Abstract
The theory that economic wealth is created through a social division of labour has been around for more than 2500 years. This theory has been given little attention since market-centred thinking took hold in economics after the 1870s. This first chapter introduces an axiomatic framework that provides a rationale for this theory and aims to place this perspective back at the centre of economic reasoning and theorising. The social division of labour emerges from the human ability of increasing returns to specialisation (IRSpec) and the principle of gains from trade within a network-institutional trade infrastructure. Some computational examples of simple production situations illustrate how institutional configurations guide the social division of labour in the production of goods and services.
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Notes
- 1.
Ricardo’s argument was innovative and revolutionary: Competition among capitalists will force the rate of return on investments to equalise in the economy. The sector with the lowest marginal productivity will thus determine the overall rate of return in the economy. Ricardo determined this resource to be arable land, the agricultural output of which will diminish with more intensive use. Diminishing returns on less productive land now drives the economy to an equilibrium in which the social division exactly generates enough resources to reproduce itself, thus enhancing the arguments seminally put forward by Malthus (1798). For a detailed discussion I refer to Foley (2006, Chapter 2).
- 2.
- 3.
In Chap. 2 I discuss the idea that the 2007/2008 financial crisis was mainly caused by the fact that the prices of most financial derivatives did not reflect the true values and risks related to these products. Hayek’s view does not consider seriously the effects of misinformation and unfounded beliefs in the assessment of the competitive market system as the main allocation mechanism.
- 4.
Only very recently in Gilles (2017b) I have formally shown this to be the case for a “large” economy in which individual productive abilities are subject to Increasing Returns to Specialisation. The theory requires a sophisticated mathematical treatment that goes beyond the scope of Yang’s original framework.
- 5.
The current state of neo-classical economics is that it is held together and defined by its methodology. Indeed, its practice and theories have a common methodology based on the principles of methodological individualism, methodological instrumentalism, methodological equilibration and the axiomatic method (Arnsperger and Varoufakis 2006).
- 6.
As mentioned, Marx (1867, Chapter 1) already pointed out that the focus on the commodity as the main subject of study obscures a view of the underlying production and trade processes.
- 7.
It is common in economic theory to view a commodity solely as a bearer of consumptive and productive properties. Commodities are not considered as carriers of socio-economic processes.
- 8.
A market economy is one possible incarnation or example of such an institutional economy. However, the assumption that an institutional economy consists solely of market interactions is unrealistic, in particular since a deep social division of labour naturally results in supply chains and networks of socio-economic interactions. So, the most natural incarnation of the institutional economy is actually a network economy.
- 9.
Generally, brain size and the complexity of the social organisation of mammal populations are strongly correlated as research shows. Dunbar (2014, Figure 3.1) provides empirical evidence that there is a strong relationship between the size of frontal lobe and neo-cortex development and social group size for a variety of species. Social group size acts here as a proxy for the complexity of social organisation of the communities in which members of these species operate.
- 10.
For example, gorillas are known to eat bamboo shoots for eight hours a day to maintain their brain. To maintain this disproportionally large brain, humans invented cooking techniques to transform sufficient calorific intake from food into manageable proportions and speed up the digestion process. Without cooking, the human species would actually not have developed.
- 11.
In humans, brain development takes up the first 20–25 years of a lifespan.
- 12.
In the context of the Knightian uncertainty concept, I point out the difference between risk and uncertainty. Risk refers to measurable probabilities attached to future events. Risk is as a consequence computable and we can make assessments of risky situations using statistical tools and methods. Uncertainty, however, refers to unmeasurable events. Hence, if a situation is uncertain we cannot attach objective probabilities to the related events. Uncertain outcomes are consequentially uncomputable.
- 13.
I explore some of these organisation forms in the model of wealth creation in Sect. 1.4 of this chapter.
- 14.
This is completely antithetical to the argument that we are purely individualistic and that all our economic decisions are guided and driven by purely individualistic characteristics. This argument is known in economics as the hypothesis of methodological individualism.
- 15.
That modern humans have social preferences is commonly observed in economic experiments that have been conducted during the past decades. Under methodological individualism, this has been explained as “altruism” or “inequality aversion”, but I would like to categorise these explanations as just more fictional narratives. I refer to Bowles and Gintis (2011) and Gintis (2017) for an extensive overview of experimental evidence for this and a comprehensive discussion of the resulting insights.
- 16.
Social freedom refers to the ability to build relationships with other individuals, thereby giving up parts of one’s individual freedom. The assumption of a role in the governance system of socio-economic institutions is part of this social freedom as well. I refer to Chap. 3 for a detailed discussion of this aspect of the theory set out here.
- 17.
I emphasise here that true trust can only be established if this common ground expands to a governance system in which both tribes accept the same social institutions and heuristics in their acceptable social conduct. Such institutional expansion is at the foundation of globalisation.
- 18.
The concept of an economic agent as the embodiment of an economic decision-maker was seminally proposed by Yang (1988) and further developed in Yang and Ng (1993), Yang (2001, 2003) and Gilles (2017b). This embodiment is also referred to as a consumer-producer. This notion stands in contrast to the standard neo-classical hypothesis that consumption and production are socially separated: Neo-classical economics is firmly founded on the social dichotomy of consumption and production. See the discussion below.
- 19.
I refer to the Oxford English Dictionary’s definition of the term “value” as The importance or preciousness of something. What I refer here to as “economic value” is referred to as “use value” by Marx (1867, Chapter 1). The term “use” seems more appropriate for physical goods, but less so for service goods. This justifies the term used here.
- 20.
This exactly refers to what is meant with the word “productive” as it actually refers to increased ability. Indeed, the Oxford English Dictionary gives as one of the accepted definitions that productive means “achieving a significant amount or result”.
- 21.
This compares to the neo-classical notion of increasing returns to scale (IRS). The latter refers to the ability to have increasing output per unit of input if the production process is enlarged in total. This mainly refers to industrial or societal production processes, rather than the ability of a single individual.
- 22.
As an illustration for the principle that mixed consumption bundles are preferred, I refer to the symbol of ultimate consumptive sumptuousness, the Dutch-Indian Rijsttafel. After the Dutch East-Indian Company (VOC) established itself in the Dutch Indies—Indonesia, as it is known today—they found a rich cooking culture. The Dutch colonists brought their own interpretation to this and started to mix the diverse meals into a single sumptuous meal.
- 23.
Formally, preferences are convex if for any two commodity bundles x and y such that if x and y are equally good (x ∼ y), it holds that any mixed bundle of x and y is strictly better than both x and y—that is, tx + (1 − t)y ≻ x as well as tx + (1 − t)y ≻ y for any 0 < t < 1. This principle and its mathematical representation are further discussed in Gilles (2018).
- 24.
When tribal human societies coalesced in large empires—such as the Sumerian and the Egyptian empires—human economic development was accelerated through the creation of a large society around a common public project, the res publica. This particularly took the form of a religious project, exemplified by the temple economy of Sumer. A governance system can be viewed as an extension of this res publica in the sense that the common public project results and transforms itself into derivative socio-economic behavioural rules, socio-economic roles and other supportive economic institutions.
- 25.
I emphasise here that a “unit” is a completely fictional and arbitrary enumerator of output. The indicator P represents the output bundle of an individual for the two critical goods, foodstuffs and shelter.
- 26.
Here, social learning refers to the sharing of experiences and best practices among equally specialised tribe members. The size of the professional group is critical for social learning, since the more widespread and established a specialisation is, the higher the individual productivity of such a specialist. This strengthens the IRSpec property of the productive output of a single tribe member.
- 27.
In a more primitive peasant economy, all production stages are executed by a single non-specialised individual, namely the peasant herself. The home-produced bread is consumed by the peasant as well. In this economy there is only a rudimentary social division of labour and no exchange of intermediate goods. In Chap. 2 of Gilles (2018) this type of society is called an autarkic economy.
- 28.
Exceptions are trade relationships within superstructure organisations such as centrally controlled and guided markets.
- 29.
Classical political economists considered reproduction to be a completely natural element in their considerations of the capitalist economy. Marx (1867) developed his theory of capitalist exploitation on this feature of the social division of labour. This construct has been pursued further by Sraffa (1960) and Roemer (1981), who have both introduced mathematical representations of social division of labour that included descriptors of labour reproduction. I refer to Gilles (2018, Chapter 6) for more details of my discussion of production networks.
- 30.
I refer to the discussion of some important properties of advanced capitalist economies founded on a mixed social division of labour in Gilles (2018). There I will consider network models of the social division of labour that explicitly address the consequences of the absence of mobility and the existence of competitive barriers in the social division of labour.
- 31.
I have adopted the terminology introduced by Buchanan and Yoon (2002) to delineate these two different viewpoints. Buchanan and Yoon refer to these viewpoints as “logics”, which term I avoid. The logic of the social division of labour or of trade—as referred to by Buchanan and Yoon—is actually founded on the tripolar interaction between IRSpec, gains from trade and institutions in the social division of labour and its accompanying trade infrastructure.
- 32.
I emphasise that the Smithian viewpoint is at the foundation of the approach developed here. I believe that the Smithian viewpoint is more natural in view of what we know of human evolution based on the social brain hypothesis. In this regard, the theoretical framework set out in this book and its companion volume are Smithian in principle. Similarly, the work of Yang (1988, 2001) and Yang and Ng (1993) can be interpreted as fundamentally Smithian in nature as well.
- 33.
Amazingly, mainstream economics has never properly defined the market concept. Theoretical and philosophical discussions about the conception of the market notion can be found in, for example, Swedberg (1994), Ménard (1995), and Rosenbaum (2000). Unfortunately, this discussion just shows that the notion of a market is very hard to grasp and define, in particular if one intends to include the underlying institutional foundations such as the issue of the definition and implementation of property rights.
- 34.
It seems paradoxical that flexibility implies stability, but in this case it allows sellers to hold the asking price at a constant level even though market circumstances change. It avoids the large costs of price adaptation as is expected in theoretical markets founded on the application of the laws of demand and supply, in which prices are continuously fluctuating with every change in circumstances in which trade occurs.
- 35.
The concept of transaction costs has a long history in economic thought. Viewed as one of the most difficult concepts to theorise about, it is generally recognised as being critically important to understand our contemporary economy, but remains unclear owing to the difficulties of giving it the correct expression in economic theories. The understanding of transaction costs has been pursued in general equilibrium theory (Hahn 1971, 1973; Hahn and Starr 1976; Ulph and Ulph 1975; Sun et al. 2004) as well as new institutional economics (Williamson 1979, 2000; North 1990). I also refer to Klaes (2000) for an exposition.
- 36.
For example, throughout most of the twentieth century there was no day care for babies and toddlers, which consequently implied that child rearing was a full-time service provided within the household. It prevented many women from joining the labour force and fully participating in the social division of labour.
- 37.
- 38.
A similar conclusion is reached in a perfectly flexible economy in which production is founded on constant returns to scale or “linear” production technologies. These are known as Leontief economies after the seminal contribution by Leontief (1936). In Gilles (2017b) I show that in the long term an economy with an endogenously adapting social division of labour functions in the same fashion as a Leontief economy, thus establishing the equivalence between market values and labour values for all produced commodities. For details I refer to Chapter 4 in Gilles (2018).
- 39.
Of course, labour values should be expressed in units of (unskilled) labour time. However, using the prevailing monetary price of such a unit of labour time, we can convert it to a pound sterling or US dollar price.
- 40.
Exploitation results in unnatural inequality in the economy, which can lead to unexpected outcomes. The events of 2016—mainly the Brexit vote in the UK, the election of Trump in the USA and the rise of so-called “post-fact” social and political discourse—can be understood from that perspective. This seems to be a natural consequence of the network imperfections and the institutional failure in the global neo-liberal economy laid bare by the Great Panic of 2008 (Duménil and Lévy 2011).
- 41.
It should be pointed out that ordinal ranking is different from cardinal ranking. In the first methodology, only the rank of the item in question is important and the utility level merely expresses this ranking. In the second methodology, the utility function assigns a meaningful quantity to the consumption bundle that has relevance by itself. Thus, in that case, the difference between two assigned utility levels expresses how much one bundle is better than the other.
- 42.
In fact individual 1 has an absolute productive advantage over individuals 2 and 3, while individual 4 has an absolute advantage over individual 3.
- 43.
It can easily be checked that indeed any other specialisation pattern among the four individuals in this economy results in a lower common utility level under egalitarian division.
- 44.
It should be remarked that owing to their natural productive proclivities that we assumed here, the resulting households in this equilibrium are of mixed gender. It is therefore correct to think of these households as “families”, which also function for procreation.
- 45.
Technically, this is the same as requiring that every tribe member can select exactly one production plan from an objectively given set P = {(10, 0), (4, 4), (0, 10)}.
- 46.
I leave the details of this computation to the interested reader.
- 47.
We compare this optimal social division of labour with the case where we do not change the social division of labour and impose that there remain k 2 = 11 > k 3 = 10 hunters. In that non-optimal case, O 3(11) = (110, 180), \(C_3 (11) = \left ( 5 \tfrac {1}{2} , 9 \right )\) and \(U_3 (11) = 71 \tfrac {1}{2} < \overline U_3 =72\).
- 48.
This again refers to one of the animal spirits considered by Akerlof and Shiller (2009), namely the effect that stories have on economic decision-making. Gossip is particularly distorting within a sparse social network: Stories might morph into different forms and misinformation can abound. This is even the case in such highly developed networks as facilitated by the internet; in many cases blogging has increased the amount of misinformation rather than facilitated the improvement of the quality of the information shared.
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Appendix: The Nature of Markets
Appendix: The Nature of Markets
In our daily lives the words “market” and “market economy” are used in many different contexts and with various meanings. Remarkably, we mean rather diverse things with the same word, and these meanings do not correspond in general to the meaning given to markets in economic theory such as presented in the standard microeconomics text books. In this appendix I hope to clarify some misunderstandings about the usage of these terms.
I emphasise that the usage of the term “market” and “price” is central to a contemporary perspective on our society and especially our globalised economy. For a large part it defines how politicians view the world and it characterises how economics has influenced our perception of the world around us in a profound way. Sadly, this perception is biased and incomplete at best. Misunderstandings about markets are plentiful and strongly affect economic policies, thus resulting in misguided efforts by national and local governments and authorities. It is within this context that I provide an incomplete typology of the usage of the market concept as it appears in our daily discourse.
- Markets as cost pricing: :
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A price is often interpreted as a measurement of the production cost of a certain commodity. This reflects a pure supply-side reasoning as underlying a commodity’s market price; prices are defended based on a distinctive cost basis rather than on a demand–supply reasoning. Particularly, increases in prices of essentials such as food, energy and housing are defended and analysed on these grounds.
This reasoning about commodity prices is deeply rooted in the labour theory of value (Ricardo 1817; Mill 1848; Marx 1893). The main reason for invoking such labour theoretical foundations for the pricing of a commodity is that this reasoning is usually rather intuitive and that indeed in many instances prices do not reflect social scarcity of the commodity, but rather a cost price. Monopolistic producers, such as energy companies, justify price changes purely on a cost basis. Examples are the pricing of petrol, which is depicted as being driven by the price on the world market for oil, and natural gas, which price in Europe is linked to the price of oil rather than being determined in its own market.
Can we dismiss the invoking of cost pricing in the context of our contemporary global economy? I do not think that this is easily done. There are simply too many practical instances of the use of cost pricing in our contemporary global economy to dismiss such reasonings out of hand.
Since its inception in the 1870s, market theory has promoted the fundamental hypothesis that the pricing of traded commodities is fully determined by demand as well as supply. As discussed, neo-classical market theory embraced a market theory of value, which replaced the labour theory of value. It is interesting to see that after nearly 150 years of promoting this market theory of value, these ideas have not settled in society.
- Markets as notional demand: :
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Politicians and business leaders might also discuss and use the term “market” to represent a demand-side perspective only. This is when one says that “one’s market is determined by the local conditions under which one operates”. It is intended that the word “market” here describes the potential demand for a product. The supply of this product is not subject to this consideration.
For example, Queen’s University is the largest provider of higher education in Northern Ireland. One can describe this as being that the “market” for Queen’s University is determined by the demand for higher education in Northern Ireland. In other words, “Queen’s market” is equated with the region of Northern Ireland.
A superior terminology of such a consideration is to refer to the notional demand or the demand potential for a good. Here the notion of notional demand incorporates a more complex perspective than only the potential demand for a product; it also refers to the totality of conditions under which trade occurs. This includes the very basic ability of the economic subjects involved to be able to communicate with each other and to formulate their desires and abilities. Economic subjects therefore need to accept the same economic institutions to be able to properly interact. For example, these economic subjects need to recognise the same monetary system as a precondition for trade (Mitchell 1944).
Again the use of the terminology of a market as notional demand is rather unsatisfactory from the point of view of neo-classical economic theory. Indeed, demand and supply are principally separated and only meet in the setting of a market. A market cannot describe only one of its two essential components.
In Chap. 3 I give a more precise definition of notional demand through the broader notion of a socio-economic space. Such a space is a construct that incorporates notional demand as well as notional supply in an institutional framework. Therefore a socio-economic space introduces a context in which markets and other trade networks can emerge. It brings together all preconditions that make trade possible, including the economic institutions that facilitate such trade. These institutions include, but are not limited to, monetary systems, pricing conventions and the market institutions themselves.
- Markets as political abstractions: :
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If politicians debate economic policy, they usually invoke the abstraction of a “market” to promote their favourite economic policy. Here, the notion of a market simply refers to the ideal of a capitalistic economic system. It usually includes the ideological logo that voluntary decisions by “free” individuals determine the outcome of these economic process and, therefore, can be deemed to be “good”. In the decades since the 1980s this ideal of private decision-making has infiltrated economic policy in a fundamental fashion throughout the western advanced economies. A wave of privatisation of publicly owned and operated enterprises was the result. This included the privatisation of health care facilities such as hospitals and insurance providers, of energy providers, in particular government-controlled electricity companies, and even of postal services in the European Union.
Public considerations were reduced and replaced by private solutions supported by the idealised view that privately informed decisions are superior to public or political decisions. Indeed, market theory promotes the idea that private actions within the context of a competitive market result in an efficient or socially optimal state.
Here the reference to the “market” actually points to private decision-making rather than collective decision-making through a political process. There is usually no regard for the conditions that are required to be implemented to make such private decision-making processes result in a socially optimal state. As such, the use of the notion of “market” is very misleading in this context, which is shown by considering the actual outcomes of such privatisation processes. An excellent example is the failure of health care systems founded on private ownership of health care providers and privately provided health insurance in the USA as well as several countries in the European Union.
- Markets as actual market places: :
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Traditionally, markets were viewed as localities or physical spaces in which trade takes place. I refer to the seminal marginalists Jevons (1871) and Menger (1871) for the invocation of such a definition. The usage of the concept of a market in this context actually refers to trade taking place on market squares in cities; in buildings such as stock exchanges and shopping malls; in auction houses; and on websites such as eBay and other online trading companies.
Clearly, in this context the notion of a market indeed refers to the purest form of what actually is represented by a theoretical market: a place at which demand and supply meet and are resolved through a process of price adjustment.
However, in reality such marketplaces usually do not conform with theoretical conditions as assumed in economic models. Indeed, commodities are never truly transparent; transaction costs are rarely absent; and information about the trades that occur is hard to come by. All in all, practical markets are rather problematic examples of the theoretical constructions considered by neo-classical economists.
On the other hand, I believe that markets as invoked above come closest to the ideal advocated in economic theory. Instead, the question has to be asked whether the theory cannot be improved to reflect the actual dealings that occur in these market places. Geertz (1979) and Kirman and Vriend (2001) imply that practical market places can much better be understood as networks. Influences such as customer loyalty and long-run relationships lead me to believe that these markets are indeed networks rather than a system in which demand and supply interact totally to establish a unique market price for every commodity traded.
- Markets as trade networks: :
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Finally, I come to the usage of the notion of the concept of a “market” that comes closest to my understanding of how a market actually should be perceived and approached: as a social trade network rather than a place in which demand and supply are resolved.
The neo-classical market theory assumes that all executed trades are guided by a unique market price for each a commodity and that information about these prices and the trades performed is freely available. This free information exchange in turn makes the formation of such a unique market price possible through the competitive forces in the market that in turn are founded on the private, selfish motives of the traders.
However, in a trade network such considerations are far less obvious. It is not clear why the same, unique price can be sustained in different parts of the network, even if all information is freely available to the traders. Only if sufficient competition can be generated that actually makes the network obsolete or trivial can prices be corrected through the threat of trades at other prices with remote traders in the network. This is usually not the case. Instead, prices are not unique and are locally determined through the trades that occur in a certain part of the network and the abilities of the traders to generate competing trades.
Furthermore, information travels very awkwardly within a social network and can be distorted.Footnote 48 This, in turn, affects trade decisions. Therefore it can be expected that trade networks are particularly vulnerable to information problems.
I refer here to my discussion of the main mortgage-provision chain in Fig. 2.2, which is subject to agency problems based on ex-post information deficiencies. In practice the agency problems were compounded by the presence of misinformation, in particular the high ratings put on the mortgage-backed securities as traded in the financial markets.
From a theoretical point of view, there emerge two important conceptions from this discussion. First, the network trade processes can be captured as it were in an envelope formulation through the notion of Edgeworthian barter processes (Edgeworth 1881) and the core of the economy as a consequence captures the possible outcomes. Second, the prices of goods that emerge in these trade networks can be denoted as the network prices of a good. Therefore, one good can obviously have many network prices depending on the local conditions under which trade in the network is executed. This refers to the theoretical modelling of “product differentiation” through the diversification present in the trade network. Instead of using a contingent commodity concept to express this differentiation or diversity, it is expressed through the local conditions and the diversity in the trade network.
I do not claim to be complete in my typology of the usage of the notion of the market; far from it. Rather, I hope to capture the main meanings that prevail around us when people and decision-makers use the word “market” in their justifications. For a more elaborate discussion I also refer to Rosenbaum (2000).
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Gilles, R.P. (2018). The Principles of Economic Wealth Creation. In: Economic Wealth Creation and the Social Division of Labour. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-76397-2_1
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