Thursday, July 05, 2012

Economists vs. Entrepreneurs, 5th of July Edition

I was trained mostly in economics, but lately I have been more of an entrepreneur. The mindsets could not be more different, and they color the way I respond to arguments such as the one I blogged about recently.

One of the key concepts you learn in Econ 101 is tradeoffs.  Basically, if you get more of one thing, you generally have to take less of another thing to compensate.  Diagram I below shows a curve called a Production Possibility Frontier.   The idea is that if you are anywhere on the curve, you face a tradeoff.  For example, if you are at B, you can have more production, but in return you must do less maintenance.  (Note that "production" and "maintenance"are just example variables.  We could substitute "work output" and "free time with family" if we wanted.)

Optimistic economists assume that we are at point D, not point A or B. If you are at D, then you can have both more work output and free time if you work more efficiently.  Much of the work I did as an economist at the World Bank was helping advise countries on how to get from point D to somewhere on the possibility frontier.  But we didn't know how to get to point C, which lies beyond the frontier.  We noticed that the curve does shift outward over time, as in Diagram II below, but we didn't really understand why, and could not come up with policy prescriptions to make it happen.

Dagram I
Entrepreneurs, by contrast, take things into their own hands and try to invent a new machine, technology, process, or idea that will shift the entire curve outward.  The net result of this is to alleviate the tradeoffs seen in Diagram I (though, of course it is true that a new set of tradeoffs are introduced).  The evolution of smart phones is an oft-used example of this, where more and more features and capacity were invented, reducing tradeoffs significantly.  We can now talk on the phone while surfing the web and using several apps at the same time.  This is a vivid example, but there are many more.

Diagram II
Just because entrepreneurs believe they can shift the curve doesn't make it happen; most entrepreneurs fail repeatedly (I have).  New business ideas fail most of the time - 58 times for every success, by one measure.  But entrepreneurs don't give up.  They just keep trying again and again. And when they succeed, they push the possibility frontier outwards, bit by bit.