The History Of The Risk Bearer Commerce Essay

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This paper aims to analyse and explain in brief the historical association among the developments of entrepreneurship theories and its relation with risk as a concept. It gives an overview of some important classic contributions in the study of entrepreneurship that use risk as their primary subject of discussion. The classic contributors considered are Richard Cantillon (1680s-1734), Jean-Baptiste Say (1767-1832), Alfred Marshall (1842-1924), Joseph Schumpeter (1883-1950), and Frank Knight (1885-1972). The paper groups the first three contributors, Cantillon, Say, and Marshall, into a section discussing the early thoughts of entrepreneurship studies, while the last two, Knight and Schumpeter, are discussed under separate sections. This is done not only due to the topic being addressed, which is on the relationship between risk and entrepreneurship, but also because of the impact Knight and Schumpeter have to the study in general.

Some scholars speculate risicum, which is the Latin word of risk, to be Arabic origin, introduced to Continental Europe by Middle Eastern and North African traders during the middle age (Luhmann, 1991). The word found it significance in trade, particularly sea trade, and was officially used to explain specific legal problem as a result of loss or damage (Franklin, 2001). On the other hand, words that have similar meaning with risicum, such as rischio, ricico, or riezgo, were only spoken as a vernacular language (Luhmann, 1996). Risk finally arrived in Britain from France by the middle of the 17th century, yet first in its original French spelling of risqué (Stevenson, 2011).

According to Niklas Luhmann (1991, 1996), risk is historically a new term, which marked the transition from traditional to modern Europe. When the terminology of risk began to gain its importance, the word gradually replaced the older notion on how people at that time think of good and bad fortune. Luhmann (1996, p. 4) explain that this transition:

. . . was simply the loss of plausibility of the old rhetorics of Fortuna as an allegorical figure of religious content and of prudentia as a (noble) virtue in the emerging commercial society . . . [on] the quest for a concept able to accommodate the concrete problems of individual decision making.

Risk, at that time, started to be used to explain the unpredictability of events and the unforeseeable choice between good and bad outcomes. Risk awareness, on the other hand, was seen as the capability to cope with temporal or future contingencies.

Currently, the International Standard Organisation, through the establishment of an international committee representing over 30 countries and involving a number of experts from various disciplines, is perhaps the only institution that has done the most systematic attempt in defining risk (Purdy, 2010). The ISO 31000 (2009) defines risk as the result of uncertainty on a particular objective, which may include events or ambiguity as a product of misinformation, as well as the negative or the positive impact on that particular objective. However, the concept of risk itself in reality is inconsistent, hence making it ambiguous even today. Typically, it is easier to identify and define the concept by its corresponding impression of calculated future uncertainty or its opposing notion of safety.

The above situation has led to the emergence of various perceptions, and thus, different fields have their own approaches in managing risk (Hubbard, 2009). For instance, according to the Occupational Health & Safety Advisory Services (OHSAS, 2007), risk is the combination of the probability of occurrence of hazardous event or exposure and the severity of injury or ill health that can be caused by them. While in economics, risk is defined as the unpredictability or instability of returns, which include either potential losses or gains.

Still, despite of the mystery behind of its etymology and the vagueness of its concept, entrepreneurship studies are probably the only sub-discipline in social science that perceives risk as a supporting incentive in its theories. Widely influenced by economics, the entrepreneur as a rational economic man is believed by the study to be habitually engaged in many risky decision-makings in order to maximize their payoffs. This characterisation makes entrepreneurship to be commonly described as the act of bearing risk, where the attitude to risk is extensively assumed as the main motive that drives an individual in becoming an entrepreneur.

According to the logic of the study of entrepreneurship, while it is a common knowledge that entrepreneurial income is volatile and less certain than the wage received from a regular employment, individuals with a relatively high levels of risk aversion are more likely to choose paid work as opposed to entrepreneurship (Cramer, Hartog, Jonker & Van Praag, 2002). This assumption is the basis of various theories of entrepreneurship and has been used since Cantillon's (1931) Essai Sur la Nature du Commerce en Général.

Early Thoughts on Entrepreneurship and Risk

As I have discussed earlier, during the 17th century when risk as a term was getting more prevalent, risk taking as a component of the term was largely understood to be highly related to entrepreneurship. Although entrepreneurs were recognised as individuals who took risks, not all risk bearers were considered as entrepreneurs. At that time, entrepreneur and non-entrepreneur were differentiated by the size of their business and with who he was contracted to. A person was said to be an entrepreneur only if he own a large contracts with the state or some competent capitalist, to undertake a major building scheme or to supply the army with equipment. While at the same time, the risk that had to be endured by him was the fixed price of the bond and all other future losses that might occur because of the agreement. This identification, according to Hans Landstrom (2005a, p. 8), was highly reflected by the 17th century French Phrase of "entrepreneur, qui entreprend un bâtiment pour un certain prix", which mean the entrepreneur is the contractor who undertakes a scheme on a fixed price.

Traditionally, classic philosophers condemned entrepreneurs because of their thirst on profit (van Praag, 1999). This view is consistent with Aristotle's vision, which perceived economic activity as a one man's gain one man's loss game. Thus, at that time, entrepreneurs were seen as robbers, instead of heroes. However, this condition change drastically when in 1755, Richard Cantillon (1931), through his Essai Sur la Nature du Commerce en Général (originally published in 1755), introduced a rather different perspective of entrepreneurship. According to him, ". . . the exchange and circulation [of capital] of the state is conducted by the actions of these entrepreneurs" (Cantillon, 1931, p. 77), hence, putting them as the key player that arbitrage the economic system.

Cantillon was the first to formalise the economic meaning to the concept of 'entrepreneur.' He described the function of the entrepreneur in the economic system as the risk bearer arbitrager. Cantillon recognized that discrepancies between demand and supply in a market create opportunities for buying cheaply and selling at a higher price, and that this arbitrage would bring the competitive market into equilibrium (Landstrom, 2005b). He believed that arbitrage always involves uncertainty, and that this uncertainty has motivated all entrepreneurs because they, according to him, are eager to earn the potential profit generated from the activity of ". . . buy[ing] at a certain price and sell[ing] in their shops or the markets at an uncertain price" (Cantillon, 1931, p. 75). Here Cantillon distinguished entrepreneur and non-entrepreneur by the nature of their risk bearing attitude, which yields uncertain and non-contractually arranged incomes, where the entrepreneur should be well prepared to bear the inherent risk.

Jean-Baptiste Say, who was highly influenced by Cantillon's Essai, considered entrepreneur as a risk bearer as well. Attacking Aristotle's zero-sum game, Say (2001, p. 26), in his Treatise on Political Economy (originally published in 1803), wrote that economic activity gives existing materials a utility they did not possess before and he coined this kind of activity as the production of wealth. According to him, the entrepreneur's job is to put forward this production of wealth in order to improve the economy of a nation, since they are the only economic agent that possesses the creativity, ideas, imagination, as well as innovation to do it (Say, 2001, p. 33). To do so, Say characterised the entrepreneur as the coordinator, modern leader, and manager within his own enterprise, who bear all the risk of failure pertaining to any entrepreneur activity, because:

. . . there is always a degree of risk attending such undertakings; however well they may be conducted, there is a chance of failure; the [entrepreneur] may, without any fault of his own, sink his fortune, and, in some measure his character; which is another check to the number of competitors, that also tends to make their agency so much the dearer (Say, 2001, p. 177).

Similar to both classical economists above, early neoclassical economist, headed by Alfred Marshall, also considered risk as an important incentive to entrepreneurship. Marshall (1920, p. 232) in his Principles of Economics (originally published in 1890) wrote that ". . . trade then has its own peculiarities, but in most cases the evils of uncertainty count for something", and these evil alone has been the main features that lure individual decision to become an entrepreneur in the first place. According to him, entrepreneur as risk bearer, who is motivated by ". . . the attractive force of changes of great gain of uncertainty", drive the production and distribution process, coordinating supply and demand on the market along with labour and capital within the firm (Marshall, 1920, p. 233). In other words, Marshallian entrepreneurs are those individuals who undertake all the risks that are associated with production, lead and manage their firms, while at the same time continuously seeks opportunities to minimize costs for a given result. This is the reason why, to become successful, Marshall recommended his entrepreneur to be equipped with specialized abilities that can support them when undertaking risks, such as on the knowledge of the trade, business forecasting, as well as opportunity identification.

Knight: Risk vs. Uncertainty

If Cantillon was the first to formalise the economic concept of entrepreneurship, than Frank Knight was undoubtedly the first economist who recognized different characterisations of uncertainty, by explicitly distinguishing measurable uncertainties (risk) with true uncertainties. In reality, we have to acknowledge that early scholars who focused on entrepreneurship as their subject used both terms synonymously and interchangeably in their writings, since they considered risk as a product of any future uncertainty or as terms with the same meaning (Landstrom, 2005b). In his doctoral dissertation on Risk, Uncertainty, and Profit (originally published in 1921), Knight, utilising Schumpeter's theory on innovation as a foothold, attempted to square Marshal's neoclassical theory on profit and at the same time enhance previous theories of entrepreneurship, by making a generalisation that all entrepreneurs endure the true uncertainty not the calculated risk as proposed by Cantillon, and that the role of entrepreneurship involves more than what Say called the arbitrage function.

Resting his vision on a predetermined external postulation on the universe, Knight (1964, p. 198) assumed that an event appears to be unique if the observer only possesses a "partial knowledge" or "incomplete information" of reality to classify it properly with a set of similar conditional events in the past. Therefore, in contrast to risk where ". . . the distribution of the outcome in a group of instances is known", he believed uncertainty encompasses a variety of probability ". . . that it is impossible to form a group of instances, because the situation dealt with is in a high degree unique" (Knight, 1964, p. 233). In other words, uncertainty in his model is any unique instance that has never been recorded before in history, in which the expectations of the future are based on subjective beliefs, whereas risk refers to the calculable a priori, in which there is certainty about the distribution of possible outcomes.

Knight (1964), in chapter seven of his Risk, Uncertainty, and Profit, furthermore divided future outcomes into three categories: 1) outcomes that can be predicted using mathematical probability; 2) outcomes that can be anticipated based on their regularities in the past or with sufficient historical evidence; and 3) outcomes that cannot be predicted using mathematical probability nor anticipated from historical data. He categorised the first and the second type of outcomes as risk, while the third as uncertainty. Uncertainty claimed by Knight as the condition necessary for profit to exist. He argued that even if the future is purely risky, profit could not exist because the alternative possibilities are known and the probability of occurrence of each can be accurately ascertained. Using his words:

It is this "true" uncertainty, and not risk, as has been argued, which forms the basis of a valid theory of [entrepreneurial] profit and accounts for the divergence between actual and theoretical competition . . . since risk, in the ordinary sense, does not preclude perfect planning (for reasons which can easily be made clear), such risk cannot prevent the complete realization of the tendencies of competitive forces, or give rise to profit (Knight, 1964, pp. 278-279).

This is the reason why, according to him, judgmental decision plays an important role and should be implemented, either after making ex ante calculations of an estimated risk or when estimating the value of uncertainty. Indeed, decisions made in everyday business never concern with calculable probabilities, and Knight (1964, p. 268) alleged that the real feature of entrepreneurship within a society is on its role in dealing with this kind of uncertainty:

. . . the work of [making judgemental decision through] forecasting and at the same time a large part of the technological direction and control of production are still further concentrated upon a very narrow class of the producers, and we meet with a new economic functionary, the entrepreneur.

In his view, the entrepreneur is responsible in directing, controlling, and dealing with real uncertainties by means of judgemental decision, while other economic agents furnish them with productive service of which the entrepreneur guarantees a fixed remuneration.

Profit, thus, is the most logical reward for the bearers of uncertainty, where the competition on profit among prospective entrepreneurs, who bid in the market for society's productive services, determines the aggregate price. This is because, according to Knight (1964, pp. 284-285):

. . . profits and contractual income then depends upon the supply of entrepreneur ability in the society and the rapidity of diminishing returns from (other factors applied to) it, the size of the profit share increasing as the supply of ability is small and as the returns diminish more rapidly . . . [whereas] the size of the profit share depends on whether entrepreneurs tend on the whole to overestimate or underestimate the prospects of business operations, being larger if they underestimate.

Besides profit, entrepreneurship also come with great prestige ". . . and the satisfaction resulting from being one's own boss should also be considered when studying entrepreneurial income" (Knight, 1964, p. 366).

Knight (1964, pp. 283-290) additionally explained that to achieve all of these, successful entrepreneurship, because of its engagement with uncertainties, requires not only "good luck", but also a good entrepreneurial ability, such as 1) a high degree of self-confidence, 2) the power to judge personal qualities as compared to those of other individuals, 3) a disposition to act on one's own opinion, 4) a venturesome nature, and 5) foresight. But above all, as a leader, Knight (1964, p. 269) asserted that the most important prerequisite in becoming an entrepreneur is ". . . the power of effective control over other men as well as the intellectual capacity to decide what should be done".

In its essence, Knight's response to uncertainty was instead to reduce it to risk. Knight was dreaming to see a rational entrepreneur converting an uncertain situation to a situation of risk, which allowed computational returns and adequate compensation for capital. Since, in his mind, it would not be rational for the economic man to venture into uncertainties, where there is only intuition, opinion, or hunch without some formal expectations. Knight's logical assumption and his model on risk and uncertainty have inspired today's occupational choice theorists to consider risk as the dominant determinant that motivate an individual in becoming an entrepreneur (e.g. Kihlstrom & Laffont, 1979; Kanbur, 1979; Blanchflower & Oswald, 1998).

Schumpeter: Putting Risk Out From the Study

Perhaps there is no economist in the world other than Schumpeter, who relied solely on entrepreneurship as the main engine of his economic theories. Originally published in 1911, Theorie der Wirtschaftlichen Entwicklung is considered as his magnum opus, which reflected most of his ideas on entrepreneurship. Through the book, he turned down the predominant paradigm of entrepreneurship as the management of the firm and replaced it with an alternative one, the entrepreneur as the leader of the firm (in modern business management language). He was also the first to integrate psychological theory in the economic theory of entrepreneurship and treat innovation as an endogenous process, possessed only by the entrepreneur, who therefore believed by Schumpeter, is the prime mover of the economic system. However, most interestingly, he explicitly opposed the idea of the entrepreneur as a risk bearer and a capitalist.

Schumpeter vision on leaving out risk of entrepreneurship has surprised many economists, mostly the neoclassic, especially in the light of his view of the development process as being one where those energised entrepreneurs set in motion a revolutionary process of which he called "creative destruction", changing the traditional economy to its modern form (Schumpeter, 2006, p. 83). Schumpeter (2004, p. 61) described the traditional economy as a "circular flow":

The theory of the first chapter describes economic life from the standpoint of a "circular flow," running on in channels essentially the same year after year - similar to the circulation of the blood in an animal organism.

According to him, it is the entrepreneur's "innovative" job to disrupt this circular flow within the development course (Schumpeter, 2004, p. 72).

It is however unimaginable that an attempt, a journey into the unknown, not to be full of risk and uncertainty, a situation that was acknowledged by Schumpeter (2004, pp. 84-85) himself:

. . . outside these accustomed channels the individual is without those data for his decisions and those rules of conduct which are usually very accurately known to him within them. Of course he must still foresee and estimate on the basis of his experience. But many things must remain uncertain, still others are only ascertainable within wide limits, some can perhaps only be "guessed." In particular this is true of those data which the individual strives to alter and of those which he wants to create. Now he must really to some extent do what tradition does for him in everyday life, viz. consciously plan his conduct in every particular.

Yet, despite the attempts to "break the circular flow" as being inherently risky, Schumpeter (2004, p. 137) extraordinarily stated that "[t]he entrepreneur is never the risk bearer". He argued that:

The one who gives credit comes to grief if the undertaking fails. For although any property possessed by the entrepreneur may be liable, yet such possession of wealth is not essential, even though advantageous. But even if the entrepreneur finances himself out of former profits, or if he contributes the means of production belonging to his "static" business, the risk falls on him as capitalist or as possessor of goods, not as entrepreneur. Risk-taking is in no case an element of the entrepreneurial function. Even though he may risk his reputation, the direct economic responsibility of failure never falls on him (Schumpeter, 2004, p. 137). Risk obviously always falls on the owner of the means of production or of the money-capital which was paid for them, hence never on the entrepreneur as such (Schumpeter, 2004, p. 75).

To sum up his opinion, in his History of Economic Analysis (originally published in 1954) Schumpeter (2004, p. 531) wrote:

Since many modern economists also include risk-bearing among entrepreneurial functions, it may be well to point out at once the objection to the idea. It should be obvious, so soon as we have realized that the entrepreneur's function is distinct from the capitalist's function, that an entrepreneur, when he employs his own capital in an unsuccessful enterprise, loses as a capitalist and not as an entrepreneur. It has been said that if he borrows at a fixed rate of interest, the capitalist being entitled to repayment plus interest irrespective of results, it is the entrepreneur who bears the risk. But this is a typical instance of a very common confusion of economic and legal aspects. If the borrowing entrepreneur has no means of his own, it is obviously the lending capitalist who stands to lose, his legal rights notwithstanding. If the borrowing entrepreneur has means by which to effect discharge of his debt, he too is a capitalist and, in case of failure, the loss again falls upon him as a capitalist and not as an entrepreneur.

Schumpeter claimed that the entrepreneur's task is to innovate and to lead, particularly deciding which objectives to pursue rather than deciding on how to pursue them, therefore making him to consider that they are not the risk bearers or a supplier of capital. According to his vision, an entrepreneur does not always automatically become the director and business owner at the same time. He is the 'man of action' [1] who does not accept reality as it is and is willing to fight against any odd or obstacle. He seeks opportunities for profit and introduces new combinations by means of innovation, in whatever position, whether he is the leader or the owner of the firm.

Shumpeter (2004, p. 75) also added that an individual does not need to be rich to be an entrepreneur, because innovations can be equally well supported by credits. Nevertheless, if those innovations are supported by the entrepreneur's own wealth, then he fulfils two jobs at once: he as the entrepreneur because of his innovation and he as a capitalist because of his money in support for the innovation he built. In any case, it is the capitalist function to bears the financial risk pertaining to an innovation, not the entrepreneur.

Carrying out innovations is a profit-driven activity, and "[b]y being the first to introduce a "new combination", the entrepreneur obtains temporary monopoly power" (Baumol, 1993, p. 6). Then again, competition, particularly with the entry of new players that are more innovative, eventually erodes the entrepreneur's initial profits. This is because, Schumpeter understood that innovation is more common to be found or embodied in new firms rather than the old ones, since the latter are usually getting more static and inflexible due to their monopolistic position in the market (Schumpeter, 2004, p. 136). [2] Albeit the entrepreneur successfully builds a sustainable and indefinite monopoly, his entrepreneurial profit will be turned into monopoly rents instead and the flow of his entrepreneurial gain will be provisional. This way, old firms are eliminated whenever they cease to carry out new combinations themselves. [3] 

As a result, Schumpeterian entrepreneurship is risk free and is neither a profession nor a condition that lasts. Schumpeter's entrepreneurs do not form a social class, although successful entrepreneurship can improve the position of an entrepreneur socially, of course, in accordance with how the business is being preceded and what is the impact of the product. Without continuous innovations, Schumpeterian entrepreneurship is a temporary condition for everyone. In 1960s, all of his ideas on entrepreneurship have fuelled the re-emergence of the Schumpeterian school of economic development that studied the social origins of entrepreneurship. Many of those ideas also influenced the new socio-cultural school of economic development headed by McClelland (1961 [1] ) and Hagen (1962 [2] ) that analysed the sociocultural and psychological barriers of entrepreneurship among developing countries, particularly in relation to the differences of entrepreneurial traits among different cultures.

Conclusion

Entrepreneurship as a multidisciplinary subject is experiencing renewed interest as demonstrated by many empirical studies nowadays. Even most academics agree, that if an economy discourages entrepreneurship, it is likely to discourage newer dynamic industries from putting down the roots they may otherwise do (Berry, 2007). Zimmerer and Scarborough (1994) even predicted that the 21st century would dawn with the greatest number of entrepreneurship ever. However, there are only limited issues in economics that are supported by such a rich knowledge base of history, especially matters related to entrepreneurship. This circumstance, which in fact is precarious, was primarily induced by the temporary disappearance of the entrepreneur as an economic agent from the theoretical and empirical research agenda until the late 1960s (Setiawan, 2012). As an answer to the muddled situation, this paper has provided an overview of some important classic contributions associated with the determinants of successful entrepreneurship as the risk bearer and the position of risk as a subject in the study of entrepreneurship. From the discussions that have been presented, the paper also suggests that the classic knowledge base discussed is still valuable and applicable.

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