Nature of exchange

Tracing the evolution of economic exchange from primitive, self-sufficient production to the modern, advanced Division of Labour (DoL) makes it clear that money is one of the most useful inventions in the history of humanity. It is not an exaggeration to say that most of the wealth that currently exists today on this earth would not exist in the absence of money.

Self sufficiency

Self-sufficiency refers to the ability of an individual, family or community to fulfil all of their fundamental needs without requiring exchange with outside parties. A self-sufficient structure means that all goods and services consumed are locally produced.

In smaller communities this can mean there might not even be a need for the exchange process. Goods and services might be provided for the benefit of the entire community and be provided without an expectation for a return.

In growing communities the need for exchange can often increase due to the opportunity for individuals to specialise on certain economic responsibilities. This leads us onto the importance of the DoL. At the level of the individual, family or small community, assigning responsibilities and distributing resources can be handled in a variety of ways predicated on trust and close personal relationships. However, once a community grows to a size at which all of the members are not connected by close personal relationships, formal systems of exchange become necessary.

Division of labour

The idea behind the Division of Labour is that in a community of people, the total amount of economic output will be greater if the members divide up the tasks necessary to provide for their material needs, such that each individual specialises in one particular area of production, as opposed to each individual, household or small community working along to provide all of their needs independently of the outside world.

Adam Smith famously illustrated the concept of the DoL by describing the workings of a pin factory. He explained how ten people working together were able to produce thousands of times more pins than the ten individuals could have produced working separately. The point of illustrating the principle in these terms was to show that the DoL does not just increase the efficiency of labour 10% or 50% or 100%. Even in the case of a small-scale manufacturing process, the DoL increases productivity by thousands of percent or more. Imagine the percentage increase in productivity that is achieved in a modern factory. A single human being working for an entire lifetime couldn’t produce a single smartphone. But a modern factory can churn out thousands every day.

However, we should never lose sight of the fact that the DoL is a double-edged sword. In an advanced DoL economy, virtually no one produces all or even most of the things they need in order to live. As soon as people give up self-sufficiency, they put their very survival in the hands of the community. Since no one any longer produces all of the things they need to survive, successful exchange literally becomes a matter of life and death. In an advanced DoL system nothing is more important than the reliability and robustness of the exchange process - the ability to convert the product of individual labour into all of the goods and services that you need to survive.

As was already observed, as soon as the community grows to a size in which personal relationships are no longer a viable basis upon which to determine who is responsible for what tasks and how resources are distributed among the members, a formal economic system becomes necessary.

Barter

There are a variety of ways decisions can be made regarding who does what and who gets what in an economic system based on the DoL. One option is to empower a central authority to make all such determinations. However if the goal is to afford individuals freedom of choice in how they conduct their affairs, centralised decision making is not consistent with that goal. Furthermore, centralised systems tend to be inefficient, since they create a bottleneck in terms of the administration of the economic system.

Barter is a system whereby individuals decide for themselves how they wish to employ their energy and resources and then exchange the products of their labour for all of the goods & services they don’t produce for themselves. Barter is the direct exchange between goods and services.

Barter is consistent with the ideal of individual liberty, since everyone is free to decide how they want to live their lives, and all exchange is voluntary. However, barter suffers from a major practical constraint which has prevented it from ever being used as a widespread system of exchange. That constraint is known as the “coincidence of wants” problem.

In order for exchange to be accomplished via barter, two parties must find each other and want what each other has and in corresponding amounts. If Alice produces apples and wants milk, Bob produces milk and wants eggs, and Charlie produces eggs and wants apples, barter is not a convenient way to facilitate exchange. This problem gives rise to the need for a generally accepted medium of exchange.