Summary of JOIE article ( First View 22 March 2021) by Marek Hudik, Faculty of Business Administration, Prague University of Economics and Business and Per L. Bylund, School of Entrepreneurship, Spears School of Business, Oklahoma State University The full article is available on the JOIE website.
Our paper makes an argument for finding the proper balance between the theory and practice. Does pure theory have any role in economics, or is it too abstract to be useful? When addressing practical problems, do economists have to rely on the insights of pure theory, or can they proceed on a case-by-case basis? Economists have always differed in their answers to these questions. But we find that the modern institutional approaches find a balance akin to what Frank Knight argued in Risk, Uncertainty, and Profit. He observed:
“At one extreme we have mathematical economists and pure theorists to whom little if anything outside of a closed system of deductions from a very small number of premises assumed as universal laws is to be regarded as scientific economics at all. At the other extreme there is certainly a strong and perhaps growing tendency to repudiate abstraction and deduction altogether, and insist upon a purely objective, descriptive science. And in between are all shades of opinion.” (Knight, 1921: 5-6)
Indeed, Knight advocated a “middle way” between theoretical and historicist approaches to economics. He argued that the relative role of pure theory depends on the nature of the subject matter: economic phenomena involve both general and specific aspects and so economics needs to combine theory with institutional details. Knight argued for using “successive approximations,” in which pure theory is augmented by adding specific factors that allow the economist to thereby better explain specific phenomena. For each phenomenon, therefore, there is, depending on its idiosyncrasies, a “correct ‘middle way’” (1921: 6) between deductive theory and inductive empirical study. We thus make a case for “Frank’s way” of combining, and thereby seeking a golden middle between, theory and history. We illustrate this perspective using the study of entrepreneurship, the field that Knight pioneered.
We argue that in the century following Risk, Uncertainty, and Profit, economics has increasingly moved towards studying general aspects of phenomena and patterns in aggregate data (e.g., Hodgson, 2001) using mathematic and econometric techniques. Specifically, economists focused on allocative problems and identifying common factors affecting the allocation of resources. These common factors are typically embodied in the constraints of optimization models (Hudik, 2019). Therefore, these models work well when constraints are “tight” (Koppl and Whitman, 2004). However, this approach is less useful in addressing specific problems, that is, when constraints are “loose.” Consequently, phenomena where idiosyncratic elements dominate and do not wash out in the aggregate have been largely neglected. A diversity of habits, norms, or routines that could not be explained by the differences in costs and benefits have remained understudied (e.g., Hudik and Fang, 2020).
The study of entrepreneurship, in particular, has suffered from this development: entrepreneurial activity pursues creation and novelty, and therefore, the idiosyncratic factors, such as the uniqueness of a situation, or subjective perceptions and preferences, are pivotal. As a result, economic research has either ignored, or even excluded, entrepreneurship (e.g., Baumol, 1968) or focused on those aspects that were amenable to standard economic techniques, such as occupational choice, market entry, or human capital investments (e.g., Bianchi and Henrekson, 2005). We provide examples of studies that embody Knightian “middle way” by taking take historical specificity seriously. These examples include the application of Verstehen (McMullen, 2015), case studies (Langlois, 2018; McKelvie et al., 2020), and historical narratives (Wadhwani and Lubinski, 2017).
The importance of the Knight’s insight, highlighted in our paper, is that the usefulness of abstract and historical approaches depends on the character of studied phenomena. Therefore, our argument is not merely that both general theory and approaches focusing on individual specificity are important; that is, our argument is not primarily about methodological tolerance. Instead, we attempted to show that whether a phenomenon should be approached in an abstract or a concrete way depends on the relative importance of the common or specific factors governing this phenomenon. In our vernacular, the study of a phenomenon requires the finding of the appropriate balance between theory and history, the aim for universal truth versus the particulars of the specific case, for that phenomenon.
The conventional economic analysis focused only on the general factors affecting allocation of resources is applicable to much narrower range of phenomena than economists recognize. In particular, the standard price-theoretic approach is suitable for analyzing the effects of prices, broadly defined, but less so for the study of entrepreneurship, which takes place in “pricelessness” (Bylund, 2016). We therefore conclude that economics can only be relevant to the entrepreneurship research if it manages to incorporate both general and relatively stable aspects of phenomena, and their specific and fickle aspects. That is, if it adopts “Frank’s way.”
Baumol, W. J. (1968), “Entrepreneurship in Economic Theory,” The American Economic Review, 58(2): 64–71.
Bianchi, M. and M. Henrekson (2005), “Is Neoclassical Economics still Entrepreneurless?” Kyklos, 58(3): 353–377.
Bylund, P. L. (2016), The Problem of Production: A New Theory of the Firm, London: Routledge.
Hodgson, G. M. (2001), How Economics Forgot History: The Problem of Historical. Specificity in Social Science, London and New York: Routledge.
Knight, F. H. (1921), Risk, Uncertainty and Profit. Boston: Houghton Mifflin.
Koppl, R. and Whitman, D. G. (2004), “Rational-Choice Hermeneutics,” Journal of Economic Behavior and Organization, 55(3): 295–317.
Langlois, R. N. (2018), “Fission, Forking and Fine Tuning,” Journal of Institutional Economics, 14(6): 1049–1070.
McKelvie, A., J. Wiklund, J. McMullen and A. Palubinskas (2020), “A Dynamic Model of Entrepreneurial Opportunity: Integrating Kirzner’s and Mises’s Approaches to Entrepreneurial Action,” Quarterly Journal of Austrian Economics, 23(3–4): 499–541.
McMullen, J. S. (2015), “Entrepreneurial Judgment as Empathic Accuracy: A Sequential Decision-Making Approach to Entrepreneurial Action,” Journal of Institutional Economics, 11(3): 651–681.
Hudik, M. (2019), “Two Interpretations of the Rational Choice Theory and the Relevance of Behavioral Critique,” Rationality and Society, 31(4): 464–489.
Hudik, M. and E. S. Fang (2020), “Money or In-kind Gift? Evidence from Red Packets in China,” Journal of Institutional Economics, 16(5): 731–746.
Wadhwani, R. D. and C. Lubinski (2017), “Reinventing entrepreneurial history,” Business History Review, 91(4), 767–799.