Liberty Matters

Lachmann on Capital Theory, Entrepreneurship and Business Strategy, Expectations-formation, and the Role of Institutions in Facilitating Economic Order

In my first contribution I argued that Lachmann should not be regarded as a nihilist because his commitment to radical subjectivism does not prevent him from offering an account of how social order is possible in decentralized market economies. In this contribution I wish to examine another way in which Lachmann has made a contribution to positive economic analysis, by exploring how his capital theory has helped to inform and inspire efforts to construct a distinctively Austrian approach to business strategy and entrepreneurship. In doing so, I shall take up Lewin's invitation to explore in greater detail Lachmann's thinking about capital and also build on some of Bill Tulloch's remarks on that topic.
Lachmann on Capital
Lachmann's is, of course, a subjectivist theory of capital. "The generic concept of capital … has no measurable counterpart among material objects," Lachmann ([1956] 1978, xv) writes. "Beer barrels and blast furnaces, harbour installations and hotel-room furniture are capital not by virtue of their physical properties but by virtue of their economic functions. Something is capital because the market, the consensus of entrepreneurial minds regards it as capable of yielding an income." More specifically, as Bill Tulloch observes, capital goods are defined by reference to their place in a subjectively defined production plan. Complementary capital goods fit together and contribute to a particular production plan in ways that are expected to add value and yield profits. Of course, executing that plan takes time; it involves entrepreneurs purchasing and using resources before the demand for, and the final price of, the output being produced is established. Hence, for Lachmann, entrepreneurs must act in the face of radical uncertainty, seeking to "wrest economic meaning from the market" (Lachmann 1977, 102) by using their judgment to identify how assets can be combined so as to produce goods and services that people are willing to buy at a price that makes the whole enterprise profitable. (In doing so, they also rely on social institutions, as described in earlier contributions to this conversation.)
Uncertainty implies that the profitability of those plans cannot be definitively established ex ante. Ultimately, plans must be put to the market test. When—as must inevitably happen, given the diversity of views about the future held by entrepreneurs—some plans fail to live up to expectations and yield losses, entrepreneurs must decide whether assets need to be redeployed or scrapped. This is where the heterogeneity and multiple-specificity of capital goods becomes significant because those attributes mean there are limits to the combinations in which capital goods can be redeployed or regrouped if the initial plan is revealed to be unprofitable and in need of change. It is, once again, the entrepreneur who must exercise his or her judgement about how plans should be revised.  As Lachmann writes, "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." ([1956] 1978, 13) For Lachmann, therefore, it is the entrepreneurial search for profitable capital combinations that drives the ongoing process of capital development.
Applications to Business Strategy
Significantly, Lachmann's capital theory has been used by scholars in the field of business strategy to provide a framework for their work on entrepreneurship and organization studies. On this view, business strategy involves entrepreneurs seeking to penetrate the fog of uncertainty that clouds the future by using their imagination and judgment to identify ways in which assets can be (re)combined so as to produce goods and services that people can be persuaded to buy, thereby adding value and yielding profits. What is appealing about Lachmann's work is that it provides a single theoretical framework that brings together many of the features of the world emphasized, but in a fragmented way, by the strategic entrepreneurship literature: the importance of the entrepreneurial imagination, the centrality of the creative (re)combination of assets, the significance of time and uncertainty, the processual nature of the market, and the role of institutions in facilitating business activity. By showing how those ideas can be woven together to form a unified account of the entrepreneurially driven market process, centering on the imaginative but fallible creation, dissolution, and regrouping of complementary combinations of capital goods, Lachmann's theory promises to bring greater coherence and fresh insights to the field of strategic entrepreneurship and organization studies. If that is indeed the case—and there is a burgeoning literature arguing to that effect—then it provides further evidence for the claim that far from being nihilistic, Lachmann's radical subjectivist approach can inspire fruitful new lines of research on the topics of entrepreneurship, strategy, and the firm. (Chiles et al., 2007, 2010; Mathews 2010; Lewin and Baetjer 2011; Foss and Klein 2012; Endres and Harper 2013).