(Yesterday we quickly highlighted the impact of the Division of Labor and how trade creates wealth. We continue with a second feature of trade of that is too frequently invisible.)
Information and Incentives
The second thing trade does is create an information and incentive system, coordinating economic activity for millions of people.
Take the lowly no. 2 pencil.* Nobody (no one body) knows how to make a pencil. Raw materials must be extracted to create graphite, graphite transformed into graphite rods, trees grown and harvested, lumber processed into wooden cylinders that will hold the graphite, tin extracted from the ground, raw tin processed and rolled it into tiny cylinders for eraser holders, raw materials extracted for the eraser, eraser heads processed and shaped, dye created that will go into the paint that will go on the pencil … getting the picture? Different people in various locations are accomplishing all these tasks. But we aren’t done.
Consider that sophisticated machinery is involved at every step in this process. Each of those machines contains countless parts made of a myriad of materials. Each of those raw materials had to be extracted, processed into components, and then assembled. These machines are also part of making a pencil.
We can go deeper beyond this to the machines that created the machines to create the components for the pencil … but we haven’t even touched on the transportation infrastructure that allows us to move these components from place to place. There is much more. I’m radically simplifying the process of pencil production!
Buyers are weighing the demand for their product as they determine what they are willing to pay suppliers and suppliers are weighing what buyers are offering as the decide how much to supply at each tiny step in this dance of decisions. Price communicates the demand for a product and the willingness of suppliers to supply it. If the price for a product is going up, then the suppliers have an incentive to produce more and the buyers economize. If the price is going down, the suppliers have an incentive to cut production and buyers to buy more. (It isn’t quite this simple in all markets but the general idea holds.)
In all this, no one knows how many pencils are needed. There is no pencil czar monitoring the need for pencils and assuring that they are supplied. The vast majority of participants in this pencil making process have no clue that they are contributing to the ultimate creation of the pencil on my desk. Yet through independent responses to dynamic information and incentives, a sufficient number of pencils appear at a reasonable price every day.
Now take a close look at some items around you … maybe a stapler, a book, or a role of adhesive tape. Pay attention to all the materials and process that have gone into creating those items. How about your cell phone or your iPod? It is humanly impossible to visualize how these things came to be and we use them daily without a thought. Markets are the information and incentive network that brings all this about.
This information and incentive system explains why communism and socialism have been so ineffective. No person or entity can possibly know how to match supply and demand at any given moment, much less on when the balance changes by the nanosecond. Without a real time feedback loop there is no way to coordinate what needs to be done. Excesses of one product appear along with shortages of another, sometimes with tragic consequences.
This should also highlight why calls by theologians like John Milbank for a gift economy … where markets are eliminated and we give to each other as needed … is so misguided. While this might be practical among a face-to-face community it would end coordinated economic behavior beyond the community. There would be no information to coordinate our projects.
Similarly, there is a movement by some to return to local economies. Revisit the process of making a no. 2 pencil and imagine a person or team collecting all the resources themselves without trade (assuming they are locally available) and processing them into a no. 2 pencil. Think of the hours of labor required to bring it all together into a product that could have been bought for pennies in seconds along with other items at the store. Now take that image through the production of food, clothing, medicine, hygiene products, housing materials, etc. If local economies were genuinely embraced, living standards would revert to bare subsistence.
Finally, as I noted yesterday, many theologians are blind to the issues of production. They believe the goods we need are just there. The issue is how to distribute them. A corollary to this belief is that wealth is fixed quantity. Absent any sense of production, wealth is a preexisting fixed amount. That means economics is a zero-sum game. If I have more than the average person it comes at the expense of those who have less. I recently came across a blog by a caring young woman who praised the observation, “You cannot abolish poverty unless you also abolish affluence.” That is zero-sum thinking in a nutshell.
Now from inside the view that sees a fixed amount of wealth and goods, what could we say about markets? We would say that trade is competition where people try to get more than their fair share. Someone wins at the expense of someone losing. Instead of accepting the abundance God has given us, we covet other’s goods out of a false sense of scarcity. As Adam Smith taught, it’s all based on selfishness, right.
The essential coordinating function of information and incentives is invisible because the question of the origins of goods and wealth isn’t asked. The awareness of people expanding wealth by transforming matter, energy, and data from less useful states into more useful states and by participating in mutually beneficial market exchanges that coordinate an incomprehensibly complex economic system is lost. I’m persuaded that this is a near Copernican-like paradigm shift for many. Economic justice and efficiency does not orbit the distribution of a fixed pile of wealth and goods, but rather distribution orbits the vitality of a just and well-coordinated productivity … without this productivity there is nothing to distribute.
We turn to the issue of “self-interest” next but let me close by noting what I hope is obvious … what I’ve said in these two posts is a 50,000 foot view of the historical landscape, pointing out only two significant features that serendipitously emerged over centuries before coming to fruition in the past hundred years. Furthermore, let’s get on the record that markets function far from perfectly and that they are dependent on other institutions and values. We will talk about addressing market problems later but what should not be lost is that when it comes to the need for information and incentives, we have no legitimate alternatives!
(* Some will realize I'm channeling I Pencil.)