Entrepreneurial Alertness Theory
Kirzner's "Alertness Theory" of entrepreneurship argues that entrepreneurs balance supply and demand by detecting market imperfections and exploiting them.
Israel Kirzner is a British-American economist and emeritus professor at New York University. He is a leading figure in the Austrian School of Economics.
The Cause: Market Imperfections
Kirzner argues that opportunities exist because markets are not perfect. These imperfections are primarily caused by two factors:
- Information Asymmetry: Cases where different stakeholders have varying information about a business venture. If one stakeholder uses an information advantage to profit from another, it is considered opportunistic bargaining.
- Bounded Rationality: The idea that humans are not perfectly rational. While Neo-classical economics models the assumptions of "perfect" economic man, Kirzner acknowledges that real humans have limits on their knowledge and processing power.
The Solution: Entrepreneurial Alertness
According to Kirzner, the profits entrepreneurs receive are a reward for their tolerance of uncertainty as they eliminate arbitrage opportunities.
Arbitrage is the opportunity to sell the same product at a higher price than it was bought for (buying low, selling high). These gaps are created by the ignorance or incompetence of incumbent firms.
Entrepreneurs need to be alert to perceive these economic opportunities that others cannot yet see. Opportunities exist only because of the ignorance of incumbents; otherwise, they would already be exploited. Ignorance begets errors, and these errors can be corrected by the actions of entrepreneurs.
Uncertainty and Teaching Alertness
The entrepreneur acts under uncertainty and cannot know if their action will yield a profit until after the action has been taken. Thus, entrepreneurs must accept the risk that they may lose money (or that of their investors) if their judgment is incorrect.
Can it be learned? Kirzner believes that entrepreneurial alertness cannot be taught. However, this belief has been critiqued because market research and "customer discovery" processes can clearly help individuals recognize certain types of opportunities.
Israel Kirzner argued that opportunities are already "out there" waiting to be found by "alert" individuals.
The Controversy
This implies that the entrepreneur doesn't actually create anything new; they just pick up $100 bills that others missed. It minimizes the labour and genius of invention, reducing the entrepreneur to a mere opportunist.
Connections to other theories
Kirzner’s work is essential for understanding how markets move toward efficiency, connecting to several other theories in our sitemap:
- Schumpeter’s Theory: These two are often studied together as opposites. While Schumpeter’s entrepreneur is a "disruptor" who pushes the market away from equilibrium (Creative Destruction), Kirzner’s entrepreneur is a "balancer" who pulls the market toward equilibrium by fixing errors.
- Cantillon Theory: Kirzner provides the modern psychological explanation for Cantillon’s 18th-century "merchant." While Cantillon identified the act of arbitrage, Kirzner identified the mental state (alertness) required to perform it.
- Knightian Uncertainty: Like Frank Knight, Kirzner emphasizes that profit is the reward for bearing uncertainty. However, Kirzner adds that the profit is specifically a reward for noticing what others missed.
- Effectuation Theory: Kirzner represents the "Discovery" school of thought (opportunities are found). This contrasts with Sarasvathy’s Effectuation, which represents the "Creation" school (opportunities are made).
- The Harvard School Theory: Strategic analysis tools like SWOT or PESTEL can be seen as formalized methods to "manufacture" the alertness that Kirzner believed was an innate trait.
Video Overview: Israel Kirzner on Entrepreneurship
Sources
- Kirzner, I. M. (2015). Competition and entrepreneurship. University of Chicago Press.
- Kirzner, I. M. (2009). The alert and creative entrepreneur: A clarification. Small Business Economics, 32(2), 145-152.
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