We will now touch upon several specific areas which we believe could be enriched by the systematic application of the dynamic-efficiency approach we have proposed in this article. As is logical, we will not attempt here to perform an analysis, much less a thorough one. Our only goal is to suggest a few provisional ideas on some lines of research which appear quite promising and remain available for the future efforts of those scholars who ultimately determine that the study of the dynamic conception of economic efficiency can be productive and compelling.

First, we must mention taxation theory. We have already observed the vital role that (pure) entrepreneurial profits (and losses) play in terms of guiding the creative and coordinating action of entrepreneurs. In fact, such profits are the primary sign that directs and drives the market process which leads to dynamic efficiency. The distortion of entrepreneurial profits due to fiscal causes can seriously effect the entire process of dynamic efficiency (i.e. creativity and coordination), and thus generate a high cost in the shape of a reduction in dynamic efficiency. This cost would be additional to the one theorists refer to as “excess burden,” which, from the perspective of the economic analysis of equilibrium, corresponds to the loss of static efficiency, the only loss accounted for up to now by optimal tax theory.(58) Consequently, the ideal goal would be to avoid taxing pure entrepreneurial profits, in order to foster dynamic efficiency. It is important to recognize that this economic-policy goal presents significant practical problems which stem from the fact that under nearly all true circumstances, pure entrepreneurial profits are inseparable from other sources of income (labor, capital, land, etc.). Nevertheless, these difficulties should challenge those analysts and researchers who wish to promote dynamic efficiency, and encourage them to search for new tax procedures and to develop fiscal reforms that minimize the negative impact on pure entrepreneurial profits and thus on entrepreneurial creativity and coordination.(59)

Second, the theory of regulation and interventionism (i.e. the economic analysis of institutional coercion) could also be enriched by the systematic application of the dynamic approach. The objective here would be to examine all acts of regulation and economic intervention so that, as they take the shape of restrictions on the free exercise of entrepreneurship, their possible effects can be studied in terms of dynamic inefficiency. Moreover, the diagnosis of the inefficiency problems caused by economic interventionism should make it possible to devise reforms which can be more or less gradually implemented with the purpose of removing the existing obstacles to creativity and coordination, and of thus fostering the dynamic efficiency of the system.

Third, the dynamic-efficiency approach suggests a completely different angle from which to view antitrust legislation. From the perspective of dynamic market processes driven by entrepreneurship, and in the absence of institutional hindrances to free human action in any entrepreneurial environment, the process of rivalry between entrepreneurs often culminates in the temporary dominance of only a few producers (or even just one) in the market, at a particular time and place. Far from indicating a (supposed) “market failure,” this occurrence would constitute one of the most typical manifestations of the success of these entrepreneurs at satisfying better than anyone else the desires of consumers (i.e. at discovering and conceiving new products of increasing quality and placing them on the market at decreasing prices). Thus, restrictive legislation designed to “defend” competition could generate high costs in terms of dynamic efficiency, to the extent that potential entrepreneurs take for granted that, should they be successful (at introducing a certain innovation, or launching a product, or capturing the market), the public authorities may requisition or even partially or totally expropriate the results of their creativity. The cases of Microsoft and others are topical and currently in everyone’s mind, so it is not necessary to go into detail about them. An observation similar to the above can be made concerning many other practices, such as price agreements among suppliers, market sharing, the joint sale of goods, exclusive-distribution agreements, etc. Even though these may be seen as restrictive measures from the standpoint of static efficiency, which until now has permeated antitrust legislation, they may make all the sense in the world from the perspective of dynamic efficiency, which plays a central role in real market processes.(60)

Fourth, the economic theory of development is another sphere in which the application of the theory of dynamic efficiency is of great importance. Here the primary objective of economic policy would be to consider which possible reforms could remove obstacles and boost entrepreneurship in developing countries. Let us not forget that the entrepreneur is undoubtedly the leading figure in any process of economic development. For this reason, one cannot help being surprised at the sheer volume of pages which have been written in vain on the economic theory of underdevelopment because the authors have completely overlooked the key player in economic growth processes (the entrepreneur) and have made no mention of the role entrepreneurship plays in both its creative and coordinating facets. In this sense, neoclassical academics of the theory of growth and underdevelopment are to a great extent responsible, by omission and commission, for the failure of many economic policies in developing countries to include the necessary measures to protect, foster and encourage indigenous as well as foreign entrepreneurs who decide to stake their assets upon those countries which most need investments, as their inhabitants live near subsistence level.

Fifth, the adoption of the dynamic-efficiency view could also enrich macroeconomics in general, and monetary theory in particular. We have known from the time of Carl Menger that money evolved through custom and that its development was stimulated by the entrepreneurial ingenuity of those few who first realized that they could attain their goals more conveniently by demanding in return for their goods and services a medium of exchange easily tradable in the market. As this pattern of behavior became generalized and habitual, money emerged as a generally accepted medium of exchange. In fact, money would be unnecessary in a hypothetical, static, and perfectly efficient model of equilibrium, because such an unreal scenario would involve no future uncertainty, and thus no one would need to maintain any cash balances at all. However, real life is unpredictable, in great part precisely due to entrepreneurial creativity, which results in the constant generation of new information and in the modification of all market parameters, and thus it is essential that people maintain liquid balances to cope with an ever-changing and uncertain future. Hence, money has its origins in the uncertainty entrepreneurial creativity produces, and at the same time, it makes it possible for humans to exercise their creative and coordinating entrepreneurship, since it permits them to face a consistently uncertain future with an open set of alternatives. From this standpoint, it is important that monetary institutions not hamper the processes of entrepreneurial coordination and thereby make the goal of dynamic efficiency difficult to reach. For example, if the creation of money in the form of credit expansion permits the initial financing of investment projects at a rate out of all proportion to that of the real increase in society’s voluntary saving, then a severe intertemporal discoordination or maladjustment will arise between the behavior of investors and consumers. This maladjustment will first manifest itself in a speculative investment bubble financed through an overissue of fiduciary media which will ultimately result in a disproportionate rise in the prices of capital goods. This expansionary process will sooner or later reverse in the form of an economic recession which will reveal the entrepreneurial errors committed and the need to convert and restructure the investment processes initiated in error.(61) Thus, an interesting field of research is now opening up to scholars and involves the evaluation of the current monetary and credit institutions in light of the concept of dynamic efficiency presented here. In time, these scholars will design a series of reforms which will foster entrepreneurial creativity and also further intertemporal coordination, thus impeding the artificial maladjustments which up to now have recurrently attacked market economies since the development of the modern fractional-reserve banking system in the early nineteenth century.

Sixth and last, perhaps more than any other sphere of economics, the economic analysis of law, legal regulations, and social institutions, which up to this point has rested exclusively on the traditional postulates of the economic analysis of equilibrium, needs to be completely reworked in light of the new intuitions and contributions which only the dynamic conception of efficiency can offer. This new perspective will make it possible to evaluate the different legal regulations and social institutions in a totally new manner, i.e. in terms of their capacity to drive entrepreneurial creativity and coordination. The dynamic approach will dramatically enrich the economic analysis of contract law, of civil liability, of patent, copyright, and trademark law, of the family, etc., and in general it will exert the same effect on any other economic analysis of the laws and institutions closest to the actual social environment which it is always fundamentally dynamic by its very nature.

As is logical, the above examples and illustrations do not come even close to exhausting the possible applications of the dynamic conception of economic efficiency, an approach which, as we have indicated, can and should be applied in all areas of economics, both theoretical and applied. It is our fervent hope that these illustrations act as an incentive for young scholars and researchers in our discipline, and that, as a result of their effort, they see their contributions enriched and crowned with success.

 

Jesús Huerta de Soto
Professor of Political Economy
King Juan Carlos University of Madrid, Spain

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(58) The traditional static analysis presumes that the supply and demand functions are constant and known, and therefore that it is possible to calculate the corresponding elasticities necessary for the operative application of the Ramsay-Pigou rule: the optimal rate of taxation is that inversely proportional to the elasticity of the demand for each good compensated for by its price.

(59) In the field of public finance, the proposed approach reveals the non-existence of public goods in a dynamic sense (as the problems of joint supply and exclusion of consumption tend to be detected and solved through entrepreneurial creativity), and hence what has, up to now, been considered the main theoretical justification for the existence of the state disappears.

(60) Kirzner 1999, 67-77. On the dynamically efficient nature of collusion between private companies which is not directly or indirectly encouraged by the state, see Salin 1996, 29-42.

(61) I devoted my entire book, Money, Bank Credit and Economic Cycles, to the analysis of these phenomena. Incidentally, the rejection of the hypothesis of efficiency and equilibrium in capital markets will give rise to a reformulation of the now obsolete theory of financial markets, which was responsible for so much damage as the theoretical basis of the past speculative bubble during the years of the so called “New Economy”. In contrast, the new theory must conceive the stock market as a dynamic process of entrepreneurial creativity, a process never perfectly efficient in a static sense, but which always tends toward dynamic efficiency in terms of the discovery and creation of profit opportunities and entrepreneurial coordination. See Huerta de Soto 2002a, especially chaps. 5 and 6.