Boettke (2002) notes that economists are inconsistent in their use of the terms information and knowledge. For present purposes, and consistent with Boettke's use of the terminology, information refers to data that an individual can collect. Individuals can search for information, and may be aware of information they are lacking that, if attained, could help them achieve their goals. For example, people might read newspaper ads looking for information about prices for goods they intend to buy. They may be unaware of other information that would help them if they had it. Knowledge refers to the incorporation of information into a framework where it can be used for decision making. Information about the price someone charges will be of little use unless the person with the information can place it in context. For example, what do other sellers charge for the same or similar goods? Is this price likely to fluctuate, so that next week's price might be considerably higher or lower? Do some sellers offer non-price advantages that might make it desirable to look at other information besides prices before deciding whether to buy? These are the types of factors that enable an individual to place information in a context that makes that information a component of the individual's knowledge. Wisdom refers to the use of knowledge to make good decisions. Because many factors must be weighed to arrive at a decision, and because some of those factors may be difficult to articulate or weight in a mathematical sense, many people may have the same knowledge, but even with identical knowledge, some will make better decisions than others.
Boettke (2002, p. 268) notes that "information is a flow concept, while knowledge is a stock notion." By extension, Boettke (2002, p. 269) observes, "Knowledge is ever changing and is multifaceted, while information is something fixed." The flow of information adds to the stock of an individual's knowledge, but new information may also change the context within which old information is interpreted. Knowledge is more than just the sum of all information possessed by an individual. If one pictures a pitcher of water, and an individual adding a flow of water to the stock of water already in the pitcher, this analogy inadequately describes the relationship of flow information to the stock of knowledge. Instead, picture someone adding flour, water, yeast, and the right amount of heat, to produce bread. In the kitchen, the flow of ingredients yields a stock of food that is qualitatively different from the flow of ingredients that produced it. Just as bread is not some flour, some water, and so forth, a person's knowledge is not just all the information the person possesses. And just as some chefs are more successful than others at producing meals even with the same stock of ingredients, many individuals might have similar stocks of knowledge, yet some have the wisdom to make better economic decisions with their knowledge.
Kirzner (1973, p. 67) makes a similar distinction between knowledge and entrepreneurship. "But as closely as the element of knowledge is tied to the possibility of winning pure profits, the elusive notion of entrepreneurship is, as we have seen, not encapsulated in the mere possession of greater knowledge of market opportunities. The aspect of knowledge which is crucially relevant to entrepreneurship is not so much the substantive knowledge of market data as alertness, the 'knowledge' of where to find market data" (emphasis in original). Kirzner means by data what this section refers to as information. But knowledge as
Kirzner describes it in this passage is knowledge about where to find information. One must put that information in context to have knowledge, and must be able to use that knowledge productively to have wisdom.
In most instances, acting on an entrepreneurial insight is a risky undertaking. The well-known fact is that most new businesses fail within their first five years, illustrating that in many cases, what appears to some as an unexploited profit opportunity turns out not to be profitable after all. When Kirzner talks about someone noticing a previously unexploited profit opportunity, what the potential entrepreneur notices is information. The entrepreneur must be in a position to turn that information into knowledge, and to turn that knowledge into wisdom. The setting within which the information reveals itself plays an important role in whether the information about a profit opportunity ultimately is transformed into knowledge, and then wisdom, leading to action to exploit the opportunity on the part of the entrepreneur.
Consider a simple example of an individual who notices that apples can be bought for $0.25 in city A and sold for $0.50 in city B. These prices are information. The individual can place this information into a framework that can lead to an entrepreneurial insight: a profit opportunity may exist by buying apples in A and selling them in B. More must be known than just the prices, however. The potential entrepreneur would have to factor in transportation costs, and for a true profit opportunity to exist, not only would the entrepreneur need this information on prices, but also a reasonable expectation that the price differential would continue to exist long enough for the entrepreneur to complete a transaction. If an apple can be shipped from city A to city B for $0.10, there is still the possibility for a profit, if after buying apples for $0.25 in city A and shipping them to B, the price in B has not fallen below $0.36. The entrepreneur may have information about the propensity for apple prices to fluctuate in the short run, or may be able to avoid the risk of fluctuations in the spot market by contracting ahead of time with a buyer in city B. Prices by themselves provide information, but as this simple example shows, information by itself does a potential entrepreneur little good. The entrepreneur must be in a position to place that information in a framework that yields knowledge before a profit opportunity can be spotted.
In this sense, Hayek (1945) was discussing the use of knowledge in society, as his title says, not the use of information. Wisdom goes a step further, and is the ability to use knowledge to make good decisions. The fact that most new businesses fail within the first five years suggests that many people incorrectly believe they have discovered profit opportunities. For example, the apparent profit opportunity above might be undone if too many apples are spoiled or damaged in transit, or if the entrepreneur failed to account for the possibility that transportation costs might fluctuate even while taking account of price fluctuations for the apples themselves, or any number of other complications. Wisdom lowers the probability that one is wrong when making a decision based on knowledge.
With hindsight, one can separate good decisions from bad decisions on the basis that good decisions yield profits while bad decisions produce losses. One can never know whether a decision was "optimal," in the sense that it was better than other available alternatives, because as Buchanan (1969) notes, one can never know what would have been the outcome of a foregone alternative. Information is relatively easy to evaluate, in the sense that one can check on its validity, despite the fact that people can obtain information that is wrong, incomplete, or faulty in some other way. Knowledge is more difficult to evaluate, because one must be aware of the context within which information is used, and it is easy to envision how someone's knowledge could be faulty because the person is lacking some information the person does not even realize would be useful. Wisdom is more difficult to evaluate than knowledge, because even in hindsight one cannot compare the outcomes of decisions people make with what would have been the outcomes if they had chosen differently.
If one views entrepreneurship as seeing and acting upon a previously unnoticed profit opportunity, it is apparent that two people could observe the same information, and one would see it as an unexploited profit opportunity while the other might not, either because the second person did not have the knowledge to place that information in context, or did not have the wisdom to see that the information does, in fact, reveal the opportunity to make a profit. Ray Kroc, who built the McDonalds restaurant chain, sold restaurant equipment before he took over McDonalds. He had an order for a large number of milkshake makers, and went to the restaurant started by the McDonald brothers to see personally how a restaurant could be selling so many milkshakes. What he saw was an innovation in restaurant operation. Before McDonalds, restaurants got customers' food orders and then prepared the food, but McDonalds had the entrepreneurial insight that they could prepare the food before it was ordered so customers could get their food right away. This system required that management be good at predicting the number of customers and food orders so the right amount of food would be on-hand, and hindsight shows that they had a good system. Ray Kroc did not develop this system himself, but he recognized it as a profit opportunity. He had the information from seeing the operation of McDonalds, he had the knowledge from years of experience in the restaurant industry, observing many different types of operations, and he had the wisdom (moreso than the original innovators) to see this as a profit opportunity. So he bought the restaurant from the innovators and established it as a world-wide chain.
Perhaps Kroc was just lucky. It is difficult for an outside observer to separate out luck from wisdom, because there is no formula for identifying how individuals can use knowledge to make good decisions. It is easier to see how knowledge can prevent people from making bad decisions, by identifying potential problems before they arise, but how did Ray Kroc have the insight to see what a profit opportunity McDonalds presented when the innovators who started the restaurant were (using their sale as evidence) less optimistic. Part of the answer likely lies in the different knowledge bases of Kroc and the McDonald brothers. The McDonalds may have had the knowledge to start and operate a restaurant, and the brilliant insight to prepare the food before the customers ordered it, but Kroc, as a vendor selling to many restaurants, had a broader knowledge of the industry. Regardless of whether this speculation on the differences in knowledge between the McDonalds and Kroc is true, this is an example of how two people could have the same information about a profit opportunity, and yet because the two individuals had different knowledge bases, one saw it as a more profitable opportunity than another.
Perhaps Kroc was lucky, but there's an old slogan, "Luck is when preparation meets opportunity," and it seems to apply here.1 Kroc was prepared because of his background in the restaurant industry, and had the opportunity when the McDonald brothers were willing to sell him their restaurant. But many people believe they have spotted profit opportunities that result instead in losses. Perhaps their knowledge was faulty, but consider companies like IBM on the brink of bankruptcy in 1991, or Xerox and Polaroid on the brink of bankruptcy in 2001. Surely the management in those companies had ample knowledge of the computer, photocopying, and photography industries, respectively, but that knowledge did not translate into the wisdom that led to profitable decisions. In the real world (unlike the neoclassical model of the firm), profitability is a moving target, and activities that were profitable a decade ago - or even a year ago in rapidly-evolving industries - may not be profitable today. As Christensen (1997) notes, decision makers can be misled by their past successes into thinking that strategies that brought them profits in the past can continue to do so in the future. As the IBM, Xerox, and Polaroid cases show, more than knowledge is required to spot profit opportunities. Entrepreneurship is built on a foundation of knowledge, but also requires the wisdom (or luck) to be able to sort the good strategies from the bad.
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