Village Economics

I doubt that Joel Mokyr had this in mind, but one of my reactions to his excellent economic history of Britain – The Enlightened Economy – is that the development of economic theory has sorely lagged the development of actual economies. I doubt that many of you find this surprising, but to read history and to consider theory simultaneously is very helpful. Enlightening even.

Consider this detail: prior to the Industrial Revolution – set aside whether it was a revolution for the time being – the vast majority of people engaged in economic activities with their neighbors and friends. They lived in small communities where high levels of trust, product knowledge, price, and availability where readily accessed. Indeed they were often both consumer and producer of many of the essential goods and services they needed. The picture we recapture from this era is of local trading and exchange. The products being produced and exchanged were limited in number, traditional, and familiar. The people being traded with were likewise. Land dominated the basis of production. Agriculture, and thus those factors that affect it, provided the milieu in which to organize an economy.

This was the early backdrop for economic theory. The Physiocrats in France were entirely focused on agriculture. Early marginal analysis concerned itself with the gradations of land productivity. Simple models of transactions could represent trade accurately, because trade was in actuality fairly simple. So the loss of detail did not undermine the efficacy of theoretical conclusions based on village life.

All this changed during industrialization.

Products became more complex and more varied. The process of production became more elongated and complicated. The level of uncertainty rose accordingly: since processes take time the chances of things going wrong increased. So business firms started to pop up in order to house these processes needed to accommodate and mitigate this rise in uncertainty. The notion of simple engagement between producers and consumers fell out of step with reality. Familiarity was lost and replaced with forms of exchange that took place over distance, impersonally, and without any of the traditional mechanisms that nurtured trust. People had to get used to transacting with strangers, and to the idea that the products they consumed may not be made locally.

So the traditional way of reducing the impact of uncertainty in the economy had to be replaced by updated methods. These comprised a variety of new institutions: things like advertising became a way of communicating about products. Laws put limits on what could and could not be included in those products – early examples of product safety laws are the limits on what could be used in the mass production of bread. The whole panoply of institutions that we now take for granted had to be set up, and a great deal of trial and error lived through before the shape of a modern economy took place.

In particular the increasing complexity of products led to a massive shift in production itself. From our vantage point we assume the existence of complex production processes. And we live in an era where some of those early processes have, themselves, been radically simplified. Our technologies now make previously impossible production both tractable and ordinary. The extraordinary increase in useful knowledge – ideas that can be deployed to allow new products to be developed or new ways of transacting opened up – is the factor most closely associated with the enormous rise in wealth over the past two hundred years or so. All of it more complicated. All of it more remote. All of it more specialized. All of it requiring more and more steps along the path between production and consumption.

Much more city. Much less village.

After industrialization an economy is very different from its antecedent. Yes there are still markets, but those markets are altered beyond recognition. The physical market of the old market towns in Europe are long gone. Nowadays a market is more a concept than a reality. It is more a logical space than a physical space.

Yet much of economic theory still has a village air to it. It assumes that the same activities go on uninterrupted. It assumes the same level of familiarity. It assumes that people both consume and produce. Or at least they could. Most of all it totally fails to take into account the mediation within production of what we would call a business firm. That mediation is necessitated by the extra uncertainty injected into production by the ever increasing complexity of the products being produced and thus the specialization of the technology and knowledge required. I believe that the reason economics has such a hard time finding a proper place for business activity is that its roots are still in the villages of pre-industrial Europe. The explosion in complexity and the emergence of details that relate to intermediate steps in the production to consumption cycle have made traditional economics less and less relevant to modernity.

Living in an era prior to the complexities of modern production, and at a time when familiarity was still a strong feature of everyday life, it was easy for Adam Smith to observe order at a high level in the economy, and to assume that it was an accumulation of individual decisions. Or, rather, that observed order reflected a summation of what was occurring at a lower level within the economy, and that coordinating magic of a market could ignore the intermediate levels of activity. Those intermediate levels were sparse and could easily be simplified away. To early economists were no interesting properties of an economy to observe or take into account in the production or distribution processes – to them the market could bypass intermediaries in theory if not in fact.

To put this alternatively, economics collapsed an economy back into a village-style direct confrontation between producer and consumer in order to study markets. It never sought to re-build itself around the more complicated world that came into being after industrialization. This is despite the fact that it glories in the notion of impersonal exchange and the primacy of price in its vision of coordination.

It is easier to speculate that markets tend towards equilibrium in a village atmosphere. All the ingredients are right there in front of you. Even if you add the possibility of the occasional traveling salesman, the level of detail required to use equilibrium as your attracting point is simple. When everything sits on the table neatly it is not too much of a leap in faith to imagine that markets tend towards equilibrium. After all, at the end of the day the farmer has either sold his produce or he hasn’t. So using equilibrium as a useful yardstick and then studying deviations from it is an excusable method – as long as things are close to being that simple.

But they aren’t anymore. Perhaps they never were.

In a modern economy we live awash in a complex and much more nuanced, layered, web of relationships. Yes, at a base level we can identify individual goals and aspirations, but there is no way we can sum them up and expect the total to approximate an orderly outcome. There are those intermediate steps along the way that originate and insert properties into the system. So what pops out at as an aggregate view is not only the sum of individuals, it is also conditioned and augmented by the middle layers economics has long ignored or simplified away.

Besides, since those simple days of village economics we have learned a lot more about people: the origins of economics are rooted in what is now a very naive and inaccurate portrayal of human motivation. Some of that useful knowledge Mokyr talks about, if economists would just learn some of it, could open their eyes to the cityscapes around us.

Village economics works well in villages. Not so much in cities.

Time to learn some new things I think.

Then again, that presumes economists are open to new ideas and don’t think they have all the answers already.