ENTREPRENEURSHIP

Entrepreneurship, Knowledge, and Spatial Economics

Amirsaleh Azadinamin
Doctorate of Finance Candidate

Swiss Management Center (SMC) University

November 28, 2011

Electronic copy available at: http://ssrn.com/abstract=2017499

ENTREPRENEURSHIP Abstract Entrepreneurship is and has always been acknowledged as a micro driver of innovation, competitiveness and economic growth and this paper presents theories that were offered by the

main architects and have the capacity to explain entrepreneurship. There is extra emphasis placed on theories by Israel Meir Kirzner, Ludwig Von Mises, and Friedrich Hayek as they have been known to offer original views on entrepreneurship. As for the concept of entrepreneurship the discussion takes place on topics of knowledge and location, and how these two main factors will help the entrepreneur discover profit opportunities, if any. The second part of the paper talks about how entrepreneurship helps in changing the prices for rent as well as migration, which is a result of labor movements. The spatial extension, or the spatial economics, added to the entrepreneurial theory illuminates how rent is determined based on expected future profit opportunities, and how labor uses the wage differential to materialize a profit opportunity that eventually leads to migration. It also describes how this process causes urban and regional developments by increasing the demand of land and labor, or what some refer to as the capital and human capital.

Electronic copy available at: http://ssrn.com/abstract=2017499

ENTREPRENEURSHIP Kirzners Theory of Entrepreneurship In an attempt to expand the concept of entrepreneurship, David Andersson (2005)

explains the role entrepreneurship and its far-reaching implications through its spatial extensions. Kirzner (1973) has used a mixed view of Misess view of the market as an entrepreneurial process along with Hayeks view of the market as means of transmitting and coordinating knowledge. However, Kirzners theory is non-spatial, something that Andersson (2005) intends to expand in his paper. Since Kirzners theory uses two previous theories offered by Hayek and Mises, it is essential to touch on those theories so the reader would obtain a better understanding of the subject. Theories Offered by the Main Architects Entrepreneurship has been recognized as a micro driver of innovation, competitiveness and economic growth. Entrepreneurship in a Schumpeterian view is defined as an attitude of helping innovative ideas become reality by establishing new business models and at the same time replacing conventional business systems by making them obsolete. (Korres, et al., 2011, p. 1155) In understanding the topic of entrepreneurship, one must become familiar with theories offered by the main architects. As Joseph Salerno (2008) explains it, Ludwig von Mises, Friedrich Hayek, and Murray Rothbard were the main architects of the distinctly Austrian theory of production as it exists today[and] all three conceived the entrepreneurial function in the actual market economy as presupposing the ownership of property, specifically capital (p. 189). The theories offered by Mises and Hayek will be the subject of discussion here since David Andersson (2005) talks mainly about these two architects. Mises and Hayek perceive the entrepreneur as a pure decision maker but do not own any resources. This pure entrepreneur

ENTREPRENEURSHIP earns profits by discovering and seizing objectively existing but previously unperceived

opportunities to arbitrage price discrepancies between a bundle of complementary inputs and the output it yields (Salerno, 2008, p. 189). Kirzner (1973) has offered one of the main and original views explaining entrepreneurship as alertness to discover and exploit situations in which the entrepreneur is able to buy low and sell for higher prices, as it is explained by the difference between two sets of prices. Kirzner (1973) emphasizes that entrepreneurship is the discovery of something obtainable for nothing at all (Andersson, 2005, p. 22). In fact, Kirzner (1973) believed that entrepreneurs discover profit opportunities in various ways, ranging from an instantaneous arbitrage opportunity to a complex activity that may in it include various simpler activities or transactions. To obtain pure profits, entrepreneurs must participate in activities in various locations guided by a price signal. Only then, the entrepreneurial activity will cause the price differential to be eliminated and will lead to a more accurate and unified price. Prices may vary in various geographical locations and this is the reason that entrepreneurship equilibrates markets in terms of the price (Andersson, 2005). However, ignorance about the situation may cause opposite effects. In the presence of ignorance, participants may cause two types of mistakes: first, they may fail to recognize the profit opportunity, and second, they may cause a decrease in market coordination after acting upon a price differential that is non-existence. A Spatial Extension Adding the spatial aspect to the entrepreneurship theory remains the most essential part of the paper authored by Andersson (2005) since it explains several of the most common phenomena regarding economic developments. Urbanization and migration are two of the main

ENTREPRENEURSHIP aspects of economic developments, and yet there are related spatial implications to them as Andersson (2005) elaborates. First, there is the spatial positioning, which means that the geographical location could alert the entrepreneur to discover the profit opportunities. Second, the entrepreneurial process is a must in building a regional economics. And third, the spatial aspect will clarify illustrate urbanization and migration processes by showing how rents, profits, and capital values could change due to change in the use of land over time. Entrepreneurship, Knowledge, and Location

Even though knowledge cannot be reduced to entrepreneurial awareness, it is an essential factor in what eventually leads to a discovery of a profit opportunity. However, it is worth mentioning that profit opportunities are not realized in all locations, and thus, one cannot underestimate the importance of this very aspect, the spatial location of entrepreneurship. A great deal of literature has been offered by Loasby (1999) that clearly distinguishes between the knowledge of facts and the ability to recognize the opportunity and perform skillfully to realize a profit. These are what Loasby describe them as direct and indirect knowledge or knowing that and knowing how. The entrepreneur knows how to coordinate knowledge, direct and indirect, that is specific to time and place. The knowledge that encompasses the time and the place (indirect knowing how) will be of most interest in entrepreneurs spatial positioning. It is the interaction among competitors, suppliers, and customers that will transfer the indirect knowledge, as one can gain valuable knowledge about pricing in various locations and markets, or what is referred to as the indirect knowledge, from interactions and realize profit opportunities. Thus, a participant is unable to obtain the indirect knowledge about profit opportunities in isolation. Kirzners theory of entrepreneurship does not contain an explicit treatment of time and place. My contention is that while it is possible to abstract from time, an

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analogous disregard of space makes the theory incomplete (Andersson, 2005, p. 24). Andersson continues to reason that while the entrepreneur may be able to choose her spatial location, she is unable to choose her location in time. This becomes a valid argument in explaining that the location of time is not a choice, as opposed to the spatial location. Having exposure to a particular place may bring the entrepreneur to realize the potential in profit making opportunities, whether she has been exposed to the place by pure chance or she has found it in hopes of making profits. At the same time the discovery may occur by two methods: first, she may discover a location that is foreseen as a potential location for future profit making. And second, she may find a profit opportunity in line with Kirzners theory. Entrepreneurship and Spatial Economics In the classical and neoclassical theories of land rent, the price of a land is a function of the cost of transporting various products to buyers (Andersson, 2005, p. 25). Along with the stated classical and neoclassical theories, one can find a negative correlation between the costs of commuting and transportation and the price of the land. To put it in plain language, there is a trade-off between increasing marginal land price and decreasing transportation cost. One problem with classical and neoclassical theories would be the assumption of perfect knowledge. The lack of knowledge about the transportation requirement and cost is one that is disregarded in coming up with the theory. So, how could one determine the accessibility from the price of the land? Land may be rented or bought as it is perceived as a profit opportunity through the entrepreneurial process and discovery. So, one may choose a location that is an exploitation of a perceived profit opportunity. The entrepreneur may have some quantitative knowledge of where the state-of-the-art of his line of business is located and he may have supplementary locationspecific knowledge through a number of personal relationships in various locations (Andersson,

ENTREPRENEURSHIP 2005, p. 26). Through a search on historical prices and land prices with various characteristics,

one may unintentionally switch on her indirect knowledge and recognize profit opportunities. To continue the discussion the paper will now open the discussion about land and its market. The Market for Land. The theory offered by Fetter (1905) is useful in understanding how entrepreneurs can change prices in the land market. Here is the summary of what he has offered in explanation of rent that makes the discussion more vivid: We are using rent to mean the unit price of the services of any good. It is important to banish any preconceptions that apply the concept of rent to land only. It therefore applies as well to prices of labor services (called wages) as it does to land or any other factor. The rent concept applies to all goods, whether durable or nondurable. The price of the whole goods, also known as the capital value of good, is equal to the sum of expected future rents discounted bythe rate of interest. (Rothbard, 1970, p. 417-18, quoted in Andersson, 2005, p. 27). One implication from the stated summary is that the value of all production goods can be measured in two ways: either a rent or a capital value. The simple difference between the two is that rent refers to a payment for a temporary use as opposed to the capital value which is a payment for a permanent use or ownership. The rent or the capital value is the expected streams of value added by the resource, the land (as it is the topic of the discussion here). Regardless of the entrepreneur buying or renting, the price must reflect the profit opportunity potentials of the location from that point forward. Other point worth mentioning is that the change in the land use may also cause a price change. As the population increases and urbanization occurs the purpose in the use of many locations may change. For instance, many farm or agricultural areas may change to residential building, a factor that can cause higher demand and thus, a price hike in the

ENTREPRENEURSHIP land. So, one may conclude that accessibility, in addition to the expected flow of value added, is yet another factor that determines the price of the land. Profits, Rents, and Migration Up to this point the discussion contained rent and its permanent form capital value. Now let the discussion turn to migration and how entrepreneurship plays a part in the process. Labor, which is the other factor of production, is mobile, as opposed to capital; however, regarding labor it is worth noting that, an analysis that makes use of Kirzners theory of entrepreneurship and Fetters theory of rent shows that it is the same entrepreneurial process that coordinates the two spatially distinct market (Andersson, 2005, p. 29). The entrepreneurial process could also buy labor in a particular market and sell for higher in a different market in presence of price differentials. The entrepreneurship in the labor market is what causes migration, and for a labor

to go from a lower paid location to a higher paid location, where it is known as the labor market. Here again we see how an entrepreneur will attract imitators that will increase the rent (the perceived opportunity cost) that accrues to workerswhile reducing revenues in product markets until the pure profits of the original entrepreneur have been wiped out (Andersson, 2005, p. 29). In case the labor migrates and profits from the price differential herself, she becomes the entrepreneur, and in the meanwhile the urbanization occurs as this group of entrepreneurs relocate in search of a promising opportunity. In this case, where the labor becomes the entrepreneur, she realizes that the revenue from selling her service in one market exceeds the cost of buying the same service in the previous location. The change in location of masses who realize this profit opportunity will cause the lack of labor in the previous labor market and causes the price of labor to rise. Same procedure causes the opposite effect in the latter market, and thus unifies the labor price. Hence, equilibrium is reached.

ENTREPRENEURSHIP Concluding Remarks Adding a new extension, the spatial aspect, to the entrepreneurship theory expands ones understanding about the theory as well as its implications. The spatial extension was clearly capable of explaining some phenomena like rent prices and migration. It illuminates how rent is determined based on expected future profit opportunities, and how labor uses the wage differential to materialize a profit opportunity that eventually leads to migration. The new extension is also able to describe how this process causes urban and regional developments by increasing the demand of land and labor, or what some refer to as the capital and human capital. The main point that is to be emphasized here is the fact that the bigger price differentials in a freely transferable property rights will lead to a stronger coordinating and equilibrating tendencies in a market that is driven by entrepreneurial activities.

ENTREPRENEURSHIP References Andersson, D. (2005). The spatial nature of entrepreneurship. Quarterly Journal of Austrian economics, 8(2), 21-32.

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Korres, G. M., Papanis, E., Kokkinou, A., & Giavrimis, P. (2011). Measuring Entrepreneurship and Innovation Activities in E.U. Interdisciplinary Journal Of Contemporary Research In Business,3(3), 1155-1167. Salerno, J. (2008). The Entrepreneur: Real and Imagined. Quarterly Journal Of Austrian economics,11(3/4), 188-207. doi:10.1007/s12113-008-9043-5