Keywords

JEL Classifications

The essence of Austrian economics is its emphasis on the ongoing economic process as opposed to the equilibrium analysis of neoclassical theory. Austrian concepts of competition reflect this emphasis. Indeed, one of the central challenges by Austrians to the neoclassical model, and a common denominator of virtually all Austrian economics, is the rejection of the concept of perfect competition. In this respect, a number of economists who cannot be considered Austrian in all aspects of their work, share, nonetheless, the Austrian emphasis on actual market activities and processes – for example, Joseph Schumpeter (1942), J.M. Clark (1961), Fritz Machlup (1942) and others.

When the concept of competition entered economics at the hands of Adam Smith and his predecessors, it was not clearly defined, but it generally meant entry by firms into profitable industries (or exit from unprofitable ones) and the raising or lowering of price by existing firms according to market conditions. There was little recognition, and virtually no analysis, of entrepreneurship as it might be reflected in these and other forms of competition, but there was a recognition that business firms do in most situations have some control over market prices, with the degree of control varying inversely with the number of firms in the industry. These basic ideas, expanded and supplemented, are generally compatible with most modern Austrian analysis.

What is objectionable to Austrian economists is the neoclassical concept of perfect competition, developed during the 19th and early 20th centuries. The development began with Cournot (1838), whose concern it was to specify as rigorously as possible the effects of competition, after the process of competition had reached its limits. His conceptualization of this situation was a market structure in which the output of any one firm could be subtracted from total industry output with no discernible effect on price. Later contributions by Jevons, Edgeworth, J.B. Clark and Frank Knight led to the model of perfect competition as we know it today (Stigler 1957; McNulty 1967).

The trouble with the concept from the Austrian point of view, as Hayek has emphasized, is that it describes an equilibrium situation but says nothing about the competitive process which led to that equilibrium. Indeed, it robs the firm of all business activities which might reasonably be associated with the verb ‘to compete’ (von Hayek 1948). Thus, firms in the perfectly competitive model do not raise or lower prices, differentiate their products, advertise, try to change their cost structures relative to their competitors, or do any of the other things done by business firms in a dynamic economic system. This was precisely the reason why Schumpeter insisted on the irrelevance of the concept of perfect competition to an understanding of the capitalist process.

For Schumpeter, any realistic analysis of competition would require a shift in analytical focus from the question of how the economy allocates resources efficiently to that of how it creates and destroys them. The entrepreneur, a neglected figure in classical and neoclassical economics, is the central figure in the Schumpeterian analytical framework. The entrepreneur plays a disequilibrating role in the market process by interrupting the ‘circular flow’ of economic life, that is, the ongoing production of existing goods and services under existing technologies and methods of production and organization. He does this by innovating – that is, by introducing the new product, the new market, the new technology, the new source of raw materials and other factor inputs, the new type of industrial organization, and so on. The result is a concept of competition grounded in cost and quality advantages which Schumpeter felt is much more important than the price competition of traditional theory and is the basis of the ‘creative destruction’ of the capitalist economic process. It produces an internal efficiency within the business firm, the importance of which for economic welfare is far greater, Schumpeter argued, than the allocative efficiency of traditional economic theory (Schumpeter 1942).

His emphasis on the advantages of the firm’s internal efficiency led Schumpeter to a greater tolerance for large-scale business organizations, even for those enjoying some degree of monopoly power, than was typical of many more traditional theorists of his time. This is a not uncommon characteristic of Austrian economics. Hayek, for example, makes the distinction between entrenched monopoly, with its probable higher-than-necessary costs, and a monopoly based on superior efficiency which does relatively little harm since in all probability it will disappear, or be forced to adjust to market conditions, as soon as another firm becomes more efficient in providing the same or a similar good or service (von Hayek 1948). And that is precisely Schumpeter’s point. The ground under even large-scale enterprise is constantly shaking as a result of the competitive threat from the new firm, the new management, or the new idea. Schumpeter’s competitive analysis was less a defence of monopoly power than of certain business activities which were judged to be monopolistic only from the comparative standpoint of the model of perfect competition. He insisted that the quality of a firm’s entrepreneurship was of far greater significance than its mere size.

The leading contemporary Austrian theorist of competition is Israel Kirzner (1973). Kirzner’s approach draws on the analysis of market processes and the concept of ‘human action’ developed earlier by Ludwig von Mises. For von Mises, entrepreneurship is human action in the market which successfully directs the flow of resources toward the fulfillment of consumer wants (von Mises 1949). Kirzner’s more fully developed theory of competition is based on the idea that the means – end nexus of economic life is not given but is itself subject to creative human action. This creative role Kirzner defines as entrepreneurship, and it is essentially the ability to detect new but desired human wants, as well as new resources, techniques, or other ways through which to satisfy them. Whether he discovers new wants or new means of satisfying old ones, the Kirznerian entrepreneur is the one who sees and exploits what others fail to notice – the profit opportunities inherent in any situation in which the prices of factor inputs fall short of the price of the final product.

There is a difference between Kirzner’s theory of entrepreneurship and that of Schumpeter. Schumpeter’s entrepreneur is a disequilibrating force in the economic system; he initiates economic change. Kirzner’s entrepreneur plays an equilibrating role; the changes he brings about are responses to the mistaken decisions and missed opportunities he detects in the market. Unlike Schumpeter’s entrepreneur, he is not so much the creator of his own opportunities as a responder to the hitherto unnoticed opportunities that already exist in the market. Thus, in the competitive market process, the Schumpeterian and Kirznerian entrepreneurs may complement each other – the one creating change, the other responding to it.

Austrian dissatisfaction with the perfectly competitive model extends to the theories of imperfect and monopolistic competition. Hayek’s and Kirzner’s criticisms are the same as of perfect competition, namely, that the analysis is limited to an equilibrium situation in which the underlying data are assumed to be adjusted to each other, whereas the relevant problem is the process through which adjustment occurs. Schumpeter criticized monopolistic competition for its continued acceptance of an unvarying economic structure and forms of industrial organization. Nonetheless, the incorporation into economic theory of quality competition and sales efforts, complementing the traditional and limited focus on price competition, as well as the efforts on the part of some industrial organization specialists and institutional economists to analyse and explain actual market processes, are developments that are generally within the Austrian tradition.

See Also