 Freedom is important from many perspectives. Economists argue that freedom permits the economy to be efficient. By saying that, economists are not denigrating other possibly more important moral grounds for supporting freedom. But we are arguing that a society based on freedom can confer economic benefits, benefits having to do with efficiency that are important and that should be recognized. The question is, how is that the case? Why is it that economic freedom promotes efficiency? After all, freedom permits individuals to act as they wish, to act almost unpredictably. That's what freedom means. And the more one recognizes the potential of individuals to act in possibly unsystematic ways, the more paradoxical it becomes to make the claim that out of such freedom, out of such apparently unsystematic behavior, there can occur, there can emerge regularities that ensure at least a tendency towards efficiency and the elimination of waste. There is a deep-seated paradox here. I came across a quote from a non-Austrian economist, a very eminent economist, Willan Smith, who wrote his follows. The pricing system, how is order produced from freedom of choice, is a scientific mystery as deep, fundamental, and inspiring as that of the expanding universe or the forces that bind matter. There is an intellectual problem here, a challenge which economists have faced for 200 years and it has still not been completely solved. We as economists should not believe that there is no paradox here. There is a deep mystery here, how out of freedom there emerges order. Out of apparent chaos there emerges indeed an orderly universe which guarantees a tendency for coordination. This of course is Adam Smith's invisible hand, but giving it a name doesn't explain how it occurs. Now the procedure of standard economics, the procedure of mainstream microeconomics is to model the economy, that is it is to abstract from certain aspects of human behavior and to imagine a world in which people were not unsystematic, to imagine a world in which freedom is used in a rather systematic way and in effect standard economics achieves its results by considering individuals to be maximizing machines who indeed come on the scene with their own independent scales of values, their own scales of preferences, but who once they come into the scene with these scales of preferences can be guaranteed to behave in clockwork like fashion and to interact with others in clockwork like fashion by abstracting from the unsystematic aspect of human behavior standard economics hopes and has to a large extent succeeded in presenting a body of theory that indeed seems to explain efficiency, seems to explain the pattern in which an economic system can avoid waste. But as I say, there has been a price that has paid in order to achieve this mode of understanding and when we understand the price that has paid I am afraid that we have to wonder whether the price was worth paying, in other words whether what has been achieved is satisfying and satisfactory. I opened a textbook on intermediate microeconomics the other day and I find that the author quite frankly says in this textbook we are going to assume make three assumptions, we are going to assume certainty, we are going to assume pure selfishness and we are going to assume purely calculative rational behavior. In a world in which everything is known, remember certainty, certainty in the sense in which the textbooks are using it is a very demanding assumption. Not only do I know what you are going to do but you know that I know that and I know that you know that I know that. Add infinite item. So it's a very demanding condition which standard economics is making that everybody knows everything. I would say it is a paralyzing condition. Once you really think into the meaning of assuming that everybody knows everything that I know what you are going to do and you know that I know it. Once you carry that through to the extreme you have paralyzed the system in a manner which really is most unsatisfactory and is most disturbing when we try and apply a model of that kind to the real world. Now textbooks are perfectly frank. They say we are making these assumptions not because we really believe they are true but this is because this is the only way in which we can sort of get a handle on what happens in the real world. Selfishness, it is assumed that each individual is strictly homo economicus in the most crass form of most crass conception of what that means. Each individual is absolutely bereft of any ounce of altruism of anything else except a complete urge for selfish materialistic consumption and complete rationality nobody ever makes a mistake. Everything is calculated down to the T no impulse, no emotion. Well, there are problems with these assumptions. The problems with these assumptions are that these assumptions confine us if we take these assumptions to their ultimate implications these assumptions confine us to a state of complete mutual coordination that is to say they require us to perceive the economic system as one in which every single decision is already prereconciled with every other single decision being made in the system. Now there is a very impressive intellectual feat to develop in detail to develop in conceptual detail exactly what an economy would look like where indeed every single decision was completely coordinated and fully dovetailed with every other decision. But when we ask how does this relate to the real world what we have to recognize is that these assumptions confine us to the intersection point of the supply and demand curve for each market not in equilibrium only but in equilibrium always. That is to say we are confined to understanding the real world as always being always in full coordination so that if you see something in motion if you see somebody on his way to mail a letter there is no disequilibrium there that I have to get to mail the letter because I haven't yet completed my goal I am exactly where I have to be exactly where I have to be every moment of time every individual is exactly where he or she has to be and to be a bit closer to the mailbox would have been inefficient because that would mean that I would have had to run a bit faster and every single decision is completely dovetailed with every other single decision at every possible moment of time there are no mistakes there are no discoveries there are no surprises and there is no explanation because in a world where mutual knowledge is incomplete and has to be incomplete the great intellectual challenge that faces us is how individuals who are free individuals who are not centrally controlled how they manage to generate economic order through their free activities this is the mystery that Vernon Smith pointed out it is a deep and profound mystery how does order emerge out of freely a mass of freely made decisions where knowledge is imperfect where emotions have their part to play in particular and I have an axe to grind here in standard economics there is no room for the entrepreneur there is no room for the entrepreneur the entrepreneur is an individual who is characterized by boldness he is characterized by vision by hunch these are the raw materials of entrepreneurial success or failure and surely when we think of these matters of boldness, of impulse, of hunch surely they seem to render the possibility of systematic determinant chains of events remotely unlikely because we are in the hands of entrepreneurs who are unsystematic by very definition so in order to perceive regularities amidst the apparently chaotic vagaries of real world entrepreneurial volatility it seemed to mainstream economics that it was a methodologically valuable ploy to imagine away the entrepreneur in standard economics there is no entrepreneur there can be no entrepreneur because in a world in which all decisions have been completely coordinated there is no opportunity for profit there is no opportunity for loss everybody knows everything if everybody knows everything there is no room for any entrepreneur who can think that he knows something that other people don't know everybody knows everything and everybody knows that everybody knows everything so we have this bizarre this bizarre circumstance that standard economics proceeds to try and understand how a market works by deliberately excising from their models those individuals who are after all the central figures in a market economy how can you analyze a market economy by imagining that there are no entrepreneurs it is I believe bizarre and yet that is the way in which mainstream economics proceeds it's as if we are saying that you want to understand the real world you can ignore entrepreneurs you can imagine that what they do can be sort of filtered out it's true that entrepreneurs act on hunches it's true that entrepreneurs are bold it's true that the headlines in the business pages every day are telling us about bold new moves by entrepreneurs but that doesn't matter you can ignore that that's just headlines you can filter that out and the real important the really important determinants which ensure coordination are what happens when you filter that out and it's the fundamentals which in effect generate the order that we see we see order we observe order empirically we observe order we see that the market works you don't need faith in the theory to see that the market works you need a theory to understand how what we see is true and standard economics proceeds by providing an explanation which gets off the ground only after it carefully deletes all of those activities which are the most obvious and most visible activities in the real economic world what I shall argue of course is that a sounder approach to economic understanding does proceed exactly from the opposite direction and I am I won't say I'm exaggerating but I am emphasizing the distinction between an Austrian approach an entrepreneurial approach and the mainstream approach I am emphasizing that distinction not because I believe that the mainstream theory has no value I think it has great value enormous enormous value but I think that that value is reduced when the line is mudded that separates a mainstream approach from an Austrian entrepreneurial approach and I think for purposes that we are here this evening understanding the paradox of order out of chaos it is important to emphasize rather than to smudge that line of distinction and the paradoxical truth that I will try and develop here this evening is that the explanation for economic order is to be found not by filtering out the unsystematic activity apparently unsystematic activity of the entrepreneur but just the opposite the explanation lies strictly and purely in understanding what entrepreneurship means and what it does and yes there is order in a market system and the source of that order is entrepreneurial activity and this simply underscores the paradox that we are discussing this evening well how is it then that precisely the unsystematic activity of bold impulsive visionary imaginative entrepreneurs how is it that it is precisely their activity which I believe can be called upon to explain and account for the co-ordinated properties the orderly properties in a market economy now the short answer will develop a little bit more detail this answer but the short answer is that what seems to be unsystematic is because we observe the entrepreneur from the outside we observe the entrepreneur without seeing what the entrepreneur sees the entrepreneur sees opportunities we don't see them if we saw them we'd be the entrepreneurs as I say I teach about entrepreneurship but if I could see what entrepreneurs were doing I wouldn't be teaching entrepreneurship I'd be the entrepreneur so we and I use this in the sense of observers of the social scene who remark on the unsystematic character of entrepreneurial activity we see this activity from the outside without seeing it from the perspective of the entrepreneur himself or herself entrepreneurs act in a very systematic way they see opportunities and they grasp them nothing unsystematic about that but to see entrepreneurs excuse me but to see opportunities requires a very special kind of vision entrepreneurial vision and that requires that the entrepreneur act in ways which others who have not seen what the entrepreneur is seeing requires that the entrepreneur act in ways which would seem unsystematic would seem impulsive would seem to be disorderly from the point of view of the outsider there is method in entrepreneurial madness what seems to be unsystematic and without method turns out to be easily understandable once one recognizes what an opportunity consists of where an opportunity comes from what creates an opportunity and what the role of seizing an opportunity is in achieving order I would put it this way opportunities are created by errors opportunities are created by absence of perfect knowledge if everybody knows everything there are no opportunities left nobody who knows everything is going to act in a way that will leave a known opportunity unceased and ungrasped so by postulating certainty and perfect knowledge one is excluding the possibility of discovery of opportunity but we have to start the other way to recognize that we live in a world of uncertainty we live in a world of imperfect knowledge not merely imperfect knowledge in the sense that there are books in the library that I have not read that I know that I have not read because those books that I have not read the mainstream economists can understand that too he understands that there are books that it doesn't pay to read the cost of reading them so I know there are languages that I haven't learned I know there are important sciences that I have not mastered because time is scarce life is short and consequently we don't memorize all of the numbers in the telephone book we are ignorant of telephone numbers who cares we are optimally ignorant we know exactly the number of telephone numbers that it's worth while remembering and the rest we know where to look them up if we'll need them standard economics can grapple with that there's no problem imperfect knowledge that's relevant to our task means imperfect knowledge that we don't know that we don't know imperfect knowledge means that there are opportunities out there that I would have grasped if I would have known them I would have grasped if I would have known how to achieve them but wish we do not know that they exist that is the kind of imperfect knowledge that we have to grapple with we have to deal with the phenomenon the central phenomenon of the human existence is that we don't know what's behind us not simply that we know there is something we haven't read but we don't know what there is there that's the human condition we don't know what's behind us and we don't know how rapidly to look around we don't know whether we should be revolving all the time and even if we do revolve we don't know for sure what it is we've noticed and what it is we haven't noticed when you walk down the street millions of images impinge on the retina of your eyes not all of them register you don't notice everything you see everything but you don't notice everything how many of us have paid any attention to the pattern of the floor we haven't noticed everything we can't we can't that's imperfect knowledge that we haven't noticed everything and there are things that we don't know that we don't know and once we recognize that there is this kind of imperfect knowledge the ubiquity of error is a phenomenon of the world that we cannot assume away it's central it's a central phenomenon of the world the world is saturated with error without blame what we don't know we don't know what we don't know that we don't know we certainly don't know we certainly don't know now there are two kinds of error I think it would be helpful if we classified error into two kinds there are over optimistic errors and over pessimistic errors let's talk about over pessimistic errors for the time being and I will if you will bear with me I will explore a limited a limited bit of economics with you if there are two markets room A and room B this is room B room A there is a market and room B there is a market and there are people there willing there to pay high prices for a commodity which I have but I'm not aware that there's a market there I'm not aware that the prices there that are higher than I can sell my goods for here I will be selling goods here for a price that is low and the price I could have got I'm over pessimistic why do I sell here why do I sell for 10 when the price over there is 20 I sell for 10 because I believe that 10 is the highest price I can get I wouldn't sell for 10 if I could think I could get 20 not because I'm selfish but because I'm purposeful and the reason why I'm selling is because I have purposes in mind selfish purposes maybe but maybe altruistic purposes zero maybe I want to sell the goods in order to support a hospital whatever it is I'm not going to sell them for a less than the highest price and if I think that if I'm selling for 10 that is evidence that I think that the highest price I can get is 10 not more than 10 but in fact there are people there paying 20 I'm over pessimistic conversely the people who are paying 20 in the next room they're over pessimistic they would never pay 20 if they knew that there were sellers in this room selling for 10 why are they paying 20 because they're unaware they're over pessimistically unaware they believe they believe that the lowest price at which they can buy the commodity is 20 that's why they're paying 20 over pessimism generates the phenomenon of two prices two prices for the same commodity now a great British 19th century economist William Stanley Jevons developed what came to be called the law of indifference which means that there is a that there is a law which argues that there must be a single price for the same commodity throughout the market now that is true as a result of the market activity but certainly there can be more than one price for the same commodity when you recognize the possibility of over pessimistic error over pessimistic error generates the phenomenon of more than one price for the same commodity but this error this over pessimistic error that resulted in more than one price for the same commodity by that very token this is where the marvelous mystery of the market begins to unfold begins to open up that error generates a profit opportunity those errors the over pessimistic errors have resulted in two prices which means it is now possible to buy a 10 and sell a 20 error has generated a pure profit opportunity a pure profit opportunity has the capacity to attract entrepreneurial attention entrepreneurs have antennae they can smell profits around the corner and we are all entrepreneurs that's something that my great teacher Ludwig von Mises emphasized all human action is entrepreneurial all human action involves guessing what's around the corner to some extent because we live in a world of uncertainty we live in a world in which the future is unknown we live in the world in which we don't know what it is about the future that we don't know so we are all acting by taking stabs at what the future may hold and we all have this sense that's what to be human means to have the sense of somehow sensing what is around the corner so the two prices which result from the over pessimistic error generate a profit opportunity which attracts attention entrepreneurial attention entrepreneurs move in to buy a 10 and sell a 20 and what happens when they do that the price where it was 10 rises the price where it was 20 falls so Jevons was right after all there is a tendency for a single price to emerge not because we start out by assuming perfect knowledge well of course if you assume perfect knowledge it can only be one price who is going to pay 20 if someone else is selling for 10 who is going to sell for 10 if someone else is paying 20 so if you start out by assuming perfect knowledge if you start out by assuming we all live in glass houses and we know exactly what everybody else is doing and we know that everybody else knows that everybody else knows etc. at infinite then you are frozen paralyzed into a situation where there can never be more than one price but if you recognize the role of error you begin to recognize that the market contains a marvelous self-operating autonomously operating system which sponges up information on these kinds of over pessimistic error and transforms the market into the co-ordinated direction moves the market in the co-ordinated direction as a result of what? as a result of the entrepreneurial vision what was responsible for bringing one price out of two prices what was responsible for generating the correction of these errors entrepreneurial vision of a pure opportunity that was generated by error this is what drives the market what drives the prices together what guarantees a tendency for prices to move towards each other is entrepreneurship it's not that you can understand the market by filtering out entrepreneurship you can only begin to understand the market when you introduce entrepreneurship then you begin to understand how the market works when one recognizes the simple elements of economics and I recall it was in 1960 I believe at a conference at New York University where Hayek and Friedman and a number of others were there I believe Leonard was there at that time I remember at that time Hayek pointing out to the law of the single price as being the single most important economic law of all and that made an impression on me and I think it's absolutely correct because when you understand what the law of single price means and you understand how far reaching it is it doesn't only apply to apples being sold in room A and apples being sold in room B it applies right across the market where you're talking about resources moving from one industry to another where you're talking about labor migrating from one part of the country to another you're talking about entrepreneurs snapping up scarce resources and bidding them away from other industries you're talking about two prices you're talking about entrepreneurs you recognize that you can buy steel in one part of the country and put it to work in construction in another part of the country and make a profit what in fact is occurring is that the entrepreneur is sensing the presence of two prices for the same ton of steel two prices for the same barrel of oil if oil is currently being used and prices is a production that of less value to consumers the price entrepreneur price presently being paid for that oil is less than the price which the visionary entrepreneur recognizes the error is less than the price that he will be willing to offer for the oil to transfer it to the more valuable industry where consumers are willing to pay higher prices for the product of that oil so resources move across the country move across the economy in response to entrepreneurial vision what is it that they are seeing they are seeing two prices for the same commodity two prices for the same resource two prices for the same person hour of labor two prices for the same ton of steel two prices for this for the same weight of cement this is what moves resources entrepreneurs don't have to be central planners entrepreneurs in exercising their wholesome and corrective activity do not have to be thinking about anything else other than grasping opportunities for pure profit but in so doing, what are they in fact doing they are identifying errors that have been made over pessimistic errors that have been made where resources were used in industries that are of less importance to consumers than the other industries where these resources might have been put more valueably to work what about the other kind of error over-optimistic errors over-optimistic errors are much easier to understand an over-optimistic error is for example where sellers believe that they can sell for 30 now if everybody believes you can sell for 30 and buyers believe that the price is going to be 30 the price will be 30 but over-optimism means that sellers believe that at a price of 30 they can sell as much as they would like to sell at 30 and that may be wrong it could be that the eagerness of buyers to buy a particular product at 30 is much less intense than the sellers have believed so sellers are holding out for a high price because they're wrong, they make a mistake they over-estimate the willingness of buyers to buy or it could be that buyers are insisting on a low price because they over-estimate the eagerness of sellers to sell in each of these cases of over-optimistic error this error is corrected much more easily much more easily because you soon discover how wrong you were you soon discover that you were over-optimistic you don't need to see something which other people haven't seen you simply have to face reality you're left with unsold goods on your shelves you realize that you're asking too high a price you were standing online expecting to be able to buy at 5 and long before you reached the counter all the goods had been sold you realize that the eagerness of sellers to sell is not as great as you thought it was you thought there would be more goods forthcoming at the price of 5 and what do people do when they realize they've made mistakes well, they revise their anticipations if you've been over-optimistic you revise your anticipations downwards if you're a seller who's been hoping to get a too high price you're lowering the price that you ask if you're a buyer you raise the price that you offer and what happens as a result of this prices that are too high tend to fall prices that are too low tend to rise what is responsible for this? Error what is responsible for the correction? the discovery of error so both with respect to over-optimism and over-pessimism and we're going through some very elementary economics as you can see but we're going through it with a special emphasis on the importance of departing from the fundamental assumptions of mainstream economics we can get to first base in this elementary economics only by denying the assumption of certainty only by denying that errors are not made only by denying that opportunities don't exist it's only because errors are made it's only because knowledge is imperfect utterly imperfect in the sense that we don't know what we don't know only because of that are there opportunities that are not grasped only because of that is there a scope for entrepreneurship and it is only because there is scope for entrepreneurship that there is indeed a systematic market process whereby errors tend to be discovered and corrected this is the entrepreneurial view of the market process so once again the paradoxical result emerges that the order that we perceive in a market the tendency for prices to converge not merely to converge to one price but to converge to the price that clears markets the market clearing price the tendency towards a market clearing price which emerges spontaneously in a market emerges only as a result of the errors that are made and discovered by profit seeking entrepreneurs is there paradox? maybe maybe but we can understand the solution to the paradox order emerges from the vision by entrepreneurs and to the outsider I repeat to the outsider this vision seems to be unsystematic it's recognizing what other people have made errors it's recognizing what other people have not seen it's recognizing what is around the corner which nobody else sees that is what is at the root of the market process of the entrepreneurial market process and this is the solution to the paradox order out of chaos are there potential problems with such a starry-eyed view of the market? yes there are yes there are and on all honesty I must never forget that my late eminent colleague Ludwig Lachman used to emphasize the risks that entrepreneurial activity may frustrate the anticipations of others and economists have debates on this economists do have debates as to the extent to which entrepreneurial activity in one part of the market can be relied upon systematically to correct all errors or to the extent to which such activity may in fact frustrate the vision of other entrepreneurs so I don't want to overemphasize I don't want to exaggerate the co-ordinated capacity of markets but we see that markets do coordinate our problem is not to predict whether or not markets will coordinate we see that markets coordinate we see the enormously intricate division of labor where without central direction great cities get fed that was Bustillat's example how does Paris get fed? great city of Paris enormous quantities of food converge on Paris who ordered them? who arranged it? who managed to make sure that there is a reasonable reasonable configuration of exactly those kinds of foods that the citizens of Paris need in any particular day the enormous complexity of modern economic life and the enormous prosperity of modern economic life tells us that coordination occurs and the great mystery as Wynn and Smith put it the fundamental scientific mystery is to explain how on earth such coordination can occur and the solution is that coordination occurs through entrepreneurial activity where entrepreneurial activity is profit-motivated the motivation of a pure profit not selfish necessarily it's purposeful people pursue profits where they see them because where profits permit them to achieve their own purposes whatever they are altruistic selfish or whatever this is the driving force of the market and this is what brings about the tendency towards coordination let us return to the question of economic freedom I'd like to contrast once again the picture of the world painted by standard theory on the one hand and the picture of the world painted by an Austrian entrepreneurial approach on the other in terms of what it says about freedom what the standard picture tells us and once again let me add as a footnote here I do not wish to be understood to denigrate the importance and the value of mainstream economics there are important problems important work-a-day problems of economics where the assumptions of the textbooks are highly useful when Mises used to talk about the consequences of rent control he was a mainstream neoclassical economist he was assuming equilibrium but if one wants to understand the operation of the market if one wants to understand how markets coordinate if one wants to solve this fundamental scientific mystery of how order emerges out of chaos we need an entrepreneurial approach and once one recognizes the role of the entrepreneurial approach and the role of entrepreneurial competition I use the word competition because entrepreneurs are inspired to see by what they feel breathing down their necks the competition of fellow entrepreneurs that inspires people to notice that puts people on their toes none of us is as active and as alert as one is have it not been for one's very well-grounded fear that there are others who will grasp the opportunities that lie before one's nose so we are pushed to be alert to notice to what is in front of us by competition and competition simply means absence of privilege competition simply means freedom of entry that no one should be borrowed from pursuing an opportunity which he or she perceives this is what we mean by competition not anything that has to do with textbook perfection of competition or anything like that competition simply means absence of privilege now let's consider the implications of all this for economic freedom the picture of the world painted by a neoclassical mainstream textbook is that if we all know everything if we are all captured and molded in a way we are all imprisoned as it were in a scene where every decision that we make has been pre-reconciled with every decision that every other participant makes then under those circumstances we are led as if by an invisible hand to do what is efficient and what is somehow good for society but let's just think about that for a moment what does that mean? that means that if everybody is already put in the right place freedom will result in people being in the right place that doesn't sound very interesting at all in fact it sounds almost trivial it's telling us that if you if people have already been told you can be free to do whatever you want provided you do that which you would have been which you would have done had everybody known everything including yourself what is the value of such freedom? what is the importance? what is the economic importance? of saying we don't need a central direction whereas if one understands as Austrian economics does understand that the coordinated properties of the market arise out of the free decisions of the entrepreneurial participants not just big entrepreneurs each one of us as I quoted from Mises each one of us is an entrepreneur if each one of us is permitted to pursue the opportunities which he or she perceives if we are permitted to see and to gain by what we think we see if we are permitted to do that we will be led as if by an invisible hand to see the errors that have been made we will be led we will be pushed ourselves to reduce the number of errors we make such errors consisting in overlocking opportunities such errors consisting in over-optimistically expecting things that cannot happen we will be led as if by an invisible hand to be alert to what others are able to do and to what others are able to permit us to do and this is what is responsible for the tendency to efficiency once again there are no doubt profound moral ethical reasons to celebrate a society of free individuals the economist is a very modest role the economist role is to show that by permitting individuals to pursue what they think they see we are encouraging a prosperous society a society in which individuals can achieve the goals that they wish to achieve whatever those goals may be then if one recognizes this one understands the role of freedom in a way which I believe can make a real and genuine contribution to the kind of society that we want to live in and I thank you very much