrepreneur himself—who, with the factors already mentioned, arranges for the production of the goods or services that are to be offered for sale in the market—from the highest ranks of intellectual workers down to the humblest hired hands.
Besides the material means or factors of production, the entrepreneur has to provide himself with technical means, choosing those that he considers to be the most adequate. There are diverse methods of producing textiles, iron or steel, chemical or pharmaceutical products, etc. Each has its advantages and its disadvantages, and he has to select the one that is most appropriate for his purpose, taking into account the wants he wishes to satisfy, the processes used by his competitors, the costs involved in the use of each method, and the corresponding profit to be expected from its employment, etc., etc. In certain cases the entrepreneur may himself be the inventor of a technical process for which he obtained a patent, or he may have obtained from another inventor such a patent or a trade-mark or a design or an industrial model of an earlier producer or of a foreign producer who has granted him, for a period of time, an exclusive license to produce or to distribute the commodity in question.
But this is not all. Among the technical problems that the entrepreneur has to resolve are the provision of raw materials and the system of production, i.e., whether to undertake the complete process of turning the raw material into the finished product or to begin with half-finished goods, whether to hire labor at a fixed wage or to pay on a piecework basis, etc. Also very important are the extent of the enterprise and of the means that the entrepreneur has at his disposal, the prospects of the market, and, above all, the net return yielded by his industrial unit. All of this calculation he will do in the light of his own knowledge or that of people paid by him to provide expert mechanical, chemical, technical, industrial, or commercial information, and also on the basis of the teachings of economic experience that are comprehended under the rubric of economic geography, economic history, and statistics.
Within this body of knowledge needed by the entrepreneur in order to exercise his power of choice in launching and managing his enterprise are included what are commonly called economic laws. Among the latter should be mentioned chiefly the law of comparative cost, the law of marginal utility, and the law of diminishing returns.
According to the law of comparative cost, more recently known as the law of association, as formulated by the classical economist David Ricardo, in view of the greater or lesser extent of industrial progress of different countries, if, for example, producer A needs three hours to produce commodity X and two hours to produce commodity Y, while producer B (in a country in a less advanced state of industrial development) needs five and four hours respectively, it is advantageous for all concerned for A to produce only commodity Y and for B to produce only commodity X; for in that case each of them will produce a greater quantity in the same number of hours, and the two together will produce more of both commodities than if each had undertaken to produce them both. This is the so-called law of association or law of comparative cost, a corollary of the law of the division of labor. It constitutes one of the most powerful arguments against the policy of economic nationalism and autarky. At the same time, it serves as a guide to the entrepreneur in his attempt to obtain from his efforts and his venture the greatest possible profit and, concomitantly, to increase the supply in the market for the benefit of the consumer.
The law of marginal utility was formulated almost simultaneously by three economists of the last third of the nineteenth century: Carl Menger, Stanley Jevons, and Léon Walras. Until then economists had been perplexed by the paradox which resulted from the fact that, although iron is unquestionably more necessary and more useful than gold, the latter is nevertheless more highly esteemed, greater value is attached to it, and it commands a higher price in the market. The economists who formulated the theory of marginal utility took account of the fact that economic utility is the power to satisfy any want, even though the latter may be altogether capricious, like the vanity of wearing jewelry. Hence, the difference between the utility of iron and that of gold is not determined by comparing the serviceability of all the gold and all the iron in the world, but consists in the difference between the economic services, expressed in terms of supply and demand, that can be rendered by the last available unit of the one or the other metal. Consequently, even though an iron or a steel building is objectively more useful than a gold wristwatch, since iron is much more abundant than gold, it is natural that the last available unit of gold in the market should be economically much more useful and in demand, and therefore much more costly in terms of money, than the last unit of iron.
The theory of marginal utility demonstrates, in effect, that the economic measure of the utility of a thing is a function of its scarcity in relation to the needs of the market. Though advertising may sometimes succeed in creating in the consumers a need for certain things, the entrepreneur must still take into account, in calculating the probability of success in the market, the concept of the utility of his product in terms of public demand rather than his own ideas of its usefulness. It makes no sense to go to the market to offer chewing gum to those who want to buy tobacco, however innocuous the former may be and however harmful the latter. The truth of this law and the relativity involved in its application are confirmed by what happened during the first World War. In the middle of the war Germany found itself short of many things, among them iron, the supply of which was almost completely exhausted, while coal was abundant. As its geographical and military situation enabled it to make imports, which it needed to pay for in gold, the government made an appeal to the patriotism of the German people, and they responded by giving up their gold jewels in exchange for garish iron imitations that carried engraved on them the phrase, “I have given gold for iron.” Practically no gold was left in Germany in private hands. But there was also a great scarcity of iron and other metallic objects, especially kitchen utensils. People valued iron highly and preferred it to any gold jewel that could be offered to them. For several years in Germany the marginal utility of iron was much greater than that of gold.
The law of diminishing returns, more recently known simply as the law of returns or also as the law of the proportionality of the factors of production, was first formulated by economists in its application to land. They noted that the yield from a given piece of land could be increased by the application of labor and other means of production such as machines and fertilizers, but only up to a certain point. Beyond this the increased expenditure invested in its more intensive exploitation was not translated into a corresponding increase in production, but resulted simply in an increase in unit costs: the land no longer yielded more, but, in a certain sense, less, because the product became more costly once the point had been passed at which the land had yielded its optimum return. Hence one spoke of “diminishing returns.”
Later it was observed that this law is applicable to any and every form of production. In a shoe factory, for example, the employment of more modern machinery, an increase in the number of workers, the utilization of more or better auxiliary materials, such as dyes, lubricants, etc., will result in an increase in the net return more or less in proportion to the means employed. But a time will come when the optimum return is obtained, and if one seeks to go beyond this point with a more lavish use of the means of production, the return, instead of rising, will fall. This is something that needs to be carefully taken into account by the entrepreneur in making his economic calculation. He will have to pay heed to the particular circumstances of time and place in which production is to be carried on (such as the kind of motive power that is available; the supply, the quality, and the price of industrial labor; the cost of auxiliary materials; etc.), and he must calculate or discover by experience the precise combination of all the factors of production that, in the given time and place, will produce the optimum yield. If he does not do this and allows himself to be dazzled by appearances, by the example of other countries or other times, etc., then he runs the risk of obtaining, instead of a greater, a lesser return on his investment, to his own detriment and that of the market.
Among the problems of economic calculation confronting the entrepreneur, that of time stands in the forefront. Indeed, one might go so far as to say that entrepreneurial activity consists essentially in the struggle against time.
The economy is not something static, knowledge of which, once acquired, holds good forever. It is, on the contrary, a living thing which undergoes continuous variations, and consequently the data of the market today are not what they were yesterday or what they will be tomorrow. The raw materials available, technical advances, and the way of life, the tastes, and the wants of the consumers are constantly changing. On the other hand, a very important role in the economic calculation of the entrepreneur is played by the rhythm of production. By this is understood not only production properly so called, but also the process of distribution involved in bringing a particular thing or service to the ultimate consumer, for until this point is reached, an investment of capital and labor still has to be made; only when a commodity reaches the market can its price be determined. Corresponding to the greater or lesser rapidity of this rhythm will be the greater or lesser amount of circulating capital needed by the entrepreneur; an error in the calculation of this amount can lead to the failure of the enterprise.
The entrepreneur has to foresee the rhythm of his turnover so that he can calculate and make provision for the amount of the circulating capital that the enterprise is going to need. At the same time, he must also calculate the quantity of immobile means of production that he needs, which will determine the amount of fixed capital to be invested in the business. But this foresight must likewise extend, so far as possible, into the future configuration of the market: he has, in a certain sense, to foretell whether and how long the production that he wishes to undertake will find a market, whether the demand for his product will increase or diminish, whether prices will rise or fall in the course of time. This will tell him how far he can or ought to risk the available capital, how rapidly he has to amortize fixed investments, and many other things determining the volume and character of his business.
It is easy to understand, then, that none of these many calculations, which in their totality constitute economic calculation, can be exact: all are calculations of probabilities, and, a fortiori, so is the total economic calculation.
Statistics, provided always that they are exact and rightly interpreted, tell us only what has happened up to the present, not what will happen tomorrow. Technological progress is not always predictable: revolutionary inventions sometimes come like a bolt from the blue; political or international events occasionally destroy in an unforeseen and unforeseeable way all the hopes based on the availability and price of raw materials; and it is even more difficult to anticipate the reactions of the consumers to these events. Who would have expected, for example, that at the outbreak of the First World War, when a scarcity of textiles became evident, women would persist in their refusal to wear short, narrow skirts and demand long, wide ones? However many data the entrepreneur takes into account in undertaking or managing his business—commercial geography, history and statistics, books and periodicals on the latest technological advances and those continually in progress—his decisions will always come up against an unknown quantity that he will have to determine by intuition on his own responsibility and in the spirit of adventure: he knows what happened yesterday and today, but tomorrow is in the hands of Providence. In a word: every enterprise, every business, every economic act in general, because it occurs and develops in time as well as in space, is necessarily a speculation that can result in profit, but can also result in loss.
Production, around which all economic life revolves, is, then, the great adventure of mankind: it is the struggle with tomorrow, the struggle with the unknown. The champion, the hero, and frequently the victim in this struggle is the entrepreneur. He undertakes some enterprise in quest of profit. But in order to obtain it, he is obliged to satisfy the consumer, that is to say, the public in general. Competition takes care of this. The consumer never loses. The entrepreneur, on the other hand, can see all his hopes of profit transformed into a loss that he alone must bear: the profit that the consumers (the general public) made is theirs to keep, while the entrepreneur is ruined. This is an unavoidable necessity. We have already seen that it cannot be avoided by any scientific cognition because the future is an unknown quantity that eludes every calculation and all foresight.
But can all this be avoided by political means? We shall concern ourselves later with the proposals that have been advanced and even tried with this object in view, whether by way of a change in the whole economic system or by way of corrective measures designed to overcome the alleged “weaknesses of free enterprise.” But here we can already anticipate this much: What the entrepreneur cannot foresee, nobody can foresee, because, as we have said, science is impotent in the face of the unknown. The only thing that the state can do is to extricate the individual entrepreneur from his loss by depriving him of his profit, that is to say, to assume the risk of the entrepreneur, or rather, to make the general public take the risk, because the state has no other resources than those it takes from the people. In this dilemma, it would appear to be more sensible for the entrepreneur to run the risk rather than the general public.