The Efficient-Markets Hypothesis Is a Good Example of the Neglect of the Entrepreneur in Economic Theory

The entrepreneur is a key figure in the market economy. In a dynamic economy, ideas, products, and services are constantly changing. Entrepreneurship, broadly defined, refers to actions of individuals as they strive to cope with constantly changing market conditions. When viewed in this way, all market participants—consumers, producers, and investors—engage in entrepreneurial activity.

Despite the crucial role of entrepreneurship in the market process, the entrepreneur is often neglected in economic theory. A good example of this neglect is the efficient-markets hypothesis (EMH) of financial investments. This theory holds that the individual investor cannot outwit the market because all available information is already incorporated in stock prices. The efficient-markets approach taken to its logical extreme “means that a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the expert.” The implication is that a buy-and-hold strategy is as good as any other and that there is no scope for entrepreneurial activity in financial markets.

Insights from the Austrian theory of the competitive market process are used in this article to show that the role of the entrepreneur in investment decisions is similar to that in other spheres of economic activity. Entrepreneurial opportunities exist whenever markets are not perfectly coordinated. Hence, it is argued, there is scope for entrepreneurial activity in financial markets just as there is in other markets. In a world of uncertainty and costly information, the pinpointing of economic inefficiencies is found to be just as difficult in financial markets as it is in all other markets. Since the EMH is a version of the zero-profit theorem of competitive equilibrium in the conventional theory of the firm, it is argued that shortcomings of the EMH are similar to those of other long-run competitive theories that focus exclusively on equilibrium outcomes while ignoring the entrepreneurial market process that generated those outcomes. The conclusion is that neither the dart-throwing monkey nor any other automaton is a good substitute for the entrepreneur in investment markets where relative prospects for different assets are constantly changing. Before specifically considering the role of entrepreneurship in financial markets, the reason for the neglect of the entrepreneur in conventional economic analysis is briefly analyzed.

—E. C. Pasour Jr., “The Efficient-Markets Hypothesis and Entrepreneurship,” Review of Austrian Economics 3, no. 1 (December 1989): 95-96.