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Ludwig von Mises on the Difference Between Entrepreneurs and Managers

Summary:
When Ludwig von Mises noted that a manager is a "junior partner" of the entrepreneur, he did not mean to downplay the role of management in the economy. On the contrary, he wanted to make clear how the economic functions are different yet related. From the point of view of the economic system, i.e. how the ...

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When Ludwig von Mises noted that a manager is a "junior partner" of the entrepreneur, he did not mean to downplay the role of management in the economy. On the contrary, he wanted to make clear how the economic functions are different yet related.

From the point of view of the economic system, i.e. how the market works, entrepreneurship is, according to Mises, the uncertainty-bearing of enterprise: entrepreneurs allocate scarce, productive resources between different types of production, many of which are not yet in existence. The bearing of uncertainty means simply that you're committing resources, which have multiple valuable uses, to specific production processes. If that decision is "wrong" you suffer a loss; if the decision is better than most you earn a profit.

Thus, the entrepreneur's only function in the economy is to find better uses for resources, which means s/he needs to figure out how resources can create the most value for consumers. In this sense, entrepreneurship takes on the role of the central planner  but in a decentralized, distributed fashion.

As entrepreneurs focus on what they know and understand, because their decisions are limited to a few lines of production (not the whole economy), and because they compete with each other, many wills influence production. And their bidding for resources generate prices for the means of production that incorporate all entrepreneurs' expectations of how consumers are best serviced by these productive efforts. Entrepreneurship in the aggregate generate those prices, while individual entrepreneurs must take those prices into account when making decisions.

In other words, entrepreneurs collectively produce a division of intellectual labor with respect to the allocation of productive resources in the economy overall.

Under central planning, there is only one will: all or nothing. But what about the manager? S/he oversees the production process. This task is super important to cut costs, streamline production, and position production and the produced goods in the competitive market. But this can only be done when resources have already been allocated to the "project."

The manager is an expert of organizing production, whereas the entrepreneur is an "expert" on imagining it.

But note an important difference: there cannot be a market without entrepreneurship, but there can be a market without management. It is perfectly conceivable that there could exist an economy where all production takes place through market contracts (without firms): where the entrepreneur is self-employed as are all workers and administrators. Such an economy would still need the direction of resources toward specific ends, i.e. the choice to produce one good and not the other.

In a fully distributed, no-firm economy the role of the entrepreneur is to coordinate market contracts toward the type of production that s/he imagines most valuable to consumers. But there would be very little use for managers since there would be no "maximizing" or cost-cutting throughout production processes: this is accomplished through market contracts (i.e., prices). Within such an economy, it is easy to see that there would be immense transaction costs that would make non-contractual coordination less costly than direction.

This is Ronald Coase's argument for why there are firms in the economy. But this requires specific assumptions, e.g. that production is not standardized (because then there are established market prices for all "pieces" of production, and thus no "haggling"). The real problem, however, is when entrepreneurs imagine or envision novel production, for which there cannot be market prices. This is not a matter of transaction costs or coordination of existing resources within a production process, but about creation.

In a growing economy, there is a continuous competitive pressure on existing production from new and previously unknown types of goods and types of production. An important role of entrepreneurship is to imagine what could be but isn't, and then appraise and compare the value of the existing and the yet to be realized. This allocation between existing and not-yet-existing requires a means for the economy overall to express relative resource values: market prices. It cannot be done by a central planner since there is no trial-and-error and no decentralized and distributed imagination.

Some of the division of intellectual labor is the "knowledge problem" that Hayek famously noted, but the core of the problem is not the aggregation of (tacit) knowledge but the imagining and appraisement of possible futures. As soon as entrepreneurs aim for the novel and yet-to-be-realized, there is no knowledge.

There are also no prices, so such decisions are unguided with respect to the actual future they're aiming for. But they can rely on the prices that are generated by entrepreneurs collectively as they bid for resources in their quest for profit choosing between different already existing types of production and those they imagine — and their relative profitability. Prices embody entrepreneurs' joint valuation of resources: if the entrepreneur imagines s/he can do better find higher valued uses for resources — then the project may be profitable. But such novelty in production must be coordinated without respect to prices: it must be organized.

This is, as I argue in my book, the true reason there are firms: that novel, pre-prices production must occur in integrated "units" guided by the end imagined by the entrepreneur and coordinated by the manager.

In a sense, without entrepreneurs there would be no allocation of resources between alternative production processes — and without management, no novel production could be organized.

So "junior" in Mises' phrase is not intended to subject management to entrepreneurship, but only to make clear that there is no management without prior allocation of resources to the line of production coordinated by the manager.

In a sense, without an entrepreneur there is no manager.

Formatted from @PerBylund on Twitter
Per Bylund
Contact Per BylundTwitter AwardsLawrence W. Fertig Prize in Austrian Economics Per L. Bylund, PhD, is Assistant Professor of Entrepreneurship and Records-Johnston Professor of Free Enterprise in the School of Entrepreneurship at Oklahoma State University. Visit his website at PerBylund.com.

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