 Good morning and welcome to our first named lecture, the FA Hayek lecture. Our speaker this morning, Nikolai J. Foss, was invited by me to give this lecture. I had been familiar with some of his work and I thought I knew most of his work, but as it turns out I was merely familiar with a fraction of it. Nikolai is one of the most productive Austrian scholars in Europe, if not in the world. He was born in Denmark. He has residences in both Denmark and Norway. He received his PhD degree from the Copenhagen Business School in 1993. Currently he's professor of strategy and organization at the Copenhagen Business School, a part-time professor of knowledge-based value creation at the Norwegian School of Economics and Business Administration, and the head of the Department of Strategic Management and Globalization at the Copenhagen Business School. He also holds part-time and visiting professorships at several other leading universities in Europe. He is the founder of the center, now the Department of Strategic Management and Globalization at the Copenhagen Business School and currently serves as its director. Foss is a panel member of the European Research Council. He was one of the founders of the Danish Research Unit for Industrial Dynamics and a co-founder of the Libertarian-Conservative Center for Policy Studies, the most influential privately-funded think tank in Denmark. Professor Foss's prodigious publications include 136 journal articles, 81 book chapters. In addition, he is authored or edited 22 books and several have been published by very high-profile publishers such as Cambridge University Press and Oxford University Press. His work has been published in the Academy of Management Review, Academy of Management Journal, Organization Science and several other leading journals. And he serves on the boards of 18 journals. Several of his articles and books have been translated into Chinese, Spanish and Russian. So I could go on and on, believe it or not. I had to edit this down. But without further ado, it's my great pleasure to introduce Nikolai Foss. Well, thanks a lot for the very kind introduction and the invitation. I want to say I'm particularly honored and delighted that this lecture is named after Friedrich Hayek. Back in the mid-1980s, when I was still an economics student and discovered Austrian economics, Hayek's works, particularly his knowledge essays, if you like, were really my first discoveries of Austrian economics. Discovery that was prompted by the writings on Keynes of Axel Leyenhoefhut. If you're familiar with Leyenhoefhut, he's a great Swedish now retired economist who tried to make sense of Keynes from or through a Hayekian lens. A project I suppose was pretty much doomed to failure. But that's what he tried to do. And his books from 1968 on Keynes in Economics and the Economics of Keynes is most definitely worth a read for Austrians who are interested in macroeconomics. But back to Hayek, his works have influenced me ever since I discovered them about 30 years ago, or 25. So it's only appropriate to pay homage to Hayek in this lecture, and I should really try to do so. And one way I'll do that is by diverging from my usual business school professor presenting format, which is about, you know, jumping frenetically in front of my PowerPoint slides and strolling the aisles and so on. I'll adopt a relatively civilized posture and stand here and read my talk in an appropriate Germanic perhaps, style, perhaps Hayekian. But I should also pay homage in a more substantive way, namely by talking about a favorite Hayek topic, namely that of capital theory. As we all know much of Hayek's early work of course concerns capital theory either directly or more indirectly as of course in Hayek's elaboration of Austrian business side of theory. But I would go so fast to argue that capital theory may really be in some sense a foundation of all, virtually all Hayek's work in economics. Now this is obviously the case for what was intended to be the first volume of Hayek's projected, but unfinished Magnum Opus, namely the pure theory of capital which as the title indicates is indeed a book about capital theory. Some of you may have tried to read it and some of you may also know it's a true classic. It's cited by very few people. It's not read by even fewer and it is certainly, I think, unreadable. One of the most difficult books I ever tried to read definitely. I've argued myself in an old paper published back in 1996 in the history of political economy that capital theory played a crucial role in prompting Hayek's thinking about the challenge to economic theory represented by disposed knowledge. Roughly the argument in my old paper is that the knowledge-based challenges of inter-temporal coordination of a structure of heterogeneous capital which as Roger Giresen has often told us is the essence of Austrian macroeconomics, led Hayek to think carefully about the role of knowledge in economic affairs. So it's quite crucial, foundational even to significant parts of Hayek's thinking. But there are many other interesting ways in which capital theory makes an essential connection to other parts of the Austrian corpus, as it were. There's, for example, an obvious relation between heterogeneous capital and the Misesian calculation problem. Mises was probably not led to the discovery of the calculation problem merely by noting the presence of heterogeneous capital in economy per se. Because even if capital were homogeneous, there would still be calculation problems. Left, for example, how much capital, homogenous capital in this case, to devote to production now versus later. So calculation problems wouldn't evaporate if capital were homogeneous. But these calculation problems would surely be much more trivial compared to the situation with heterogeneous capital. So to Mises, the entrepreneur and heterogeneous capital goods are really complementary phenomena. To some extent, two sides of the same coin. As Mises says, and I quote, the various complementary factors of production cannot come together spontaneously. They need to be combined by the purpose of efforts of men aiming at certain ends and motivated by the urge to improve their state of satisfaction. Lachman in the book on capital theory that Peter Klein mentioned earlier this morning, echoes Mises stating that, quoting, the entrepreneur's function is to specify and make decisions on the concrete form the capital resources shall have. Specifies, modifies the layout of his plant. As long as we disregard the heterogeneity of capital, the true function of the entrepreneur must also remain hidden. I think these various examples of the role that capital theory play in Austrian economics suffice to indicate that capital theory is really fundamental in a sense of foundational and indispensable as part of Austrian economics, on par with subjectivism, dispersed knowledge and entrepreneurial appraisement. And that it is, in fact, intricately woven together with exactly these things. So the implications of heterogeneity in capital theory go really much beyond the Austrian theory of the business cycle. Of course, my sense is that Australians are perfectly aware that they stand apart on the issue of capital theory and they insisting that there is, meaningfully, such a thing as capital theory which goes beyond corporate finance and the theory of investment behavior is almost a bit of an oddity in contemporary economics as Roger Garrison again has noted. However, seems to me that surprisingly, Austrian capital theory is also a bit of an oddity in contemporary Austrian economics. So to illustrate, just loosely, out of the 197 articles that were published in the review of Austrian economics, from 2002 to 2011, both years included, only 11 dealt directly with capital theory. The quarterly journal of Austrian economics is doing better, but only slightly better. There are 189 articles in the same period and there are 15 of them that deal directly with capital theory. That's somewhat better performance. One could may fear, of course, that this reflects a belief even among Austrians that Austrian capital theory somehow lost the historical debate that the Cambridge capital controversies of the 1960s proved that this is just one big mess, that Schrafer and Knight really proved that Austrian capital theory was full of internal contradictions and so on. Whatever that may be, I want in this talk to argue that Austrian capital theory should make something of a comeback as a really crucial item on the Austrian research agenda. I should say that in arguing this point, I'm also wearing my management scholar's hat, it should make a comeback as essentially a part of the theory of production. That is the theory of the economic process of converting inputs to outputs, perhaps rather than as a part of the theory of distribution or even the theory of interest. But as a part of the theory of production, the Austrian theory of capital stresses the heterogeneous nature of capital assets, the subjective nature of capital as a part of the entrepreneur's plan and of course the time dimension of production. Thus understood, I think this is pretty uncontroversial, but thus understood at least the Austrian theory of capital has opportunities for theoretical developments that are not yet fully explored. And what I shall do today is to examine some of those opportunities in the context of business firms. Drawing on my work with Peter Klein among others, and I should also argue that looking at heterogeneous capital in the context of business firms provide an important underpinning of our understanding of the sources of economic growth. Prenuall issue in economics, since Adam Smith. Here's my title, Austrian ideas on heterogeneity represent an important challenge to homogenizing assumptions in much of mainstream economics and in management theory. These ideas, these Austrian ideas, not only challenge, but they can also constructively further our thinking on firms and the growth process. Potentially establishing Austrian economics as a highly relevant voice in the contemporary discourse on firm organization and economic growth. Now in his treatise on Austrian capital theory, called Capital Theory in Disequilibrium, Peter Lewin notes that Austrian capital theory has become synonymous in the literature with Böhm-Baväckian capital theory. So capital theory is often equated with questions like, is capital a fund? What's the nature of the owning of capital? What determines these earnings and so on? One of the latest restatements and refinements of Austrian capital theory, namely Rothspaths in main economy and state, of course deals with these important questions as well. These are conceptual questions, obviously, they're distributional and they are quite often sort of couched in a macro language. If you look at Böhm-Baväck, I think, and Hayek, at least in prices and production, they're impressions of a leaning to the macro side. Hayek, Böhm's concentric circles, if you remember them in his Capital Interest treatise on Hayek's triangles in prices and production, of course, allow for implied perhaps capital heterogeneity of capital goods, at least between those stages of production. Very little is actually being said about heterogeneity within the stages of production. But there are also notions of the average period of production, the total value of flow capital and so on. They are macro notions. And these macro notions are still pretty much the notions that are associated in the mind of mainstream economists, at least those mainstream economists, those few mainstream economists who have heard about Austrian capital theory with Austrian capital theory. So try reading Mark Blauch's economic theory of retrospect where he deals with and smashes Böhm-Baväckian capital theory and you'll see what I mean. I think there's a danger that these macro concepts may direct attention away from something very basic and very, very important in Austrian capital theory, namely the fundamental heterogeneity of capital. It seems to me that heterogeneity is a theme that becomes increasingly important in Austrian thinking on capital from about the mid 1930s. And my guess by conjecture, if you like, is that the development and the fate of Austrian capital, Austrian business cycle theory in the interwar period played a role here. So in, for example, Böhm-Baväck's basic stationary state, the specificities and the complementarities between all sorts of heterogeneous capital goods are very easily missed because all productive operations proceed smoothly as they must in a stationary state. The downturn of the business cycle, on the other hand, which Hayek had difficulties theorizing, I think, is very much about capital goods that simply cannot be profitably deployed to other uses for which they are not really fit. So as Dennis Robertson said in his variation on Austrian business cycle theory, work on the new cunardus will be suspended. We are left with a big mass of heterogeneous capital goods that just cannot be easily deployed. So heterogeneity in the downturn suddenly becomes of overriding importance. This is the Aquitania, supposedly the most beautiful of them all. It survived both the Böhm-Baväck cycles of meddling politicians and the German torpedoes before it was finally retired from service in 1950. But the point here is that there's a conjecture again, a conjecture in doctrinal history. But I would like to go further into this. And perhaps Roger Gerson or someone else here has thoughts on this. Seems to me that from about the mid-1930s, we see an increasing interest among Austrians in the heterogeneity properties of capital. I think Richard von Striegel in Capitalen Produktion is a really good example. Lachmans 20 or so years later capital and structure is another good example. So is Kirchner's neglected an essay on capital and Peter Lewin's contemporary work pretty much exemplifies this very strong emphasis on heterogeneity as perhaps the important aspects of Austrian capital theory. Now it seems to me that the key notion in all of this is the manjuring one that capital goods are essentially forward-looking components of multi-period plans. And as Mises argued, this conceptualization in itself invalidates the aggregation of capital goods. As Mises says, the totality of the produced factors of production is merely an enumeration of physical quantities of thousands and thousands of various goods. Such an inventory is of no use to acting. So as I indicated already this emphasis on heterogeneity and the subjectivity of capital goods in the entrepreneurial production plan seemed to me to move the theory of capital somewhat away from its traditional concerns with distribution and with interest theory and move it more towards the theory of production. But it's a special kind of theory of production that I'm talking about here. Austrian capital theory has actually often been compared to the economics of the classical economists. Higgs, as you may know, famously made the argument that the Austrians and the classicists shared pretty much the same emphasis on capital as a fund in the process he lumped together Bumbaverk and Hayek with Clark and Knight, rather absurdly. Mr. Rokersna has a great comment on this in the 1976 book, I think it's the, is that the salt of Royals on one or is it the later one? I think there's a spare derail one. But the point here is that the classical theory of capital is a part of the theory of production. The classical theory of distribution, sorry, the classical theory of production on the other hand is a theory of the progressive division of labor. And it seems to me that the Austrian emphasis on heterogeneous capital aligns closely with this aspect of classical economics, the progressive division of labor aspect, as Alan Young argued in a famous paper many years ago. Both involved time and heterogeneity and therefore the need for coordination. Both the classical theory of production and the Austrian theory of capital are sharply opposed to the way production is portrayed in modern economics, what we may call the production function U. As Axel-Lion Hufford, whom I mentioned earlier and here's how he characterizes the U of production in modern mainstream economics, the production function U. He says that the new classical constant returns production function does not describe production as a process, i.e. as an order sequence of operations. It's more like a recipe for bouyabase where all the ingredients are dumped in a pot. Cano, it's heated up, this is a function. And the output X is ready. This abstraction from the sequencing of tasks is largely responsible for the well-known fact that new classical production theory gives us no clue to how production is actually organized. Smith's division of labor, the core of his theory of production slips through modern production theory as a ghostly technological change coefficient or as an equally ill understood economies of scale property of the function. Now, what's the U of capital that is implied in the new classical production function U? I've discussed this at length with my more mainstream colleagues and they argue that as a purely mathematical approach the production function U is capable of handling both heterogeneity and time. In actuality, I think it is not. And this is perhaps best seen in modern mathematical macroeconomics models. Of course, mainstream macro models given their focus on economy-wide phenomena, you know, gross domestic and national products, employment, growth rates and so on, they tend to focus on aggregates, industries, sectors, whole economies, aggregation in turn per definition leads to some kind of homogenization. As a minimum, there must be some shared unit that the relevant items can be measured in terms of. Often, however, the assumption is explicitly made that everything within the aggregate is homogeneous. So mainstream macroeconomic theories, whatever their stripe, all adopt the assumption that production firms, industries and economy are homogeneous and fungible. So labor means homogeneous, labor units, capital has the same interpretation. You know, Paul Samuelsen, later Robert Solo, is Paul Samuelsen to the left in the slide. Adopted the imagery of Schmu from a comic called Lil'Apna that some of you may recall. Schmu's are identical creatures, you can see them in the top of the slide, identical creatures shaped like bowling pens with legs. And they, of course, adopted this imagery to capture exactly this kind of homogeneity. So Samuelsen essentially said, for many purposes, it's perfectly fine to treat capital as if capital was Schmu. I think the plural of this is Schmu, naturally. But that's a whole website dedicated to Lil'Apna and these subtle details of high interest to capital theorists, obviously. This is a kind of reasoning, as Ludwig Lachmann reminded us, that originated pretty much with David Ricciardo. Of course, founded a very useful simplification in theorizing about distributional concerns and other things in the United Kingdom 200 years ago. It can be. But sometimes, and perhaps usually, economists' assumption of Schmu-like capital, in particular, and homogeneity in general, sacrifices explanatory scope on the altar of the tractability that formal mathematical economists so adored. And the underlying, the subtext is, the heterogeneity of capital doesn't really matter that much. Let's proceed as if capital was Schmu. So let me give you a few examples of why capital heterogeneity seriously matters. Examples that go beyond the Austrian business cycle theory. And I'll go as away from macroeconomics down to the level of firms, and then again from firms up to the level of economic growth. Now, so the bottom line here is that the Austrian perspective on heterogeneity as something quite essential has mostly been lost in contemporary macroeconomic discussion. There's a great quotation from Kenneth Bolding, who had certain Austrian leanings. From his review of Samuelson's Foundations of Economic Analysis. The review published in 1948. And Bolding says the following. It's a question of acute importance for economics as to why the macroeconomics predictions of the mathematical economists have been on the whole less successful than the hunches of the mathematically unwashed. This seems very contemporary, doesn't it? The answer seems to be that when we write, for instance, let I, Y, and capital I stand, respectively, for the interest rate, income, and investment, we stand committed to the assumption that the internal structures of these aggregates or averages are not really important for the problem in hand. In fact, of course, they may be very important and no amount of subsequent mathematical analysis of the variables can overcome the fatal defect of the heterogeneity. And I said, this sounds very, very contemporary because so much of the discussion surrounding, for example, the stimulus packages in US and in Europe has occurred at a very high level of aggregation. So despite the highly populous failures of the particular financial institutions like AIG, Lehman Brothers, and so on, government officials spoke in terms of the banking system, the financial system, the economy as a whole. Henry Paulson told Congress, you'll probably remember that in back in September, 2008, that radical steps were needed to avoid a continuing series of financial institution failures and frozen credit markers that threaten American families. And American families, financial well-being, the viability of businesses, both small and large, and the very health of our economy. So for example, the discussion of frozen credit markets focused on high level indicators with a focus on total lending, not the composition of lending across individuals, firms, and industries. The Federal Reserve Systems Actions noted Ben Anke were needed to increase liquidity and stabilize markets and so on and so forth. But it seems clear that a decline in average home prices, reductions in total lending, volatility in asset price indexes and so on, reveals very little about the prices of particular homes, the cost of capital for specific borrowers, and the prices of individual assets. So in analyzing the credit crisis, the critical of Christian really is, which loans are being made to whom and why? It is impossible perhaps to understand the origins of the credit crisis without looking at the lending practices of government-sponsored enterprises like Freddie Mac and Fannie Mae, and I don't really need to tell you this. And the various policies that encourage lenders to lower their underwriting standards on the assumption that in a sense, all borrowers were really equally credit worthy. So there is a sense in which assumptions about homogeneity during, of course, a period of rapid central bank credit expansion is at the root of the current financial crisis. As you all know, the critical issues here are the composition of lending, not really the amount. Total lending, total liquidity, average equity prices, and the like, all obscure the key questions about how resources are being allocated across sectors, firms and individuals, whether bad investments are being liquidated and so on. The aggregate notions homogenize, and in doing so, they suppress critical information about relative prices. The main function of capital markets, after all, is not really to moderate the total amount of financial capital it is to allocate capital across activities, of course. Now, if not all borrowers are the same, it's even more true that not all banks are the same, and that the Treasury's troubled assets relief program was designed explicitly on the premise that the banking system itself, rather than the individual banks, was in trouble. To avoid signaling the financial conditions of specific banks to the market, the Treasury insisted that all large banks take top funds, whether they want it or not, as you recall. Some 250 banks ultimately refused to participate in this. Now, such programs, of course, create strong adverse selection problems. Banks that followed more prudent lending policies did not invest in complex mortgage-based securities, and the like, they have little incentive to take government subsidies accompanied by government control of future lending and investment and even practices such as executive compensation. So by bolstering inefficient banks, creating incentives to keep issuing mortgages that ought not to be issued, in the interest of reviving the macroeconomy policy, such as the top scheme, are repeating the mistakes that caused the problems in the first place. And it all has to do with assumptions about homogeneity. Of course, generally, the U.S. stimulus packets and similar schemes and proposals around the world are characterized by a Kingston-style reliance on macroeconomic aggregates. Now, the common wisdom still really is that the bank crisis led to a collapse of effective aggregate demand and only massive increases in government expenditure, and certainly that can kickstart the economy. But in a world of heterogeneous capital resources, spending on some assets, but not others, alters the pattern of resource allocation in the economy and in a sort of path-dependent process, the overall performance of the economy in the future. In a world of capital heterogeneity, our world, capital assets just cannot be costlessly shifted from one activity to another activity as many of these schemes tacitly presuppose. And this is particularly the case in a modern economy in which so much capital is embodied in industry-specific, firm-specific, and worker-specific capabilities. For example, human capital. So there is a strong potential here for really deploying Austrian ideas on capital heterogeneity effectively in the context of a critique of conventional macroeconomics and crisis management. And I think we can all agree that this is a very worthwhile use indeed. So the function of economics as Mises reminds us as a weapon in the service of exploding fallacies and nonsense is not one of its least important social functions. But there are also sort of little bit more constructive implications in the sense for the building of theory of the Austrian insistence on capital heterogeneity. Specifically, there seem to me to be very strong implications, theory implications of the very point that capital assets just cannot be costlessly shifted from one activity to another activity. I argued earlier that we may think of the Austrian theory of capital as a theory of production which seems to me to imply that the firm level becomes relevant. Indeed, the idea that resources, firms, and industries are very different from each other that capital and labor are specialized to specific activities and projects that people are in terms of human capital are really distinct is key in the theory and practice, of course, of management, notably strategic management. It seems to me that Austrian ideas on capital find therefore a close parallel in management thinking on firms as bundles of heterogeneous resources, assets, and activities. Peter Lewin has recently argued that Austrian capital theory may therefore form the basis for what he calls a capital-based theory of the firm. Of course, as Peter and I told you this morning, Peter Klein and I have developed similar arguments in a string of papers, many of which are essentially summarized in this book, Organizing Entrepreneurial Judgment. To get a basic idea of some of our over-arguments, consider the world of Samuel Sony and Schmu, the world in which capital is indeed homogeneous. This is a world where individuals face very low costs of searching for assets. For example, the capabilities of potential takeover targets or suppliers, assets that may fit existing operations. They don't really have any cost of measuring or ascertaining the inherent characteristics of assets because one asset is just like another capital asset. There are trivial costs of coordinating assets and so on. And most of those very real problems of exchange and organization that economists put under the transaction cost rubric, they simply disappear. They go away in a world of homogeneous capital assets. So per implication, the understanding of the sources of transaction cost in a modern economy involves, it seems to me, the understanding of capital, heterogeneity and its implications. Conversely, it also seems to me that a significant part of the problems of what Joe Salerno calls, and drawing on Ludwig von Mises obviously, called entrepreneurial appraisement and indeed a significant part of the recession calculation problem itself involve transaction costs. This is an argument that Peter Klein made in a great paper in 1996, and I believe the Rio of Austria in economics. So to some, namely those of us who specialize in the economics of the firm, or like me, work in business schools, these ideas are really inherently attractive. They matter a lot to me and to Peter, but many of you may not be interested in firms, management, strategy per se, what you're interested in may be the, say, the economy-wide implications of these ideas, linking together, for example, capital, heterogeneity, and transaction costs. So are there economy-wide implications of these ideas? And so what may they be? It seems to me that there are plenty of absolutely important economy-wide implications of looking carefully at capital, heterogeneity at the firm level. So for example, John Matsusaka has argued that the processes of mergers and divestments, which of course matter to the overall performance of the economy and which anti-trust authorities are very interested in, these processes should be understood as experimental learning processes that must be undertaken precisely because it is not obvious exactly what is the efficient combination of a bundle of highly heterogeneous capital assets. These micro-level processes, they are essentially entrepreneurial ones because an important part of the entrepreneur's role is to arrange and organize heterogeneous resources. Peter quoted Lachman's take on this, this morning I'll do it again because it's a great quotation. So what Lachman says is, we are living in a world of unexpected change, hence capital combinations will be ever-changing, will be dissolved and reformed in this activity. We find the real function of the entrepreneur. On the aggregate level, and I hope you'll excuse me for indulging in a little bit of so mainstream economics terminology now, just a temporary lapse, I hope I'll be excused, but these processes are what make the economy track its moving production possibility frontier as a mainstream economist would say, improving the efficiency with which resources are utilized. So these dynamic firm-level processes have been estimated to account for about half of so-called aggregate productivity growth. It's been found that the automatic restructuring of industries in developed countries really imply a very serious penalty in terms of forgone growth. So the constraints, the incentives, the opportunities faced by appraising entrepreneurs trying to combine heterogeneous capital assets must really ultimately enter as an absolutely crucial element in the understanding of economy-wide phenomena connected, for example, to economic growth. Now, much of the understanding of the growth process in mainstream economics has been based on models of accumulating semisonian smooth along equilibrium growth path. So the accumulation of homogeneous capital, essentially. There are applications of Austrian capital in the context of growth theory that do allow for heterogeneity, but otherwise portray growth as a smooth process of accumulation of physical capital along, again, an equilibrium growth path. Hicks's work, John Hicks's work from the 1970s is a good example of that. Hicks, in fact, interpreted the Austrian cycle theory as fundamentally a theory of how this kind of smooth equilibrium growth can be disturbed by government intervention. And according to Hicks, that's a famous essay from 1967 where Hicks looks back at his career and how he interacted with Hayek and to Hicks the essence of the Hayek story, as he called it, was that no one really understood that Hayek was fundamentally talking about growth, which seems to me to be a really a rather far-fetched interpretation of Hayek. Now, of course, also those who have taken a different approach to the growth process, one that perhaps Austrians would be more sympathetic to. They argue that the growth process driven by improvements in total factor productivity, which is, again, aggregate umbrella term for a host of very diverse, very heterogeneous processes that, to a large extent, takes place on the firm level. That's been long been recognized that this total factor productivity is about much more than technology. Technology in the sense of recipe-like advances in scientific knowledge. There's been a lot of attention, of course, to R&D in the economics of growth since Solow's work in the 1950s, but it's not R&D, of course, that in itself drives growth. Innovations that emerge from R&D, farm from R&D, research and development, drive growth. And in turn, innovations are introduced by enterprising individuals by entrepreneurs. And, of course, innovations at the firm level have many other sources than the R&D function. They include your process innovations, innovations of management practices, innovations of organizational practices. All these processes are entrepreneurial ones. They amount to appraising, combining, recombining heterogeneous assets in the uncertain pursuit of profitable opportunities. The economy-wide level implications of productivity advances and improvements in resource utilization, that is, increases in total factor productivity. Surprisingly, because we know that the entrepreneur is the prime mover of progress, it's only very recently that growth economists have begun to take seriously the entrepreneurial function in the economy, model it, measure it the way they go about things. And the reason lies exactly in something I talked about earlier, namely the dominance of the production function framework in mainstream economics, and therefore also in growth economics. If production factors are assumed to be homogeneous within categories, capital, labor, land, and production is always at its efficient frontier, there's, of course, extremely little entrepreneurs to do. Everything has been taken care of already by assumptions of perfect knowledge and equilibrium and so on. Of course, capital in actuality is heterogeneous and the combination of those heterogeneous capital assets requires technical and commercial processes that, in a very real sense, are experimental. The optimum combination of inputs, capital inputs, for example, just isn't a datum, and what is, at any moment, the optimum combination will change as a result of changes in the underlying schematics, as Lachman reminds us. These processes, again, are driven by the judgment and the appraisement of capitalist entrepreneurs. So the basic message here is entrepreneurship matters to growth, to economic growth, because entrepreneurship influences these processes that we put under the rubric of total factor productivity, at least if we are economic growth theorists. So it seems to me that there really is an opportunity for engaging profitably, even with some of those suspect mainstream types to talk about growth, because they are interested in these ideas about capital heterogeneity. Now, something related has to do with the influence of institutions on growth, which has been a huge theme in recent growth economics. So there are scholars who argue that institutions rule. They specifically rule in the sense that institutions overwhelm all other determinants of growth. It's not always entirely clear why this is so. So there are missing micro foundations for many of these arguments, I think. But a key reason to expect institutional quality to affect growth positively is that it has to do with the transaction cost dimensions of the recession calculation problem. So institutions matter because they influence transaction costs through reduced uncertainty of economic transactions and productivity enhancing incentives. The institutional economist Douglas North tells us that the major role of institutions in a society is to reduce uncertainty by establishing a stable, not necessarily efficient, but stable structure to human interaction. The overall stability of an institutional framework makes complex exchange possible across both time and space. In turn, higher certainty implies lower transaction costs because the cost of entering into embarking, monitoring, protecting, contractual rights, ownership rights, they're reduced. This increases the expected value of projects and makes them more likely to be undertaken. So this in turn establishes a link to total factor productivity, which I talked about earlier. We know that increases in total factor productivity, the efficiency with which factors of production are used, result from new processes, new modes of organization, ways of better allocating resources to their preferred users and so on. Given all this, the flexibility with which appraising entrepreneurs can carry out these processes becomes highly important to the growth performance of the economy. And no classical economists capture this by the notion of the aggregate elasticity of factor substitution. And this is, again, this is a measure of the flexibility of the economy, for example, with respect to reacting to external shocks. The aggregate elasticity of substitution, the flexibility of the economy is endogenous. Austrian capital theory would seem to me to matter here greatly because it suggests that there may be inherent technical constraints that reduce flexibility because what Lachman called multiple specificities may obtain. But the bottom line here is that this endogeneity of the elasticity of substitution, the flexibility with which we can combine and recombine, for example, heterogeneous capital assets, is influenced by institutional determinants. For example, those that we sometimes call freedom variables, such as the quality of the legal framework, sound money, how secure property rights are, and so on. So they influence the flexibility of the economy which in turn leads to high factor productivity because it means that resources can be more easily allocated to highly valued users. Now there are huge litigious and economic history that essentially make a number of these points in a verbal manner that perhaps formal growth economists are not particularly fond of, but they are going in the right direction. They stress the importance of entrepreneurial activity of property rights being well-defined and enforced. I've in mind work by Douglas Northigan, by Joel Makaya, and so on. So well-defined and enforced property rights matter because they reduce the transaction costs of carrying out entrepreneurial activities. So again, with secure property rights, there are low cost of searching for, negotiating with, and concluding bargains with owners of those capital inputs that enter into entrepreneurial ventures. Similar reasoning applies to sound money. Inflation, particularly erratic inflation, jams the signaling effect of relative prices, harms the process of allocating resources to their most highly valued users, and therefore negatively influences total factor productivity, and therefore economic growth. For many reasons, the size of the government, of course, also influences total factor productivity. If, for example, economic activities in certain industries or sectors have been nationalized, the scope for entrepreneurship in those industries or sectors is correspondingly reduced because nationalization so often implies a public monopoly. And most parts of the Western world, this is a case of childcare, health care, care for the elderly, and so on. And as Mises, of course, reminds us, the effective nationalization of all of these industries means that the operation of the price mechanism becomes severely hampered, and eliminating entrepreneurship and reducing therefore their adaptability, the adaptability of these industries to adapt to changing circumstances. Kristian Bjonsko, Danish colleague and myself, have tried to make these ideas empirical and subject him to statistical testing. We argue in these two papers, essentially, that economic freedom, including the rule of law, easy regulations, low taxes, limited government, and interference in the economy, that these things are good, not just for more reasons, but because they allow entrepreneurial experimentation with combining productive factors to take place in a low transaction cost manner. So this micro mechanism that I have sketched from institutions to experimental processes of combining heterogeneous capital assets on the level of firms up to economic growth are things that we try to talk about in an empirically informed manner in these two papers that are shown here. So again, the argument is that institutions of liberty increase the aggregate elasticity of substitution, they increase the overall flexibility of the economy, which translates into increasing total factor productivity and therefore growth. And we assess these ideas empirically again. So we build a panel data set of 25 countries from 1980 to 2005 and we test the influence of entrepreneurship and institutions on total factor productivity. And we find, well, and behold, that entrepreneurship very strongly, significantly influence total factor productivity and that some, not all, of the institutions of liberty sound money, for example, as well as classical liberal economic policies more broadly, liberal economic policy regimes promote growth and productivity across these countries. And I don't summarize these arguments to try to convince you, because I'm not sure I can convince that many of you that this is the way we should dough Austrian economics at all, this is about, you know, pretty conventional positivist hypothesis testing. We draw on a lot of pretty mainstream economics, but the point here is that there are certain key Austrian ideas that you can actually place in more of a mainstream economics argument. And perhaps this is one way to sell some key Austrian ideas to the mainstreamers. At least that's what we try to do in this paper, these two papers. Right, so to sum up here, what I've been doing, I have made a plea, essentially, for the continuing relevance of Austrian capital theory. Historically, Austrian capital theory has, of course, been a central research area in Austrian economics, and substantively, it is an integral part of Austrian economics. It has, however, had a reputation of being, I think, a particularly difficult part of the Austrian corpus. And perhaps for this reason, it could be argued that it is one of the least intensely researched areas in the Austrian revival of the last four decades. I think it's time to change that. The Austrian capital theory has the potential to make interesting advances. I think there is still a lot to do with respect to understanding the role of heterogeneous assets in entrepreneurial appraisement. There are many fertile links to related thinking in management theory and other parts of economics, as I've argued, such as perhaps empirical growth economics. So perhaps Austrian capital theory can serve a strategic purpose for Austrians, namely by extending their theorizing into new areas while sort of keeping intact a central core of Austrianism. There's definitely room in the Austrian tent for applied research on anarchism and pirates. There's room for telling, instructing mainstream economists about how they should do economics. There's room for integrating Austrian economics and complexity theory, we call it BRICE, and other trendy topics. But the core of Austrian economics remains mundane topics such as capital theory. And I'll stop here. Thank you.