What Austrian Economic Theory Has to Say about Entrepreneurship

What Austrian Economic Theory Has to Say about Entrepreneurship

by | Mar 15, 2018

Although Austrian economic theory remains a blur for most business school students, Austrian-based ideas have made significant contributions to our understanding of what drives entrepreneurship.

Why This Matters  It’s important to understand that new businesses emerge for a variety of different reasons.

The Takeaway  Creative visionaries such as Henry Ford or Steve Jobs are just one of many types of entrepreneurs.

In depth

When most business school students think about Austrian economists, just a couple of names typically come to mind—say, Joseph Schumpeter (1883-1950) and Ludwig von Mises (1881-1973). The author of the landmark book, Capitalism, Socialism and Democracy (1942), Schumpeter coined the oft-used phrase “creative destruction,” which describes how innovative entrepreneurs temporarily destabilize markets as they go on to create entire new industries. And von Mises, who is considered the father of libertarianism, wrote influential papers on classical liberalism stressing the critical importance of economic freedom to the rational functioning of society at large.

But Adina Dabu, a senior research scholar at the Mercatus Center at George Mason University, is trying to change this simplified picture of Austrian economics that permeates many business schools. “Over the last generation, Austrian scholars have also made major contributions to our ideas about business strategy and entrepreneurship,” she says. And in a recent paper, “Entrepreneurial opportunities in the nexus and effectuation approaches: a theoretical conversation,” she discusses the key role that Austrian-informed theory plays in current debates about what drives entrepreneurial action.

As Dabu explains, the nexus approach is the brain child of Israel Kirzner, an American economist, who did his graduate work at New York University under von Mises. According to this theoretical model, entrepreneurs make decisions based on their knowledge of market opportunities and circumstances. In contrast to neoclassical economics where market equilibrium is considered the default state of economic exchange, writes Dabu, “Austrian … theory is concerned with the unfolding of the market process as it occurs under conditions of market disequilibrium. In this view, the market process…is driven by entrepreneurial action under radical uncertainty and imperfect knowledge.” This action consists of two steps. During the discovery phase, entrepreneurs settle upon an opportunity; they then figure out the means to bring that opportunity to fruition during the exploitation phase. Take the example of Henry Ford.  In the early 20th century, this industrialist harbored a clear vision of what he wanted to accomplish—and it was something that no one else had ever imagined.  As Ford wrote, “I will build a motor car for the great multitude….It will be so low in price that no man making a good salary will be unable to own one.” Ford then put this plan into action by mobilizing the necessary resources, which in his case, meant mass-producing cars by means of a novel procedure—assembly-line production.

In this paper, Dabu also addresses the effectuation model developed by Saras Saravathy, a professor at the Darden School at the University of Virginia. This alternative view, which grew out of a dialogue with the nexus approach, emphasizes that entrepreneurs often lack the grand vision of pioneers such as Henry Ford or Steve Jobs. They start not with pre-defined goals, but from the resources under their control. To illustrate the effectuation model, Dabu cites the success of entrepreneurs like David Beattie, who turned his hobby—building slot cars (toy racing cars)—into a million-dollar business. Beattie had no idea that this personal obsession could ever evolve into a viable economic opportunity. But he soon stumbled upon some enthusiastic customers such as a Ford executive who was eager to find a way to spend more time with his son.  “In contrast to the discovery entrepreneur who is a visionary, the effectual entrepreneur is typically myopic about the future,” says Dabu.    

Dabu concludes her paper by stressing the value of both the nexus and effectuation approaches. Given the wide variety of entrepreneurial ventures, she believes that scholars need to remain mindful that there are various paths to the formation of new businesses and thus to the production of the new goods and services. “It’s best if we try to observe the entrepreneurial process with a diverse set of theoretical lenses,” she says.   

Dabu plans to keep getting the word out about the ground-breaking Austrian scholarship on entrepreneurship. Along with Rajshree Agarwal, the director of the Ed Snider Center, she is working on two new publications on Austrian economic theory. One is an edited volume featuring papers both by 20th century Austrian economists such as Schumpeter and by management scholars whose current research builds on this classic work, and the other is a multi-media project (videos, podcasts and written transcripts) on management theory consisting of interviews with contemporary Austrian economists.

Dig Deeper:





Joshua Kendall has written on business and healthcare for numerous publications including BusinessWeek, Fortune.comThe New York Times, The Boston Globe and The Washington Post. For more about his work visit JoshuaCKendall.com.