While most mainstream economists focus on the analysis of equilibria, Austrian economists examine the phenomena that are crucial in real-world markets operating in disequilibrium. Two of the most central aspects are economic calculation and entrepreneurship. In this regard, the Austrian school of economics offers profound insights into both the dynamics and the stability of capitalist societies.
One of Ludwig von Mises’s most significant contributions was his demonstration of the impossibility of socialism. He famously argued that without private ownership of the means of production, markets for these goods cannot exist, and thus, no prices can be established. As a result, a socialist central planning authority lacks the ability to gauge the relative scarcity of resources and allocate them efficiently across different societal needs. Mises expanded on this point in his works Socialism and Human Action. Building on an often-overlooked article by Carl Menger from 1888, Mises explained how, in capitalist societies, entrepreneurs are guided by monetary calculation. They incorporate all assets into their economic evaluations to determine the profitability of their decisions. Economic calculation, Mises wrote,
...serves to bring the original properties of a concern under one denomination, whether they consisted of money or were only expressed in money. The object of its computations is to enable us to ascertain how much the value of this property has altered in the course of business operations.
Economic calculation renders the countless and diverse means of production manageable. It enables entrepreneurs to assess past actions and make rational decisions between various investment opportunities. In contrast, under socialism, rational economic calculation is impossible, as it depends on market prices for the means of production, which reflect the subjective preferences of market participants. Such prices cannot exist in socialist societies where private property is prohibited.
Entrepreneurship is, unsurprisingly, another crucial topic emphasized by Austrian economists, as it is essential for understanding how markets work. Firms, industries, and markets do not spontaneously come into existence; they must be created and managed by real people who bear real responsibility. For generations, Austrian economists have highlighted that entrepreneurs are the “driving force” of the market.
Naturally, both economic calculation and entrepreneurship become irrelevant in a world characterized by equilibrium. In this hypothetical state, market prices are exogenous and perfectly reflect the relative scarcity of goods. Entrepreneurs and economic calculation are unnecessary, as the “market” would already be in its optimal state. This is why much of mainstream economics, with its focus on equilibrium, tends to overlook these key aspects of capitalist societies.
In a recent article, we demonstrate that the Austrian analysis of capitalism becomes even more compelling when these two phenomena are systematically integrated. In real-world markets, entrepreneurs cannot function without economic calculation, and economic calculation is most meaningful for entrepreneurs who purchase means of production and sell goods in actual markets.
To understand how economic calculation is linked with entrepreneurship, we must recall Mises’s important observation that, “Every single step of entrepreneurial activities is subject to scrutiny by monetary calculation.” Mises further distinguishes between prospective and retrospective economic calculation, both of which are essential to the entrepreneur. As he notes: “The premeditation of planned action becomes commercial precalculation of expected costs and expected proceeds. The retrospective establishment of the outcome of past action becomes accounting of profit and loss.”
It is through this distinction between forward-looking and backward-looking calculation that we can see how entrepreneurship and economic calculation are inherently connected. Retrospective, or backward-looking, economic calculation aligns closely with Israel Kirzner’s concept of the alert entrepreneur. According to Kirzner, entrepreneurs create an equilibrating force in the market by identifying arbitrage opportunities. By comparing prices in the market for raw materials and production factors with those in the sales market for finished goods, the entrepreneur recognizes price gaps. This drives up input prices through increased demand for undervalued production factors and drives down output prices by increasing the supply of expensive products.
Interestingly, retrospective calculation—specifically the accounting of profit and loss—has traditionally been structured to reward alert entrepreneurs in the Kirznerian sense. Positive profits are recorded only when the entrepreneur has successfully identified and capitalized on actual discrepancies in the price structure. In this way, retrospective economic calculation incentivizes and rewards those entrepreneurs who contribute to a tendency toward market equilibrium.
Forward-looking or prospective economic calculation, in contrast, supports the innovative activities of entrepreneurs as described by Joseph Schumpeter. Unlike Kirzner’s entrepreneur, who moves the market toward equilibrium, Schumpeter’s entrepreneur disrupts it. He is the driving force behind creative destruction, which fuels the dynamics of a market economy. In the pursuit of innovation, the entrepreneur compares the subjective value of future benefits with the current market price of an investment. He invests only when he believes the expected benefits exceed the price to pay. In doing so, the entrepreneur effectively bets against the market, relying on his subjective evaluation of future potential. This is where prospective calculation plays a vital role, as it involves comparing various investment opportunities from an economic perspective. Forward-looking economic calculation aids the entrepreneur in identifying innovation potential in Schumpeter’s sense and in making sound entrepreneurial judgments, as emphasized by Nicolai Foss and Peter Klein.
Both the entrepreneur and economic calculation are phenomena rooted in the real world. Austrian theory provides a framework that allows for the integration of these two critical concepts into economic theory. Recent research further highlights the significance of the Austrian School of Economics, offering an intellectually robust bridge that connects the fields of entrepreneurship and economic calculation. Mainstream economics and business administration could benefit greatly from Austrian economics, as it focuses on studying reality, not hypothetical worlds of equilibrium.
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