In the last chapter we used single-animal economies as examples, like that of a castaway living alone on an island. For our castaway there are no rules: she can go anywhere, do anything, use anything. That allowed us to see what is fundamental to any economy: for production to occur you need the desire to produce, resources and work-effort. Now we will turn to consider the economies of societies: ‘social economies’.
Humans – along with bees, ants, monkeys, wolves and many other animals – are social beings and usually work in a group, with the potential for different individuals to specialise in different types of work. This is a much more complex situation than a single-animal economy, because we have to think about what the group or ‘society’ wants, not just the individual. By contrast to the unusual situation of having no rules like our castaway, in normal human economies there are a myriad of rules that we live by. They are so ingrained in us that we largely take them for granted. You cannot go anywhere, do anything or use anything. Some of the rules are formalised in law and others are norms or customs. What these rules are, decides very largely how the economy functions.
While other social animals do not write down their rules, we can see that they do have rules and customs, especially if they work cooperatively. Where do the rules come from in the first place? Many of them are I assume instinctive: in the complex social organisation of insects such as bees, termites and ants, biological evolution would select for rules advantageous to the species concerned. In the human world we know that apart from whatever rules come with our biology, we also have rules that are part of our culture and have to be learnt. These cultural rules also evolve over time as societies discover new or better rules that make them more effective, with the more effective societies then being likely to displace societies with ill-functioning rules; such concepts are discussed in books like Jared Diamond’s fascinating ‘Guns, Germs and Steel’.[11]
Let’s now look at a rule that is fundamental to our human economy – the notion of ‘ownership’ – and at what that rule makes possible: the ability to trade and the concept of value.
The concept of ownership is essential to our modern economy – buying and selling would be meaningless if things couldn’t belong to anybody – but what does it really mean to own something?
Human societies have a strong sense of ‘ownership’ or ‘property’: to be allowed to use a resource you have to own it or at least have some temporary right over it, e.g. by rental. The idea of property is so familiar to us from childhood that it is easy to think of ownership as something clear-cut (it’s either yours or it isn’t). In practice there are shades of grey: If something is ‘yours’ it means that the rest of society recognise your control over it: your right to determine who uses, consumes or destroys it ... but only up to a point!
Perhaps you have a piece of paper somewhere that says you own your house: a title deed. If so, could you build a factory or a rocket testing site on the land? Almost certainly not: ownership is an agreement amongst humans to allow someone certain rights over property, but those rights are not unlimited. For example most city councils won’t permit you to do whatever you like to your house, and may well take it away from you if they need the ground for a new road.
Suppose that you wave that title deed at the ants in your garden, will they take notice and clear off your property? Not likely! Your rights over that land are accepted only by human society – and then not by all of it. Yet many other animals do have notions of ownership, asserting their rights over territory, prey, food, and mates.
“In order to attract a female to mate with him, a male bird has to obtain and defend a territory. This territory will help determine his breeding success by providing him, and his mate, with food. Males claim a territory by singing in it, which tells other males to stay away. They leave gaps in their song to listen to replies, so they can discover where any rivals are and focus their defensive efforts on strangers looking to take over the territory.”1
“Aha” we might say. “Those other animals are just fighting for stuff, that’s not recognising ownership”. Well maybe they do fight sometimes when the moment is opportune, but in between fights they may recognise the status quo. Rather like we humans, who recognise the status quo for lengthy periods but now and then are tempted to go to war and seize other people’s property.
Also, a fight between animals isn’t necessarily physically violent, as with the bird described above that defends its territory by singing ... sort of more like a court case. By the way, if there is a bird singing in your garden, please note that as far as he’s concerned, it’s not your garden at all, it’s his!
Why discuss rules, where rules come from, and whether other animals have them too? Well apart from curiosity, it could be important to distinguish which rules are part of the human psyche (we’ve evolved to have them, and they’d therefore be hard to override), and which are more arbitrary, and although they may seem ‘natural’ if we have lived with them for many years, could nevertheless be modified.
Once society recognises property, then ‘trade’ or ‘exchange’ become possible: you can swap things with other people. A trade is an exchange of ownership/control – what was yours becomes theirs and in return what was theirs is now yours: buying and selling would be meaningless if things couldn’t belong to anybody.
The existence of trade makes it possible for individuals to specialise in something: if your job is shoemaker, you’ll have to swap (or ‘exchange’ or ‘trade’) most of the shoes you produce for the other things you need such as food. Money makes this swapping easier and more flexible – first you swap the shoes for money, and then you swap the money for food.
When exchanging goods, what decides how much they are ‘worth’? Suppose you own something that you have produced – let’s call it stuff A – and you would like to trade it for something else that you don’t or can’t produce – let’s call that stuff B. The classic economics problem is “How much of A should you swap for a given quantity of B?” Or if you like, “How many kilograms of A is a kilogram of B worth?” More familiarly, this is a question about prices: we are asking why is the price of a kilogram of one thing (such as cheese), different from the price of a kilogram of another thing (say potatoes). A moment’s thought tells us that prices are not related to the true value of things: food and water are essential to survival, yet they are cheap compared to luxuries we could perfectly well do without.
Marx amongst others, believed that what decided how much a thing was worth was how much work or ‘labour’ it took to make it. Thus if it takes six times as much work to produce 1kg of cheese as it does to produce 1kg of potatoes, then in the market, the cheese to potato swaps will be at a rate of 1kg of cheese for 6kg of potatoes – in other words cheese will be six times the price of potatoes. The concept is known as the labour theory of value. Marx believed that labour was the source of all value – which was a convenient conclusion for a revolutionary who sided with the working class – but he struggled to explain how things like land can have value when no human labour has gone into producing it. Today he would also have to explain how heavily-promoted branded goods can be so much more expensive than unbranded equivalents that took the same amount of labour to manufacture.
Personally I think that there is little point in looking for some universal underlying source of value that can be applied to all things, such as Marx’s idea that it is the labour that went into making them. There are so many reasons why people may want things that it’s better to accept that things have market value only because people want them: the value that they have is then simply how many other things people are willing to offer in exchange for them. Classical economists draw supply and demand curves to illustrate this, which roughly speaking tell you that: (a) if something is scarce and a lot of people want it, then it will be expensive; whereas, (b) if something is in plentiful supply compared to the number of people who want it, then it will be cheap.
It is clear however, that the amount of labour that goes into making products does affect their prices. This is because although at any given moment in time, supply and demand determine prices, in the longer term the level of prices feeds back into what producers do. So if something is in short supply, producers will tend to switch to making that because a day’s work producing that earns them more than a day spent producing other goods. Accordingly, for manufactured goods, the amount of labour required to make them often does decide their relative prices (i.e. how much of one you exchange for another).
One might suppose that the cost of materials – the steel, copper and plastics that go into our gadgets – would be a major part of their price. But all these materials can in turn be costed in terms of the labour required to extract them. Essential to understanding this is the fact that from an economics point of view, the world’s resources are free until they actually begin to run out. So when you buy metal to make into a car, what you pay for the metal is related mainly to the amount of work required to dig it up, process it and transport it.
Resources taken from the environment are ‘free’ because the environment isn’t a human being and asks for nothing in exchange. Of course a human might own the land where the resource is found, such as a mine; however in a world market (and excepting cases where a monopoly can be established), the owning company or country cannot charge more than the labour cost of extraction because a competitor could undercut them. The fact that there may be only thirty years supply of the mineral left on the planet is irrelevant. If the mineral becomes harder to find, it increases the amount of labour required to prospect for, mine and process what are likely to be poorer ores, and as a result the cost increases to reflect the increased labour. Only when it becomes impossible to produce more of a resource through extra labour, will the price go up beyond the labour cost and reflect scarcity instead of just the labour required to extract it. An example of this would be the last tree on the planet: it won’t be harder to find or cut down than any other tree, but assuredly the sale value of the wood will be a great deal more than the cost of that labour.
Accordingly, examples of market scarcity (where the price of something isn’t just determined by the work required to make it) are harder to find than one might think. However, when there is genuine scarcity, such as of paintings by famous artists or of desirable houses in central London, or when hiring top class footballers, then prices bear no relation to any labour involved and are limited only by how much buyers want these things and how rich they are.
Note that when there is scarcity in the supply of something other than labour, then the prices of things made out of it will be related by how much of it they use, in just the same way as the prices for most manufactured goods are related by how much labour they use. For example, land is a scarce resource in London, so the prices of houses in central London are strongly related to the area of land they take up: a house that occupies twice the area will tend to cost twice the price, other things (such as quality of the building, neighbourhood, views, etc.) being equal.
The castaway living alone on an island has no rules and so needs no government. But in the social economies we live in we have lots of rules that regulate how we interact, and there’s no point in rules unless they are kept. In small groups this might be possible by mutual consent. Among children in the same family for example, young John may well accept that the book his sister Mary bought with her pocket money is hers, and Mary accept that the toy John was given for his birthday is his; no written documents are involved, though there is a level of governance (their parents) should a dispute arise. For bigger groups we need more formal governance to enforce the rules.
Most of us live under multiple layers of governance, not just the national government of your country, but also layers of local government such as a town council. It doesn’t stop there: schools have governance and rules, so do employers, so do clubs and societies, churches, political parties, and any place that we might go that is managed by an organisation – the transport system or local supermarket for example. There’s also a level of international governance, through agreements reached under the auspices of the United Nations or any one of numerous other bodies such as the EU or NATO.
Why accept so many rules? We do so – most of us – because the obligations they place on us are also placed on others. I cannot take other people’s property, but they cannot take mine either. I’m not allowed to physically assault people who annoy me, but neither can others assault me. Modern governments don’t only enforce such basic rules, they also provide a whole range of services: education, healthcare, transport networks, parks, and much more.
Of course all of these government functions do not come for free. If we are to have police to protect us from violence and our property from theft, then those of us working to produce goods and services have to accept that the government takes some of what we produce to provide to those working for the police force. In other words, we have to accept some form of taxation.
So it sounds like the deal is: ‘we give up a bit of the cake we’ve produced to the government and in return we get security and some other benefits’. But good government is far more valuable than that because it enables us as a society to produce a far bigger cake. The development of sophisticated industries requires a stable business environment, a trained workforce, good infrastructure, and so forth. Governments can also finance scientific research and technological development. It’s quite common to meet people who’ve always lived under and benefited from relatively strong and stable governments, who are nevertheless very ready to complain about high taxes – but you don’t notice many of them migrating to semi-lawless countries with weak governments. The migration is in the opposite direction: into countries where taxes are higher and more effectively collected but where people hope to feel safe and see their children educated.
Governments vary considerably in the rules they set and the degree to which they try to direct the economy. At one extreme you have governments that try to plan economic activity, directly telling some or all businesses what they should do – so called ‘command economies’. As example of such planning, we typically think of communism as it was practised in the former Soviet Union2 and still is at the time of writing in North Korea. During wartime, capitalist countries may also choose to direct their economies to a far greater extent than they do normally; notably the USA and UK during the Second World War (WW2).
At the other extreme is the ‘light-touch’ free-market philosophy that the job of governments is only to provide a police and army, and enforce clear rules regarding property and trade. Apart from that, businesses should be free to make their own choices, with the direction of the economy being set by the operation of the market.
Our current world is now dominated by countries that have free-market economies – although they usually also have larger and more influential state sectors than light-touch free-market purists would like. In most industrialised western countries for example, the state provides free education and healthcare; both things that the purists believe should be left to the market (i.e. they believe that the public should instead have to pay to use private schools and hospitals). Meanwhile, the communist parties of China and Vietnam also allow private business and a market. China calls their system a ‘socialist market economy’ and accepts that private capitalists and entrepreneurs can co-exist with public and collective enterprise.
Private-sector businesses operating in market economies therefore determine to a great extent what gets produced and the level and conditions of employment. So to understand how our economies work we need to understand markets.
Human economies are social economies which are governed by extensive rules that affect how the economy functions. Governments set and enforce many of these rules. The cost of good government is generally accepted because of the benefits it offers in terms of protection of individual rights and property, and other services such as health care. The concept of property enables trade and the operation of markets.
While governments can choose to suppress markets and plan economic decisions, as the former Soviet Union did under communism, currently almost all industrialised countries allow markets to operate, with private sector businesses therefore having extensive influence on employment levels and what gets produced. Accordingly, we will next look at markets in more detail.
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