ECONOMICS ON TRIAL--The Freeman, March 1999

Y2K AND ENTREPRENEURIAL ERROR
by Mark Skousen

"No businessman in the real world is equipped with perfect foresight; all make errors."
--Murray N. Rothbard (1)

Over the past year, I've been involved in a series of debates over the impact of the Year 2000 Problem, the potential collapse of computers--and perhaps the economy--owing to the fact that since computer programs use two digits instead of four to indicate years, the year 2000 will be treated as 1900. On the one extreme is Gary North, who claims that the Y2K problem is so serious that it will gravely disrupt society for years. On the other end is Harry Browne, who says that enlightened entrepreneurs will avert a worldwide disaster.

What's interesting about the debate is that free-market advocates are found on both sides. North and other naysayers focus on the propensity of market players to make entrepreneurial errors and engage in shortsightedness. Browne and other optimists stress the entrepreneurs' ability to solve problems, especially when so much is at stake. (Some businesses could go bankrupt if they don't address the Y2K problem.) In short, the market works.

My concern is that the "market always works" camp comprises true believers who blindly think the market can solve all problems almost automatically. They seem to fit into the rational equilibrium-always school of economics where entrepreneurial misjudgment, imperfect knowledge, and uncertainty play little or no role.

MARKETS ARE NOT PERFECT

The Austrian economists teach otherwise. Israel Kirzner, noted for his studies on entrepreneurship, attacks the model of perfect efficiency as "wholly unsatisfying." He adds that, "It is most embarrassing to have to grapple with the grossly inefficient world we know with economic tools that assume away the essence of the problem with which we wish to deal." (2)

The market is characterized by profit and loss, success and failure, certainty and uncertainty. There is always room for improvement, and the entrepreneur's role is to eliminate errors and inefficiencies. Thus, it should come as no surprise that many businesses and financial institutions are making significant headway in fixing their computer programs to avert the Y2K problem.

On the other hand, it would be folly to ignore that many businesses have budgeted insufficient time and money to fix or replace their computers. Evidence is growing that most firms, especially small businesses, are not doing enough. Many major corporations and government agencies, both here and abroad, admit that they only have time to fix critical systems. The rest will fail on January 1, 2000.

Free-market advocates sometimes place too mcuh faith in the market's ability to solve problems and ignore ubiquitous error in an entrepreneurial economy. Think about all the ways people make mistakes every day in the marketplace: Investors buy the wrong stock. Businessmen declare bankruptcy. Marriages break up. Consumers over-spend and over-eat, especially during the holidays. Kids fail to do homework. Drivers have accidents. Ships sink. Builders don't meet deadlines. Economists make false predictions. Entrepreneurs cut corners, deceive customers, and embezzle funds. Economic failure, stupidity, and incompetence are common to human nature. As Ludwig von Mises noted, "To make mistakes in pursuing one's ends is a widespread human weakness." (3)

The decision by computer programmers in the early 1950s to use two digits instead of four is a classic example of individual shortsightedness. To save space, they cut corners, and now, a generation later, the whole world is paying a heavy price for their blunder.

CLUSTER OF ERRORS

In most cases, entrepreneurial error is random, unpredictable, and self-correcting. As Murray Rothbard states, "As a rule only some businessmen suffer losses at any one time; the bulk either break even or earn profits." (4)

There are, however, cases of widespread error--mistakes that affect virtually every part of an industry or economy. Rothbard, in standard Austrian school fashion, explained depressions in terms of "a sudden general cluster of business errors." (5) Of course, the Austrians attribute those errors and the business cycle in general to monetary inflation by government.

Yet can't error with far-reaching harm occur in the market without government being responsible? Austrian economists don't normally discuss this possibility, but it undoubtedly exists. Market decision-makers have made shortsighted blunders that have had universal consequences. Examples of such errors include asbestos in construction, pesticides in agriculture, and air and water pollution in manufacturing. The Y2K computer glitch is a particularly tough challenge because it is universal and time-sensitive. In most cases, the deadline cannot be postponed.

THE MARKET'S SELF-CORRECTING MECHANISM

Fortunately, the market has a built-in mechanism to minimize mistakes and entrepreneurial error. The market penalizes mistakes and rewards correct behavior. Business leaders know that computer problems can destroy their business; fixing the Y2K bug will avoid losses and may even be profitable. They are willing to pay the price. As Kirzner has said, "Pure profit opportunities exist whenever error occurs." (6) At the same time, the market will severely penalize businesses that have ignored the Y2K problem or have procrastinated.

Followers of free markets should take note: markets may be self-correcting, but they are not all-seeing.

FOOTNOTES

1. Murray N. Rothbard, Man, Economy, and State (Nash Publishing, 1970), p. 746.

2. Israel M. Kirzner, "Economics and Error," in Perception, Opportunity, and Profit (University of Chicago Press, 1979), p. 135.

3. Ludwig von Mises, Theory and History (Yale University Press, 1957), p. 268. Mises adds that "Error, inefficiency, and failure must not be confused with irrationality. He who shoots wants, as a rule, to hit the mark. If he misses it, he is not 'irrational'; he is a poor marksman."

4. Murray N. Rothbard, America's Great Depression, 4th ed. (Richardson & Snyder, 1983 [1963]), p. 16.

5. Ibid.

6. Kirzner, op. cit., pp. 132-33.