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April 10, 2007

Arthur Foulkes: Entrepreneur critical in real world, not in ‘equilibrium’

By Arthur E. Foulkes

TERRE HAUTE — Many of us were taught economics in a way that downplays or ignores the important function that entrepreneurs play in a dynamic and improving economy.

Our textbooks and teachers often mention “labor,” “government” and “capital,” but the critical role of entrepreneurs often largely is overlooked.

Perhaps one reason professional economists give only passing consideration to entrepreneurship is that they use models that focus on what they call “equilibrium,” meaning a condition where things are “at rest.” Equilibrium means everyone is content with how things are and no changes in prices, wages or other aspects of the economy are taking place. When changes are introduced into these models, the return to equilibrium seems automatic. Little attention is paid to the process of change itself.

In the real world, we never reach “equilibrium” and change always is taking place. Entrepreneurs create changes, respond to changes and attempt to anticipate changes. While equilibrium models are all about certainty and being “at rest,” entrepreneurs are all about uncertainty and change.

Everyone is, to some extent, an entrepreneur since all our actions are based on what we believe will happen or what we want to happen in an uncertain future. For instance, I might invest the time and trouble to put an umbrella in my car if I believe there is a good chance it will rain. If it rains, my action rewards me; if it doesn’t, I’ve wasted some effort. Even when we act as consumers we are, in a sense, acting as entrepreneurs because we are investing in a good or service under the belief that the “return” to us in the form of pleasure or the avoidance of pain will outweigh the financial investment we made.

But in a market economy, entrepreneurs play a very specific and important role. In the pursuit of profits, they make guesses about the future and then direct scarce productive resources, either their own or someone else’s, into a particular line of production. If they guess correctly, they earn profits; if they guess incorrectly, they suffer losses.

The late economist Murray Rothbard described the role of the entrepreneur very well. He wrote that an entrepreneur “earns profits only if he has by superior foresight and judgment, uncovered a maladjustment — specifically an undervaluation of certain factors [of production] by the market. By stepping into this situation and gaining the profit, he calls everyone’s attention to that maladjustment and sets forces into motion that eventually eliminate [the profit].” Losses, on the other hand, Rothbard wrote, “are a sign that [the entrepreneur] has added further to a maladjustment.”

Entrepreneurship is a talent that combines creative thinking, foresight and a tolerance for risk. It probably cannot be taught in school; indeed, many very successful entrepreneurs never graduated from college or even — in decades not long past — high school.

The English author Somerset Maugham wrote a short story that shows how education and successful entrepreneurship do not necessarily go hand-in-hand. The story, called “The Verger,” is about a man who for many years was the verger — a custodian or caretaker — of a fashionable London church, St. Peters, Neville Square.

This verger, named Albert Edward Foreman, could neither read nor write. One day, the church’s newly appointed vicar, “a red-faced energetic man,” told the verger that having an illiterate church caretaker was “impossible.” After all, the vicar said, “We haven’t the right to take the risk of some accident that might happen owing to your lamentable ignorance.”

The verger was getting on in years and “didn’t seem to ’ave the knack” for reading and writing,’” he told the vicar. As a result, at the end of a three-month trial period, the vicar of St. Peters, Neville Square, let the verger go.

Wandering the streets of London after losing his job, the verger, not at all sure what to do with himself, wanted a smoke. Unfortunately, the street where he was wondering had no tobacco shops. That’s when an idea hit him.

“I shouldn’t wonder but what a fellow might do very well with a little shop here. Tobacco and sweets, you know,” the former verger thought to himself.

To make a short story even shorter, Foreman used his savings to rent a small storefront on the street and opened a tobacconist shop there. His store was a success and soon he was wandering other London streets looking for places that might need a tobacconist shop. Eventually the former verger had a whole string of profitable tobacco shops.

The story of the verger ends when the former verger is approached one day by the manager of the bank where he has been taking his daily deposits from his different shops. The banker asks if the former church caretaker knows how much money he has in the bank.

“Not within a pound or two, sir; but I’ve got a pretty rough idea,” the former verger answers.

The banker explains that Foreman has a “very large sum” on deposit and suggests the money might be better used if it were invested where it can earn a higher rate of return.

Foreman indicates he might be willing to invest his money in some very low-risk securities, but, when the banker then explains that this would mean there would be papers to sign, the former verger’s face takes on a troubled look. He explains to the manager he can neither read nor write. I’ll let Somerset Maugham finish the story:

“The manager stared at [Foreman] as though he were a prehistoric monster.

‘And do you mean to say that you’ve built up this important business and amassed a fortune … without being able to read or write. Good God, man, what would you be now if you had been able to?’

‘I can tell you that, sir,’ said Mr. Foreman, a little smile on his still-aristocratic features. ‘I’d be verger of St. Peter’s, Neville Square.’”

Arthur Foulkes is a native of Terre Haute and a longtime resident. The Tribune-Star reporter writes a weekly column on business and economics. He can be reached at (812) 231-4232 or arthur.foulkes@tribstar.com.

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