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J Evol Econ (2002) 12: 83105
c Springer-Verlag 2002
Weber, Schumpeter and Knighton entrepreneurship and economic
development
Maria T. Brouwer
University of Amsterdam, Department of Economics and
Econometrics, Roetersstraat 11,1018 WB Amsterdam, The Netherlands
(e-mail: [email protected])
Abstract. This paper interprets the discussion on
entrepreneurship and economicdevelopment that started off with
Webers papers on the Protestant Ethic. Webersought the reason for
the relatively rapid growth of the Occident in the
rational,Calvinist attitude to life. Calvinism in his view exactly
suited a society of freelabourers, whowere not tied tomaster and
soil by extra-economic considerations asin tribal and feudal
societies. Schumpeter gave an alternative explanation, empha-sizing
the importance of innovation and entrepreneurship. Knight, who
stressedneither rationality nor innovation but uncertainty and
perceptiveness as the solesource of progress and profits, followed
up German language writing on this sub-ject. Only the investor who
can detect hitherto hidden qualities in people can gain.The paper
demonstrates how these three authors influenced each other. The
debatebetween these three authors has raisedmany issues of
governance and organizationthat feature contemporary thinking.
Key words: Entrepreneurship History of economic thought
Organizationalbehavior Bureaucracy Uncertainty
JEL Classification: B25, D23 , D73, D81, K11
1 Introduction
Theories of entrepreneurship span a long period, at least from
Cantillons timeup to the present. Many scholars have contributed to
the literature on the subject.All wanted to unravel the way in
which entrepreneurial initiative contributed toeconomic development
(Hebert and Link, 1982). This paper analyzes the contri-butions of
three leading social scientists: Max Weber, Joseph Alois
Schumpeterand Frank Hyneman.Knight. All three authors wrote their
theories during the firsttwo decades of the 20th century and were
well aware of each others writings.
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84 M. T. Brouwer
This paper will indicate how they reacted to one another. Their
work constitutes afascinating debate on themotives and effects of
entrepreneurship, their theories ex-plaining why new ventures
emerge and how they are financed.Weber held the viewthat Calvinist
parsimony would finance investment, whereas both Schumpeter
andKnight considered external finance the main source of
entrepreneurial investment.
Entrepreneurship had only been a sideshow in economic theory
after WorldWar II. Neo-classical economics had read the
entrepreneur out of the economicmodel, leaving no room for
enterprise and initiative but only for passive calculation(Baumol,
1968). Entrepreneurship escapes neo-classical modeling by
definitiondue to its relationship to novelty and change. The lack
of interest in entrepreneur-ship in the second half of the past
century can be attributed to the widespread ideathat
entrepreneurship would become more and more obsolete as capitalism
devel-oped. Weber contributed to this idea by emphasizing that
economic life would getever more rational. Large bureaucracies
would take over as the predominant orga-nizational form of
capitalism. Entrepreneurship would fade out as a
consequence.Schumpeter also became convinced that large firms would
become the main ve-hicles for innovation and economic progress. He
predicted that market societieswould evolve from competitive to
trustified capitalism, which with time wouldgive way to socialism.
Schumpeter also contended that the demise of capitalismwould be
hastened by an increase of rationality in all realms of life.
People wouldno longer tolerate the irrational elements of
capitalism such as the incidence ofbusiness cycles and income
inequalities. Hence, he considered entrepreneurshipin the sense of
new firm formation a relic of the past. Knight did not have sucha
strong opinion on the matter, but he expected that large
diversified companieswould become predominant due to their
uncertainty reducing capacities.
The view that large firms would become increasingly important
was supportedby the facts in the developed world during the larger
part of the twentieth century.Firms did get larger on average, but
this trend has been reversed since 1973. Theincreased importanceof
small firmsand start-ups is indicated by empirical research,which
indicates that the share of large firms in employment has decreased
sincethe seventies in Europe, Japan and Northern America (OECD,
2000). This courseof events indicates a deviation from a long-term
trend of increasing dominance oflarge firms1. Political and
economic events of the turn of the 21st century thus seemto mark a
break from the evolutionary path that these authors foresaw. We
want tofind out what elements of the theories of Weber, Schumpeter
and Knight are mostrelevant for contemporaneous
entrepreneurship.
2 Life and work of Weber, Schumpeter and Knight
The German social scientist Max Weber (18641920) exerted a large
influence onAmerican social science.Weber studied law in Berlin,
but held chairs in economicsin Freiburg and Heidelberg before he
became seriously ill and was kept fromwork-ing for about four
years. After that time he lived as a private scholar in a state
1 The alleged superior innovative and job creating capacities of
new and small firms have spawneda large theoretical and empirical
literature (Acs and Audretsch, 1988).
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 85
of semi-invalidism in Heidelberg. He only accepted a regular
appointment at theuniversity of Munich one year before his sudden
death in 19202.
Joseph Schumpeter (18831950) was born in Moravia, which now
belongs tothe Czech Republic but at that time to the
Austro-Hungarian empire. As a youngboy hemoved to Viennawith
hismother after the sudden death of his father. Hewasa brilliant
student of law and economics at the famous University of Vienna,
whereprominent economists such as Boehm-Bawerk and vonWieser
taught. Schumpeterwas an economic prodigy, who wrote a history of
economic thought at the age of25 (Schumpeter, 1908). After taking
stock of existing theory, he wrote his owntreatise,Theorie der
Wirtschaftlichen Entwicklung, which was first published in1911.
Schumpeter contended that all economic theories up to that date
only appliedto a stationary economy and could not explain change.
His theory diverges fromthat of his teacher Boehm-Bawerk on several
crucial points, and it may be due tothis divergence of opinions
that Schumpeters career had a slow start. He got aprofessorship at
the University of Cnernowitz, located at the borders of the
empireand was later appointed in Graz, in which provincial
intellectual climate he did notfeel well at ease. A brief career in
politics followed in the aftermath ofWorldWar I,when he
becameminister of finance in the Renner Coalition cabinet in 1919.
But hewas forced to resign after one year due to heavy political
struggles on the issue ofnationalization. Schumpeter became a
banker, but this career was also unfortunate,when the Biedermeier
bank, of which he was president failed in 1925. He becamea
professor of economics in Bonn in the same year and moved to
Harvard in 1932,where he stayeduntil his death in 1950.Hewrote
twomajorworkswhile atHarvard:Business Cycles(1939) andCapitalism,
Socialism and Democracy(1942).
Frank Hyneman Knight (18851972), a farmers son from Illinois,
studiedchemistry, German drama, and philosophy at the universities
of Iowa and Cor-nell. He also studied with Max Weber in Heidelberg.
He completed his doctoraldissertation in economics in 1916
atCornell, published in 1921 asRisk, Uncertaintyand Profit,while he
was a professor of economics at the University of Iowa. Knightmoved
to the University of Chicago in 1928 and published several works on
ethicsand economic reform, of whichThe Ethics of Competition(1935)
andFreedom andEconomic Reform(1947) are most well known3.
This paper starts with Webers articles on Protestantism and the
Rise of Cap-italism, which were first published in 1904 and 1905 in
theArchiv fuer Sozial-wissenschaft und Sozialpolitik.
SchumpetersTheory of Economic Development,which was first published
in 1911, can be considered a refutation of Webers the-ory. He
stated that not the Puritan ethic, but innovation could explain
economic de-velopment. Webers books on social and economic
organization and on economichistory, which were published
posthumously, can be interpreted as a response toSchumpeters
(implicit) criticism.Weber sketched a historical sequence of
businessorganizations from antiquity till the early twentieth
century inGeneral EconomicHistory (GEH). He pointed out that most
organizational forms were designed tosupport the status quo and
thus unable to cope with change.
2 These biographical details are from Talcott Parsons
introduction to WebersThe Theory of Socialand Economic
Organization(Oxford University Press, 1947).
3 These biographical details are from J. Buchanans foreword to
Frank H Knight (1982).
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86 M. T. Brouwer
Knight translated Webers book on economic history, which was
published inGerman in 1923. Webers book was compiled out of lecture
notes of a class he hadtaught a year before his death. Knight was
an ardent admirer of Weber, to whom hereferred asthe most
outstanding name in German social thought since Schmollerin his
preface toGeneral Economic History(GEH). Weber had more
admirersamong American academics. Talcott Parsons, a leading
sociologist, who worked atHarvard, translated Webers essays on the
protestant ethic in English4. The bookwas first published asThe
Protestant Ethic and the Spirit of Capitalism(PE) in1930. Parsons
also translated part II of WebersWirtschaft und
Gesellschaftwhichhad been published posthumously in 1921 and came
out in English asSocial andEconomic Organization(SEO) in 1947.
Apparently, prominent American scholarstook great efforts to get
acquaintedwithGerman scientific publications, tantamountto the fact
that the German-speaking world was considered foremost in the
socialsciences at that time.
Knight contributed to the debate by making uncertainty instead
of rationalityor innovation the central feature of his theory of
entrepreneurship. In this way hesolved some of the puzzles which
had emerged out of the (implicit) debate betweenWeber and
Schumpeter.
3 Weber on Calvinism and economic development
Weber sought the reason for the relatively rapid growth of
western capitalism inthe specific attitude to life of the Calvinist
Puritan. InThe Protestant Ethic and theSpirit of Capitalism(PE),
his most well known book, he associated the economicrise of
Holland, England and the American colonies with the presence of
Puritanand Calvinist religious groups in those regions, such as the
Gereformeerden, theMennonites, the Methodists and the Baptists.
These Calvinist groups distinguishedthemselves from Catholics and
Lutherans by their specific concept of salvation,which cannot be
attained through the church, but will only fall upon the
predestinedelect. The concept of predestination did not lead to
fatalism, as Weber explained.The true believer held it to be an
absolute duty to consider oneself chosen and tocombat all doubt as
temptations of the devil(PE, 111). Lack of self-confidencecould be
seen as a sign of insufficient faith. People were thus largely
self-elected,although a community of believers needed to endorse
their beliefs. Calvinism fa-vored rationality in business matters,
because material success acted as proof ofbeing one of the chosen
(PE, 114). Weber calls the Calvinist attitude to life a
ra-tionalization of the world, because magic had been banned as a
means of salvation(PE, 117). Calvinism also honored the acquisitive
motive, whereas other Christiandenominations had often denounced
riches. Confession and good works had beenreplaced by duty and hard
work and by abstinence of worldly pleasures. Calvinism- inWebers
view- perfectly fitted a society of free laborers, whowere no
longer tiedtomaster and soil by extra-economic considerations as in
tribal and feudal societies.
4 The Protestant Ethic was the translation of the first part of
WebersGesammelte Aufsatze zurReligionssoziologie(1920) and
contained the revised version of the articles that were published
in theArchiv fuer Sozialwissenschaften und Sozialpolitikin 1904 and
1905.
sanchezloperaHighlight
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 87
Such a situation existed in 17th century England, after the
enclosuremovement haddriven many peasants from the land. The
Puritans, in Webers view, followed theexample given by the Catholic
monks, who also had applied rational methods toeconomic activities.
Weber considered rationality the outstanding characteristic ofboth
(industrial) capitalism and Calvinism. He drew a sharp line between
adven-turous and rational capitalism (PE, 20), locating speculative
voyages for land andbooty the results of which could not be
calculated in advance in the first category.
Weber thus portrays the Puritans as a group that was driven by
religious zeal toapply rationality to the pursuit of economic
activities. This differs sharply from theidea of the Austrian
economists of his days, such as Menger and Boehm-Bawerk,who saw the
equation of (marginal) utility to revenue as the main motivation
ofrational economic man. Such a scheme of things was insufficient
to explain savingand entrepreneurship in Webers view, because
economic man would only put inas many hours as were required to
meet his daily needs. The Puritan, however,would be
forward-looking. He would save to obtain wealth, which was
considereda sign of godly approval. There was no room for feelings
of class resentment inthe Puritan world, because the unequal
distribution of goods of this world wasseen as divinely ordained in
a pursuit of secret ends unknown to men (PE, 177).However, the
wealthy could never rest in comfort, because their wealth wouldmake
it more difficult for them to lead the life of the righteous. But
Puritanismhad its hard, judgmental side. The consciousness of
divine grace by the elect andholy was accompanied by utter hatred
and contempt towards people who wereconsidered sinners. Since the
dividing line between saints and sinners was neverknown, sectarian
divestitures were common among Puritans in order to keep apure
church (PE, 122).Moreover, the formationof anewsect gave its
followers theopportunity to escape from ecclesiastical
regimentation of life as this had happenedin the Calvinist State
churches, which amounted almost to an inquisition (PE,152). Such
despotism would enforce external conformity but would weaken
themotives for rational conduct, according to Weber (PE, 152).
Calvinism thus hadits authoritarian features, which is also
apparent from the iron collectivist wayCalvin had organized his
church in Geneva5. However, protestant religion couldnot prohibit
the foundation of new sects due to its lack of central control.
The late 15th and 16th century constituted a period of religious
revolts. Manycities in southern Germany and northern Italy had
gained autonomy after the Ger-man Empire had disintegrated around
1100 (McNeill, 541). The cities used theirnewlywon freedom
topromote tradeandcommerce.TheReformationalsoemergedin this
relatively liberal era. Religious sects such as the Huguenots and
Wederdop-ers emerged that wanted to establish their ideal
communities. Many towns and vil-lages were converted, but
commercial cities stuck to secular laws and government.The
protestants clashed fiercely with rulers who based their claims to
authorityon the inmutable truths as professed by the Mother Church.
Spain and its Inqui-sition championed the Counter Reformation. The
Jews and Moors were evictedfrom Spain to create a mono-religious
country. The same happened to the French
5 Tawney in his foreword to the english translation of the
Protestant Ethic.
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88 M. T. Brouwer
Huguenots, who were persecuted by the unified French State under
Henry IV. TheItalian cities were brought under Spanish rule in
1498.
The Dutch Freedom war against Spain (15681648) was also inspired
by reli-gious rebellion, but did not result in religious tolerance
right away. The Reformerspillaged the Dutch Catholic churches and
monasteries in 1566 at the beginning oftheir insurrection.
TheDutchCalvinists succeeded in grabbing state power and
con-stituted a theocracy for a limited period of time. However,
some forces counteractedthemovement towards a Calvinist state. Most
important was the loose federal char-acter of the United Provinces,
which lacked strong state power. The cities could,therefore, take
their own stance in economic and judicial affairs. The city
lawyersandmagistrateswere opposed to harsh persecution of the
non-reformers.Moreover,the cities needed extra hands and,
therefore, welcomed immigrants from regionswhere the Calvinists
were persecuted such as France and Belgium, but also fromother
areas. Jews, who fled from Spain and Portugal after being
extradited, couldtake shelter in Dutch cities, predominantly in
Amsterdam. Catholics and adherentsof other religions were tolerated
after 1630, which meant that they could practicetheir religion, if
it was done non-conspicuously. However, only members of the
Re-formed Church could fulfill official positions in the 16th and
17th centuries in theNetherlands (Schama, 1987). Some Dutch
practices seem to fit Webers portrayalof the Calvinist. Weber
describes the repugnance of idleness and begging as a traitof the
Puritan for whom work is a holy duty. This attitude is reflected in
the harshpolicies pursued by the 17th century Dutch cities towards
vagabonds, beggars andidle people, who were either put to work in
the towns workhouses or deported(Schama). This contrasted with
Catholic (and Buddhist) attitudes in which beggingwas seen as a
respected way of living.
A Calvinist state was never founded in England, because the
Puritan sect mem-bers were outnumbered by the Anglicans. The
English Puritans contested the au-thority of the state in religious
and economic matters and were considered a threatto the English
nation. Their fight against statemonopolies andmilitary
conscriptionare cases in point. Weber considers this a main reason
for the early emergence of aprofessional army in England. As a
consequence they were kept from land leasesand official
occupations.
Webers theory of the Puritan ethic was not explicitly directed
towards en-trepreneurship. The Puritan ethic did apply equally to
the businessman, the profes-sional and the laborer (PE, 177).
However, many Puritans took up entrepreneurshipin England, since
they constituted a religious minority to which other routes
ofsocial advance were closed. The same had applied to other
religious minorities inthe civilized world: Jews and Christians
were the merchants and moneylenders ofthe Ottoman Empire. But those
occupations were not highly esteemed in Orien-tal civilizations
that placed them at the bottom of the social pyramid. A career
inthe state bureaucracy or army constituted the only road to social
prestige in thosecountries. England and the Low Countries, just
like the northern Italian cities ofthe 13th and 14th century, had
less absolutist forms of government and gave morescope to commerce
and manufacturing.
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 89
4 Schumpeters theory of economic development
Schumpeter contributed regularly to theArchiv fuer
Sozialwissenschaft und Sozial-politik, which was edited byWeber in
the 1920s6. It can, therefore, be assumed thathe was well aware of
Webers work. Schumpeter sketched a model of a dynamiceconomy in
hisTheorie der Wirtschaftlichen Entwicklung(WE) in 1920. His
the-ory can be considered a refutation of Webers hypothesis on the
importance of theCalvinist attitude for economic development.
Schumpeter defined the entrepreneuras the founder of a new firm and
as an innovator, who breaks up established routinesand opposes the
old way of doing things. Schumpeters entrepreneur only under-takes
those ventures which turn out to be successful (WE, 177). The
entrepreneursspecial leadership qualities enable him to see the
right way to act. Otherswill followin his wake. There are some
overtones of the Nietzschean leader in Schumpetersdescription of
the entrepreneur.
In order to introduce his innovations, the entrepreneur needs to
withstand theopposition of the environment, which is usually
hostile to deviating behaviour andnovelty.All deviatingbehaviourof
amemberof acommunitymeetswithdisapprovalfrom the othermembers(WE,
118). Moreover, the individual is also restrained fromdoing
something new, due to the psychic and physical efforts it requires
to leavefamiliar paths (WE, 120); it is the difference between
swimming with the currentand against the current (WE, 121).
Schumpeters entrepreneur, however, takes adelight in this
opposition (WE, 132). Schumpeters entrepreneur is a creative
non-conformist and not a religious dissident. He is not shunned by
society, but warmlywelcomed by the banking community that grants
him credits to finance his attackon established positions. Bankers
are supposed to be gifted with perfect foresight,for they can
discern the best and brightest entrepreneurs without
difficulty.
The entrepreneur breaks up the circular flow, actively steering
the economyaway from old paths and opening up possibilities
hitherto unknown. The circularflow describes a stationary economy,
in which economic processes are repeatedperiod after period without
change. Prices and quantities do not vary in the circularflow and
can be completely deduced from the data. The interest rate is equal
to zero,and net investments are absent. Schumpeter used the concept
of the circular flow asa point of reference to indicate the changes
that are caused by the introduction ofinnovations. His concept of
the circular flow had many predecessors as is indicatedby the
various references to the concept of a stationary state in
hisHistory ofEconomic Analysis(HEA). The first reference is to
Platos utopian vision of aPerfect State, described in hisRepublic.
Born out of dissatisfactionwith the changesthat Athens went through
in his lifetime Plato outlined the preconditions for astationary
Utopia such as a stationary population, constant wealth, division
of laboraccording to ability and limited freedom of speech (HEA,
55-6). The authoritarianaspects of Platos Perfect State are absent
in Schumpeters description of a circularflow, which is not directed
by command, but by perfect competition and
establishedroutines.Schumpeter unravels theway inwhichproductivity
increasesareproduced
6 Schumpeter published 27 times in theArchivduring the period
19101920, when Weber was oneof the editors of the journal. Massimo
M.Augello (1990).
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90 M. T. Brouwer
by the bunchwise appearance of innovative firms, which set off
(cyclical) waves ofinvestments and disinvestments.
Entrepreneurs found new firms to introduce innovations, because
establishedfirms are reluctant to change their routines. Moreover,
established businesses willpostpone innovation until their old
assets have become obsolete. New firms are notimpeded by former
investments and will, therefore, speed up economic progressby
introducing innovations at a date before incumbent firms would.
Schumpeterpointed out that innovation could inflict losses on
incumbent firms,which he labeledcreative destruction.
Schumpeter explains the way in which the innovative method of
productionobtains a premium caused by its inherent superior
efficiency. The differential withpreviousmethods accrues to the
entrepreneur until it vanishes due to competition byimitators.
Schumpeter argued that this premium constitutes the source of all
prof-its and of interest payments. Consequently, all former
interest theories, includingBoehm-Bawerks were incorrect. Neither
waiting nor the lengthening of the pro-duction period constitutes
the source of interest and profits, but rather the source
isinnovation. Capital deepeningmeans that labor is replaced by
capital, but it does notneed to entail overall productivity
increases. This can only occur, if fewer produc-tion factors are
used to produce a certain product. Schumpeter sketched a theory,in
which the interest rate equals the profitability of the marginal
entrepreneur (WE,383). This presumes that all entrepreneurs can be
ranked unambiguously accordingto their profitability. Hence,
innovative profits are split up into interest paymentsto bankers
and a residual that accrues to entrepreneurs. Entrepreneurial
income re-flects entrepreneurial quality. The best entrepreneur
receives the highest incomes,whereas the marginal entrepreneurs
profits just suffice to pay his banker.
Schumpeter agrees with Weber on the non-hedonic nature of the
entrepreneur.The entrepreneur does not resemble economic man, who
weighs (marginal) costsand benefits and stops working at the moment
when the costs of the extra effort(fatigue) exceed the extra
satisfaction (WE, 126). Such behaviour, according toSchumpeter is
characteristic of the circular flow. The entrepreneur by contrast
is prepared to work countlessly more hours in order to achieve his
goal. But,Schumpeters entrepreneur is not a Puritan. He does not
abstain from worldly plea-sures, but participates fully in politics
and culture. He is not motivated by a beliefto belong to the elect,
since the banking community has already chosen him.Schumpeters
entrepreneur is motivated by the joy of creating and by the
pleasuresuccess brings (WE, 141). Schumpeters entrepreneur in
contrast toWeber is notmotivated by rewards beyond his lifetime,
but by improving his social position (andthat of his family) in
this world. Leaders of former times had based their
leadershipmainly on military and bureaucratic expedience and less
on commercial qualities.But innovative qualities can occur
everywhere and are thus not system-specific,in Schumpeters view.
The clan-leader could also lead his people into new territo-ries,
as could the feudal knight. However, not all economic and social
systems areequally well equipped to innovation; he mentions India
and China as two countrieswithout much innovation to prove his
point that economic development is not ob-vious and automatic (WE,
113). He also remarks that it is harder for individuals to
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 91
break up established routines in primitive societies without
bothering others due totheir communal way of living as is
exemplified by the man-house (WE, 119).
Schumpeter considered entrepreneurial behaviour non-rational,
because it didnot fit inwith themodel of economicman designedby
themarginalist School.We-bers Puritan and Schumpeters entrepreneur
are forward-looking, whereas rationaleconomic man is supposed to
live only by the day. But, such long-term thinkingcould be called
rational by our modern standards. People will be inclined to
forgoimmediate consumption, if interest rates are sufficiently low.
Webers concept ofrationality was not always perfectly clear.
Schumpeter pointed this out in a seminar,which he gave at Harvard
in 1940; among the attendants were Parsons, Sweezy andLeontief7.
Schumpeter distinguished between formal or objective and
substantiveor subjective rationality in this seminar. Formal
rationality applies, if costs and ben-efits can be calculated
accurately; a means-end relationship. Subjective rationalityrefers
to the achievement of absolute values irrespective of costs.
Salvation fits inwith the latter rationality concept.
However, the two concepts coincide in Webers portrait of the
Calvinist, whobelieves he is saved if he succeeds in making ends
meet. Weber combined bothstrands of rationality as he depicted
capitalist enterprise as calculable. Schumpeterrejected Webers
portrait of the scrooge capitalist and replaced it by the
well-mannered gentleman, who wanted to build his own estate. But
calculability alsofeatured largely in Schumpeters work. The absence
of uncertainty could explainwhy financiers are only meagerly
rewarded by base rate interest payments, whereasthe entrepreneur
obtains the rest of the innovation premium in accordance withhis
capabilities. Hence, innovative investment is considered devoid of
any risk.Schumpeter, however, did mention risk in the first German
edition ofTheory ofEconomic Development,where he stated that
foreseeable risk can be reduced tocosts (WE, 49). Interest rates
will be elevated by a certain percentage, if some ofthe new
ventures are expected to fail (WE, 387). The percentage of failures
couldbe calculated based on experience. Moreover, losses would
mainly occur at the oldfirms, which were unable to adapt to new
economic conditions in time (WE, 493).Schumpeters ideas on this
matter lie at the foundation of Knights theory of profit,as will be
demonstrated below.
5 Knight on investment and entrepreneurship
FrankKnight, in his seminal contribution to economicsRisk,
Uncertainty andProfitremedied Schumpeters disregard of uncertainty
and in so doing laid the foundationfor modern finance and
organization theory. He was one of the founding fathersof the
famous Chicago School in economics. Knight was acquainted with
Germaneconomics texts. It seems, therefore, plausible to assume
that he was familiar withSchumpetersTheorie der Wirtschaftlichen
Entwicklung, when he wrote his thesisTheoryofProfitsandUncertainty
in1916,whichwaspublishedasRisk,Uncertaintyand Profit(RUP) in
1921.
7 Thearticlewas found in theHarvardArchives andwas first
publishedin Zeitschrift fuer dieGesamteStaatswissenschaftin
1984.
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92 M. T. Brouwer
Knight agreed with Schumpeter on the matter of capital
deepening. He statedthat the length of life of capital goods is a
matter of choice and can never bea source of profits (Knight,
1939). Knight also agreed with Schumpeter on thepoint, that profits
and interest can only exist in a progressive society,
althoughinterest could be paid for consumption loans (RUP, 328).
Innovation is the source ofprofits and can only occur when
investment is used to create new resources. Knightdiffered somewhat
fromSchumpeter on the point of entrepreneurial motivation.
Heconsidered the desire to excel, to win at a game, the biggest and
most fascinatinggame yet invented, not excepting even statecraft
and war most important (RUP,360).
But his theory differs from Schumpeters on an essential point.
Schumpeter didnot deal with selection problems, as was mentioned
above. Bankers would alwayspick the right entrepreneurs. It might
have been Schumpeters (andWebers) famil-iarity with the credit
mobilier type of banking and the disastrous consequences ofthe
failuresof thesebanks thatmade thememphasizecalculability.Knight,
however,contended that only uncertainty could explain profits (and
losses). Not all ventureswill become successes; some will fail.
However, which ventures will succeed andwhich fail cannot be
predicted in advance. He also remarked that the profits ofchange
come largely in the form of readjustments of capital values. Hence,
whereSchumpeter assumed that bankers do not makemistakes in
selecting entrepreneurs,Knight made errors or uncertainty the basis
of his theory of entrepreneurial prof-its (and losses). The crucial
type of decision in all organized activity, according toKnight,
involves the selection ofmen tomake decisions. Any other sort of
decision-making or exercise of judgment is automatically reduced to
a routine function (RUP,297).
Uncertainty needs to be sharply distinguished from risk in
Knights view. Riskis calculable a priori and can, therefore, be
treated as a cost. Experience can teach uswhat percentage of
bottles is going to burst in a champagne factory. These damagescan
be included in our cost calculations (RUP, 213). Other types of
risk, such as theincidence of fires, can be insured.Uncertainty, in
contrast, is uninsurable, becauseit depends on the exercise of
human judgment in themaking of decisions bymen andalthough these
estimates tend to fall into groups within which fluctuations
cancelout and hence to approach constancy andmeasurability; this
happens only after thefact (RUP, 251). The major difference between
risk and uncertainty thus consistsof the possibility of makingex
antecalculations of the incidence of an event. Thatcan be done for
fires, but not with respect to the outcomes of investment
projectsthat can only be calculated after everything is said and
done. Knight borrowed fromSchumpeter the idea that entrepreneurs
are not self-selectedbut chosenby investors,who in contrast to
Schumpeters portrayal are not infallible but subject to error.But
the vision of the investor is central to his theory and not that of
the innovator.
Knights theory portrays investment as a discovery process. Many
new ventureswill be launched, but only a few will survive and
prosper. Such a sketch of eventsfits actual developments. Many new
businesses were launched in the 1990s, ofwhich a few obtained
astronomically high valuations. This happened before theyactually
made profits, which supports Knights thesis that not actual profits
butprofit expectations are the decisive element in investment.
Knights theory thus
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 93
foreshadowed things to come. The development of financial
markets (particularlyin the US) has made it possible to measure
success by readjustments of capitalvalues before actual profits
have been reaped.We can also conclude that investmentunder
conditions of uncertainty requires other methods of finance than
debt. (High)chances of failure require a risk premium on interest,
which curtails investment.Equity capital is therefore much more
suited for the task of financing uncertainventures than debt.
Knight pointed out that only the investor with above average
skills of perceptionwould earn (excess) profits, whereas investors,
whose perceptiveness was belowaverage, would lose money on their
ventures. Perceptiveness refers both to projectchoice and to the
timing of investment. Knight contended that the average rateof
return on investment does not need to exceed the riskless rate of
return in thelong run (RUP, 284). Hence, both Knight and Schumpeter
argued that investors asa group do not need to earn excess profits.
But, the interest rate equals marginalprofitability in Schumpeters
view and average profitability in Knights.
Knightsinvestor/entrepreneurs need to be compensated for losses
caused by uncertainty.Schumpeters entrepreneurwasentitled to the
residual, which indicated his capacityat innovation. But
entrepreneurs are not entitled to the residual in Knights
view.Their incomes should take the form of salaries.
It is obvious that uncertainty in investment, just as in sports,
only exists, ifmore than one company/team vies for the same prize
and if the result cannot bepredicted with any accuracy. The match
would be superfluous, if the best teamcould be indicated before the
event. The same applies to the business world. Onlyone innovative
firm needs to be launched, if the best innovator can be discerned
exante. Thebest employeewill also be the best entrepreneur, if
standards of excellenceapply equally to entrepreneurs and
employees. As a consequence, all investorswould flock towards the
designated winner, which would drive up the price ofthat person to
the point at which no profits are left for the investor.
Moreover,this innovator has no incentive to start his own company
but will earn exactly asmuch as an employee (Brouwer, 2000). I hold
the view that Knight has correctedSchumpeters theory on an
essential point. Profits (and losses) can only appear,if
uncertainty is present. In fact, all profits would vanish, if the
winning personor company could be indicated ex ante. If everybody
had known beforehand thatMicrosoftwould become themost successful
companyof the1990s investorswouldhave rushed to provide funding and
the list of prospective employees would havebeen infinite. As a
consequence Bill Gates could have obtained all the money hewanted
at riskfree rates of interest and could have paid his employees
just standardwage rates.But,Gateswas fundedbyventure capital
firms,which tookequity sharesin his firm. The same applies to
himself and his co-founders, who were also paid(partly) by equity
shares. Most founders of high tech start-ups receive
modestsalaries, but get equity shares in compensation. Microsoft
became an enormoussuccess and everybody was handsomely rewarded for
his wise choices. However,a host of start-ups, which turned out to
be failures and whose investments werelargely lost counterbalance
the Microsoft success story.
Uncertainty can explain many features of innovation, such as the
relativelysmall size at which innovative ventures are launched. The
rationale for this is that
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94 M. T. Brouwer
losses are limited in the case of failure. It can also explain
why many start-upsare short-lived and why some grow very rapidly.
Only firms that are expected tobecome successful will receive
several rounds of finance so that they can expand.Moreover,
uncertainty is also a big motivating force. This applies to sports,
butalso to economics. No firm would wage investment in innovation,
if it knew thatit would lose out to an objectively better
competitor. But this competitor in turnwould have no incentive to
disrupt existing routines, since this could entail
creativedestruction. Both Weber and Schumpeter believed that
innovation could proceedunhindered in socialism. This becomes
plausible when we realize that both authorsdid not incorporate
uncertainty into their theories.
6 Webers history of organizations
WebersGeneral Economic History(GEH) andSocial and Economic
Organization(SEO) can be considered a response to Schumpeters
thesis, that not the Protestantethic but innovation causes economic
development. These two books also attemptto refute Schumpeters
claim that innovation is not system-specific. Weber gives apowerful
sketch of economic history from ancient times until 1920 in
hisGeneralEconomic History. He analyses several consecutive
historical forms of economicorganization, such as the clan, ancient
bureaucracy, the manor, the guilds and thebusiness enterprise.
These organizations can be embedded in larger political
orga-nizations, such as an empire, state or city.
Most primaryorganizational formsweredirected towardsprotectionof
itsmem-bers against outside aggression. This applies to the clan,
which Weber saw as theprimal organizational unit and as an agency
of blood revenge and the prosecutionof feuds (SEO, 128). The clans
did not possess written laws; clan members weretotally dependent on
their leaders for their lives and livelihood. The clan and laterthe
sedentary agricultural village were composed of several families.
The power ofthe clans could only be broken, if a political system
was established, which erodedthe absolute power of the chieftain.
All early civilizations, in his view, such as theEgyptian, Greek
and Roman civilizations, had loosened the grip of clan and familyon
people usually by force and had establishedmore rational forms of
organiza-tion. (Weber mentioned ancient Egypt as an example of a
huge bureaucracy with avery extensive division of labor). Officers
in a bureaucracy are chosen on the basisof some kind of proven
expertise. This contrasts with the selection of officers (suchas
the medicine man) in a tribal society, which relies largely on
magic.
Feudalism constitutes another organizational form, which is not
(completely)based on kinship and blood ties and thus embodies some
rational aspects inWebersview. In feudalism, the tribes are
subjugated to an overlord, who in turn has beenappointedby
theemperor or prince.Feudalismemergedgradually througheither
thecontracting out of taxation benefices to administrators (such as
to the mandarinsin China) or through the granting of fiefs to
militaries (the feudal lords of theoccident and the Ottoman
empire). The power of the clans was completely brokenin the
occident, but not in the orient according to Weber (GEH, 45). Life
on thecountryside in occidental feudalism revolved around the
estate or manor. Peasantswere either obliged to pay fixed or
variable fees (such as in sharecropping) to
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 95
their landlords and/or were subjected to compulsory labor on the
estate. A landedaristocracy replaced the clan leader in its task of
defending the life and good of thepeople. But, the manor oroikoswas
not organized along rational lines. Holdingswere usually of
sub-optimal size. Income was largely determined by privileges
andobligations, which were passed on from generation to
generation.
Part of the medieval populations lived in cities, which had
their own organi-zations. The inhabitants of the towns in Western
Europe usually did not start outas free men, but fell under the
jurisdiction of a feudal lord. It was only when theybecame engaged
in trade that they reached the status of mercator and of free
citizen.The citizens of the medieval towns were relieved from
feudal obligations but hadto pay taxes to the emperor or king. The
lords of the manor were opposed to townprivileges. The prince and
the emperor, however, were willing to grant privilegesto the towns
in order to increase tax incomes.
The guild organization of craftsmendates back to antiquity.
Ancient guildsweremainly based on clan lines. The guilds as
associations of free craftsmen did notdevelop outsideWestern Europe
(GEH, 137). Instead, every individual belonged toaclanor caste in
theOrient.Guildsneverexisted inChina, becauseclanorganizationwas
dominant. Guilds did not develop in India either, since the
division of laborwas organized along lines of castes, which can be
seen as ritualistic guilds (GEH,137).
Craftsmen and merchants populated the towns, whereas peasants,
who wereattached to the land by feudal obligations and rights,
populated the countryside. Theestablishment of the towns introduced
trade, because the town people needed to befed by agricultural
surpluses, which were exchanged for handicraft and importedproducts
on local markets or by peddlers. Towns were much more numerous
inoccidental than in eastern Europe. Weber remarks that the power
of the townsdiminished that of the estates.With the decrease of the
frequency of towns on themap there is an increase in the frequency
of estates(GEH, 89).
Its military basis made occidental feudalism rather unstable.
The power of aking or prince was never absolute, as he had to rely
on the military capabilities oflocal lords to sustain his power.
The knights could also use their power at arms tofight each other
or the emperor. The inherently instability seems to have
contributedto the development of towns and therewith to commerce
and enterprise in westernEurope. The emperor or king could curb the
power of the aristocracy and expandits tax revenues by granting
royal privileges to cities in exchange for a guaranteeof their
corporate liberties and protection against the feudal lords
(McNeill, 542).However, some cities developed their own military
capability and supplanted thefeudal lords. Towns bought up the
surrounding countryside and established theirown states. Italian
towns such as Florence and Venice are cases in point. Free
guildsbecame the dominant organizational form for craft workers
inWestern Europe aftercraftsmen had thrown off the feudal shackles.
This happened first in the free city-states of southern Germany and
northern Italy.
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96 M. T. Brouwer
7 Weber on the emergence of capitalist enterprise
Weber indicated that several organizational forms were not up to
the transitionto a market economy. The manorial system in
agriculture, which had existed inEurope for many centuries, was
bound to shatter, when faced with market forces.The newly developed
bourgeois interests of the towns promoted the weakeningof the manor
to expand their market opportunities. The manorial system curbedthe
purchasing power of the rural population due to the compulsory
services andpayments it demanded from the tenants. The manorial
system also prevented thecreation of a free labor market because it
attached the peasants to the soil (GEH,94).
The guilds promoted production for themarket, which gradually
supplanted thedivision of labor within the manor. Where the guilds
were not victorious or did notarise at all, house industry and
tribal industry persisted (GEH, 147). This appliesto eastern
European feudalism. Russian peasants could not break loose from
thesoil because of eternal rights and obligations to the estate and
to the communal mirorganization.
The western guild organization was of a more rational nature
than the manor.Craft guildspromotedprofessional competence.People
couldonly becomeamasterand open up their own shop after a long
period of training. More importantly,admission to the western
guilds was usually based on skills and not on familyties, although
minorities were often excluded from the guilds. The guilds were
firstregulated by the town lords, who demanded both taxes and
military services fromguild members, but all these prerogatives
were later acquired by the guilds (GEH,148).
After having won these battles the guilds used their newly won
freedom to es-tablish an effectivemonopoly in their trade. Guild
regulation protected its membersfrom competition. It was impossible
to set up a shop without the guilds consent.Moreover, the number of
masters and therewith of shops was strictly regulated inorder to
restrain output. Equality prevailed within the guild organization.
No mas-ter could improve his position beyond that of another.
Hence, no shop could everincrease its market share. The guilds
initial boost to progress petered out, whenthe adverse effects of
their regulations became dominant. Moreover, guild mem-bers could
own no capital of their own, and were therefore restricted to
non-capitalintensive production methods. The few capital goods in
existence such as grain andwood mills were often owned by the town
or by a cooperative.
New organizations appeared in the 16th and 17th century, which
broke thepower of the guilds. Journeymen, who were not allowed to
become masters, setup their own businesses. They could do that
outside the jurisdiction of the townsin the countryside. The
putting-out system resulted from the attempt to escapeguild
regulation. Rural labor was amply available in England due to the
enclosuremovement. Production could expandbeyond local demand to
supply exportmarkets(GEH, 94). But guild regulation persisted in
many trades especially in Germany.The German princes more or less
operated on behalf of the guilds and the guildsremained strong
within Germany for a long time. The remnants of the guild systemcan
still be found in some German trades, in which
thehandwerkergesetzeapply.
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 97
The putting-out form of enterprise could thus only flourish
outside the guildorganizations. The same applies to the trading
companies of the 16th and 17th cen-turies, which were organized in
a corporate form. The Dutch East India Company(VOC) is a prominent
example of such a joint stock company, which raised capitalby
issuing shares to participating merchants. The VOC existed from
1602 till 1790and employed several thousand people at its hey-day.
It was a multi-plant com-pany consisting of six local chambers
(Amsterdam, Rotterdam, Delft, Middelburg,Enkhuizen and Hoorn). It
exploited shipyards and warehouses apart from organiz-ing maritime
expeditions. The VOC and other trading companies had many traitsin
common with the modern corporation. However, they needed to be
chartered bythe state, because there was no free incorporation in
Holland in those days. As aconsequence the VOC was considered to
represent the national interest and couldrely on military support
to fight rival maritime nations and pirates. The Englishsituation
differed from the Dutch since the Statute of Monopolies was
adoptedin the early 17th century, which ended the Crowns
prerogative to grant monopolyrights. Monopolies could now be
challenged in courts and disappeared rapidly fromthe English scene.
Incorporation of voluntary groups spread rapidly in 17th cen-tury
Elizabethan England as is shown by the popularity of the joint
stock company(North and Thomas, 154).
We may conclude that the guilds were initially conducive to
progress, but ar-rested progress later on. The guilds came to
eschew novelty and wanted tomaintainexisting privileges and
therewith the status quo. They began to show traits of thecaste
organizations such as in India, which forbade all use of new
production meth-ods. Guild organization gradually gave way to
capitalist organizations such as thejoint stock company; but this
process was initially limited to England.
OtherWesternEuropeancountriesupheldmonopolyprivilegesmuch
longerandonly allowed free incorporation at a much later date
(Thomas and North, ch. 10).
Weber wanted to demonstrate inGeneral Economic Historythat
institutionalchange is not immanent to all types of societies. Only
some western countriessucceeded in establishing free enterprise.
Weber emphasized that capitalist busi-ness enterprise could only
emerge after production factors had become mobile andproperty
rights had been established. Labor should not be bound to master
andsoil by hereditary and, therefore, irrational traditional ties.
Such migration datesback to ancient times, when people moved from
the hills to the riverbed valleys ofMesopotamia and Egypt.
Consequently, the clan chieftain and also the father as thehead of
the family were robbed of (part of) their possessions and
privileges. Thesame happened when Greek and later Italian cities
rose to prominence. Contractuallabor relations gradually replaced
serfdom, royal privileges and communal landownership.
Apart from labour, land also needed to become freely negotiable
before cap-italism could take off. Private property in land emerged
during the 17th and 18thcenturies in Western Europe, but the
process knew several different forms and thedissolution of the
feudal system therefore resulted in the different agricultural
sys-tems of today.In part the peasantry was freed from the land and
the land from thepeasantry as in England; in part the peasantry
were freed from the proprietors as
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98 M. T. Brouwer
in France; in part the system is a mixture as in the rest of
Europe, the east incliningmore to the english conditions(GEH,
108).
France became a country of small and medium sized agricultural
firms, whenthe estates were broken up and distributed among the
peasants after the Frenchrevolution (GEH, 99). The absence of
primogeniture in contrast to England also contributed to the
emergence of small lot sizes in France. The landlords werealso
expropriated in south and western Germany. The change was the same
asin France except that it took place slowly and according to a
more legal process(GEH, 100).With the dissolution of the manors and
of the remains of the earlieragrarian communism through
consolidation, separation etc., private property inland has been
completely established(GEH, 111). The occident thus turned into
aworld which was dominated by a division of labor based on free
labor and privateproperty in land.
An additional condition, which needed to be met before
capitalism could flour-ish - in Webers view - is the establishment
of a rational state. This means a statewhich is based on rational
law and expert officialdom (GEH, 339). He contrastedthis with
states whose officials were trained in ancient literature or
religious textsas was common in theOrient. Many feudal empires such
as in China were foremostconcerned with preserving their
centralized power structure. Their local represen-tatives were not
selected by military or technical criteria but by their expedience
inChinese literature. Such vassals had to be completely loyal to
the emperor, becauseanother recruit could easily replace them.
Themandarins were also prevented frombuilding a local power base
among the population, because they were continuallytransferred from
one province to another and did not speak the local dialect.
Rational law in Webers view was based on Roman law, which
revived in greatparts of the occident, but not in England, during
the late Middle Ages and Re-naissance. Weber considers its
calculability the main advantage of Roman formal-legalistic law,
which contrasts to materialistic, theocratic or absolutist law
(GEH,340-1). Roman law also differed from other law systems by its
emphasis on civilmatters, which greatly facilitated trade. Roman
law provided reasoned and consis-tent principles of jurisprudence,
just like English common law. Most empires hadonly developed
criminal law apart from the famous Hammurabi Code of
ancientMesopotamia that also addressed commercial matters.
8 Authority and change
Weber gave an overview of institutional history, but failed to
explain why theseinstitutions had come and gone. His analysis of
charismatic authority inSocial andEconomic Organizationcan be
interpreted as an attempt to fill this void. Here, hedistinguished
three forms of authority; legal-rational, traditional and
charismatic.Some leaders derive their authority from tradition,
such as the clan leader and thelord of the manor. Bureaucracy, by
contrast, is based on rational-legal authority.We can summarize
Webers historical view by stating that the western world hadchanged
from traditional towards formal-legal societies. However, he failed
to ex-plain why such change occurred only in some societies and was
absent in others.Parsonsdiscusses this point in his introduction to
theAmericanedition ofWirtschaft
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 99
und Gesellschaft(1947). Traditional authority is opposed to
change by definition.Legal-rational authority spurs efficiency, but
it is doubtful whether it can breakup existing routines. Both
traditional and rational-legal authority seem, therefore,suited to
an established social system of a routine character (SEO, 64).
Charismaticauthority, however, wants to lead people away from
existing routines and beliefsand is, therefore, an agent of change.
The charismatic leader - as described by We-ber - is always in some
sense a revolutionary and a dissident. He promises peoplea better
future. But, a charismatic leader has to deliver. The accuracy of
his visionneeds to be proven by events, or people will turn their
backs on him.
Schumpeters innovative entrepreneur, who leads the production
process intonew grids, has many things in common with Webers
charismatic leader. Theyboth oppose established authority and lead
their flock in new directions. Webersanalysis of charismatic
authority can, therefore, be considered an attempt to blendthe
Calvinist and the innovator. But Weber situates charisma mainly in
the realmof religion and the military and not in the business
world. A founder of a newreligious sect and his disciples and a
military band are the types of organization hehad in mind.
Charismatic authority loosens all former ties to family and clan
andforges completely new loyalties. The people who have recognized
the charismaticleader are completely devoted to him in a
non-rational way. There is no such thingas promotion or dismissal
in the early stages of new religiousmovements ormilitarybands;
there is no hierarchy either. Hence the charismatic organization is
exactlythe opposite of the rational-legal bureaucracy. The
charismatic organization doesnot demand formal qualifications.
Everybody who recognizes the greatness of thecharismatic leader can
follow him and become a member of his community. Thecharismatic
leader expects much of his disciples. They are expected to
achieveextra-ordinary things. Rewards are not formalized but
consist of free gifts or booty,which are distributed on a communal
basis. However, this charismatic organizationcannot endure in
Webers view and will in time turn into an organization basedon
either traditional or legal-rational authority.
Some elements of charismatic organizations can be found in
entrepreneurialstart-ups. The (innovative) entrepreneur is often
mission-oriented. He believes inhis own capabilities and those of
his employees. No entrepreneur would ever starthis business, if he
were not convinced of its ultimate success. Most of the time
heneeds to convince at least a few others to join him in his
venture and to defer incomeuntil the moment of success has arrived.
He also needs to convince financiers andultimately customers of the
superiority of his product or process. Many start-upsare organized
along non-bureaucratic lines and the founders are prepared to put
inmany extra hours. The lack of hierarchy and formal roles and the
vicissitudes ofincome as determined by stock options are also
characteristic of start-up firms. Thisapplies most forcefully to
the founders of the organization, but also to employees,as the
example of Microsoft demonstrates. More than thousand of its
(early) hiresbecame millionaires thanks to stock options.
Webers hypothesis of the charismatic leader is certainly
powerful, becauseit can explain why people are prepared to leave
their old ways of life in orderto start anew. His theory of the
charismatic leader attempts to explain theriseof protestant sects,
instead of analyzing their characteristics. However, heretics
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100 M. T. Brouwer
are of all times, but their rise was often arrested by
repression. Examples on thepersecution of deviants or dissidents
abound.We can think of ancient Rome, whichpersecuted the
Christians, as well as of the Russia of Catharine the Great,
whichsent its religious dissidents off to Siberia. It was only when
non-absolutist formsof government arose that both freedom of
religion and of business incorporationemerged. Hence, freedom of
religious incorporation went hand in hand with itscounterpart in
business. We could, therefore, conclude that charismatic
leadershipcould only occur when certain conditions were met
9 Schumpeters economic development revisited
Schumpeterwrote a second edition of hisTheorie
derWirtschaftlichenEntwicklungof about two thirds the size of the
original version. The new edition was publishedin 1926 and became
the basis of the English translation, which appeared asTheTheory of
Economic Development(ED) in 1934.
The second edition apart from its smaller size differs from the
first on a num-ber of points. Firstly, all passages criticizing
Boehm-Bawerk and other economistshad been eliminated. Schumpeter
presented his work as a piece of economic anal-ysis and himself as
an economist. The professionalization of the social scienceshad
advanced to a stage which seemed to require a strict demarcation
betweeneconomics, sociology and history. Schumpeter thus complied
with his critics, whohad claimed that Schumpeter had not produced a
historical, evolutionary theory ofeconomic change. Schumpeter
returned to history in hisBusiness Cycles(1939)andHistory of
Economic Analysis(1954). Another criticism involved the
emphasisSchumpeter had put on the role of the individual in
economic development.Oneof the most annoying misunderstandings that
arose out of the first edition of thisbook was that this theory of
development neglects all historical factors of change,except one
namely the individuality of entrepreneurs (ED,60).
Schumpeter is not prepared to give up his original position that
the entrepreneuris the dynamic element in capitalism. He now puts a
greater emphasis on the intu-itive capacities of the
entrepreneur.Hehas the capacity to see things in away,
whichafterwards proves to be true, although it cannot be proven at
the time.Schumpetereven adds; thorough preparatory work, and
special knowledge, breadth of intellec-tual understanding, talent
for logical analysis may under certain circumstances besources of
failure(ED, 85).
Schumpetermade somesuperficial changes in his description of
entrepreneurialmotives, but he stuck to his former statement that
entrepreneurial motivation is un-like that of economic man, who is
balancing probable result against disutility ofeffort. The
entrepreneur is still motivated by the dream to found a private
kingdom,which most closely resembles the position of medieval
lordship. New motives in-volve the will to conquer, the impulse to
fight, to prove oneself superior to others,to succeed for the sake
of success. Pecuniary gain is therefore not the main motivefor
entrepreneurial action, but it is a very accurate expression of
success, especiallyof relative success (ED, 93-4). We may conclude
that Schumpeter rephrased hisentrepreneurial motives somewhat to
get them more in line with Knights descrip-tion of what moves the
entrepreneur. Knight emphasized sportsmanship to explain
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 101
entrepreneurship, whereas Schumpeter had stressed creativity in
his first edition.They nowboth share the view that entrepreneurship
can best be understood as an el-ement of the game spirit and the
ambition to win. But, Schumpeter rejects Knightsdefinition of the
entrepreneur as the capitalist and risk-taker. Schumpeter
arguesthat the usual shareholder has no impact on company policy
and hence cannot fulfillentrepreneurial functions (ED, 75).
Schumpeter also strongly repudiates theMarshallian definition of
entrepreneur-ship, which treats the entrepreneur as a manager. He
draws a sharp line betweenmanagers and entrepreneurs.The manager
chooses from the most advantageousamong the methods which have been
empirically tested and become familiar at acertain point in time,
whereas the entrepreneur looks for the best method possibleat the
times(ED, 83). He also firmly rejects Webers definition of the
entrepreneuras the person with a calling.The carrying out of new
combinations can no more bea vocation than the making and execution
of strategic decisions(ED, 77).
Theelementsof charismatic leadership that couldbediscerned in
thefirst editionhave now faded out. Schumpeter still describes the
entrepreneur as a leader, yet theheroism with which the
entrepreneur was adorned in the first edition is largelygone. He
now calls the entrepreneur a leader against his will, whose only
followersare the imitating firms that rob him of his profits. The
entrepreneur only needs toconvince or impress one man, that is the
banker who is to finance him (ED, 89).Schumpeter contended that the
days of the heroic entrepreneur were almost over.The entrepreneur
still needed to confront the opposition from the environment,but
this opposition has largely succumbed in modern times.The
importance of theentrepreneur must diminish just as the importance
of the military commander hasalready diminished(ED, 86). He
attributed this to the increased calculability andrationality of
the capitalist world. Schumpeter had first depicted the
entrepreneuras the man of action who could lead society into new
ways of doing things. Thisfigurewas replacedby the sociallymuch
lessapt entrepreneur,whoonly caredaboutbusiness and left politics
to the politicians. This line of reasoningmade Schumpeterpredict
that innovation could be delegated to expertswithout affecting
performance.Schumpeter foresaw that innovation would become a
matter of routine, executedby employees in R&D laboratories. He
did not like this course of events, becausethe world would lose
much of its splendor due to these changes. But he thoughtthat
increasing rationalization would make it inevitable.
Hence, Schumpeter held the view that increased rationality
spells the end ofcapitalism. Theorigins of Schumpeters bleak
outlook on the viability of capitalism,which he has exposed
magnificently inCapitalism, Socialism and Democracy,can thus
already be found in the second edition ofTheorie der
WirtschaftlichenEntwicklung.
Schumpeter, however, came to retrace his steps and emphasized
competitionand liberalism as crucial conditions for economic
development in his posthumouslypublishedHistory of Economic
Analysis(Brouwer, 1996). Schumpeter describesin HEA how competitive
capitalism could only unfold unfettered after liberalismhad become
the main political movement. Liberalism - in Schumpeters words
-entailed the subjugation of politics to commerce and reigned only
from the endof the 18th century till about 1900 (HEA, 761). We
could, therefore, conclude
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102 M. T. Brouwer
that Schumpeter narrowed his theory even further at the end of
his life. His theorynow only applied to 19th century western and
especially English capitalism, wherethe state had largely withdrawn
from the economic arena and the bourgeoisie hadbecome the leading
class
10 Rationality of capitalist enterprise
Weber defined capitalism as rational calculation applied to the
pursuit of economicgain. Rational capitalist enterprise exists -in
Webers view- when rational methodssuch as bookkeeping and capital
accounting are used (GEH, 275). He distinguishedrational from
adventurous capitalism. The latter is represented by the
overseastrading companies of the 16th and 17th centurywhose
ventureswere subject to highuncertainty. This is attested by the
fact that many VOC ships never returned fromtheir
voyages.Weberdates thebeginningof rational capitalismback
to17thand18thcentury mercantilist states. This period was
characterized by monopolies grantedby the state. Weber calls
mercantilism the first rational economic policy, becausethis policy
was primarily directed towards economic welfare instead of
reassuringpeace among rival groups and classes. Mercantilism meant
that the state was runas a single firm. The objective of the state
was to generate as much tax income aspossible through national
monopolies. Mercantilism thus favored managed insteadof free
trade.
Schumpeter tracked the origins of capitalism back to the
medieval city-statesthat largely depended on commerce.Capitalist
institutions, such as big business;stock and commodity speculation
and high finance had already established them-selves firmly at the
end of the 15th century, and had entailed the ascent of the
bour-geoisie(HEA, 78). Schumpeter contended that capitalist
progress was arrested bythe rise of the absolutist nation states
that ascended from the 15th century onwards.The rising bourgeoisie
had to submit for centuries to come to the rule of a warriorclass
of feudal origins that milked the bourgeoisie to fight their
endless series ofwars (HEA, 144). It was only in the 19th century
that capitalism regained its bloomunder liberal governments,
especially in England.
Weber considered the ability to calculate profits in advance as
the most distinc-tive feature of (rational) capitalism to mark it
off from its (irrational) predecessors.Capitalist enterprise would
take the form of large bureaucracies that would rewardpeople
according to their abilities. However, to restrict rationality to
capitalismseems somewhat misplaced, as Schumpeter remarked. The
lord of the manor alsobehaved rationally within the feudal setting.
The same applied to courtiers, wholived at the French royal court
in Versailles, or aspirant Chinese mandarins, whotook great efforts
to become proficient in reciting Chinese verse. All these peo-ple
used the possibilities open to them to improve their social
position; a clearmeans-end relationship (Schumpeter, 1991,
325).
Knight launched a more devastating criticism onWebers
identification of cap-italism with rationalism. He explained that
all ex ante calculations could only beeducated guesses of
prospective returns. So, it is not somuch rationality, but
percep-tion that makes a capitalist entrepreneur successful.
Perception can be consideredsubjective rationality, which can only
be borne out by the facts after the investment
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Weber, Schumpeter and Knight on entrepreneurship and economic
development 103
has been made. Subjective rationality resembles Webers
description of the charis-matic leader, who is convinced that he is
right and is eager to prove it. We might,therefore, argue that
(objective) rationality is not the distinctive factor of
capital-ism. Investment can only be subjectively rational in
competitive capitalist societies.Moreover, certain political and
institutional conditions are required before compet-itive
capitalism could occur. Absolutist rule needed to disappear to make
room forboth religious and economic freedom and
experimentation.
Modern authors on western history also hold the view that
absolutism and itsinherentmonopolization of economic life
impededwestern economic ascent. Northand Thomas explain the
economic bloom of England and the Low Countries after1500 by the
absence of absolutism in those countries. A delicate balance was
struckbetween central and local powers, in which neither got the
upper hand. In Englandthe power of the crownwas curbed by
parliament, which obtained substantial powerunder the Tudors (North
and Thomas, 147). A federal form of government, whichderived from a
league of autonomous medieval towns, ran the seven unified
Dutchprovinces (McNeill, 581). However, these were the exceptions.
Absolute monarchsruled in France, Spain Scandinavia, Poland and
Hungary. Local taxes were aban-doned and supplanted by national
taxes such as the French taille and the Spanishalcabala. Absolute
rulers created vast bureaucracies whose functionaries were loyalto
the crown. Guild rules and local monopolies were upheld. Trade,
free incorpo-ration and labor mobility were impeded. These measures
prevented the emergenceof a merchant class in countries that were
governed along absolutist lines, whichgreatly hampered their
economic progress (North and Thomas, ch. 10).
11 Conclusions
This essay traced the linkages between the theories of Weber,
Schumpeter andKnight on the issue of entrepreneurship and economic
development. Weber occa-sioned one of the great debates in modern
intellectual history with his publicationson the importance of the
Calvinist ethic for economic development. He emphasizedthe rational
i.c. anti-magical features of Protestantism and especially
Calvinism.Schumpeter contested Webers view. He put the innovative
entrepreneur centerstage. Knight differed from both Weber and
Schumpeter in his analysis of invest-ment under uncertainty. He
cast the perceptive capitalist in the leading role.
Comparing the three authors, we can note that Weber did not pay
attention toeither financial matters or uncertainty. Savings funded
investment and uncertaintywas antithetical to his conception of
capitalismas a rational system.Weber sketchedthe course of western
economic history as a process of increasing rationalization,which
resulted in modern capitalism. Schumpeter contested Webers view of
capi-talism as a predominantly rational system, but adopted some of
Webers points inhis later work. But rational capitalism, in his
view, would make entrepreneurshipobsolete and would blur the lines
between capitalism and socialism.
Schumpeter attributed a central role to the financial sector,
but largely neglecteduncertainty in his work. His emphasis on
credit as one of the main institutionsof capitalism derives from
his idea that capitalism allows people from all socialclasses to
introduce innovations. It was Knight, who explained how
developed
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104 M. T. Brouwer
financial markets could absorb uncertainty. Knights analysis
stresses the game-likeand intuitive and, therefore, largely
non-rational aspects of entrepreneurship. Theentrepreneur can
perceive qualities in people, which remain hidden to the
averageobserver. This gives the investor/entrepreneur some
prophetic features. Only themore than averagely perceptive investor
can make a profit, if capital markets arewell organized. But
capital and IPO markets (Initial Public Offerings) have
onlyrecently and in only a few countries achieved the degree of
sophistication requiredfor the smooth operation of investment under
uncertainty. Many aspects of the neweconomy such as the vital role
of equity markets and of uncertainty can alreadybe found in
embryonic form in Knights work.
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