Markets are trust reducers. When functional, they make sure that you mainly need to trust one thing: that others will be self-interested. And since, as Adam Smith pointed out, you can trust even butchers and bakers to be self-interested – markets greatly increase the number of people you can trade with.
"Markets!" my econ professor would proclaim in a thick Armenian accent. "If only they were a machine! People would love a machine where you can put in wheat and pick out a helicopter."
That is a marvelous machine.
But one should not forget what it is built for: enabling transactions with strangers. Being able to transact with strangers doesn't mean transacting with strangers is in your self-interest. Not always. Not, I have noticed, as often as I had thought.
Often relying on non-market transactions is more efficient than markets. What is a non-market transaction? It is a set of different things: neighbors providing each other mutual aid, or friends trying to outcompete each other in generosity. Gift economies. Iroquois longhouses. Transactions that take place within your family, your circle of friends, and the people they can refer you to – your network of trust.
Last year, two incidents made me sit down and calculate just how much markets costs me compared to my network of trust. There are a bunch of things that markets can do, but my network can't: assemble the raw material to a computer, ship me a banana. But in areas where I could rely on trust, it turned out to be surprisingly cost-effective.
Friends are cheap
A few weeks after covid-19 closed the borders, I had to ship my furniture from Sweden to a Danish island in the Baltic Sea. At first, I tried markets.
It wasn't easy.
The only shipping company that quoted reasonable-sounding prices turned out to have a business model based on making people's belongings disappear. Alas, I had already signed the contract when I figured this out – a contract that on closer inspection turned out to have a clause that stipulated that if I wanted to break of the deal, I would have to pay the equivalent of a month on a median Scandinavian salary.
This is a very gripping story, but to cut to the chase: after having convinced the criminal truckers that it was in their best interest to drop the case, I called my friend Torbjörn –
"Could you get a vacation next week?"
"Of course." (This is Sweden.)
– and that saved me about 20 days' salary.
By which I mean, the amount of money I would have paid a shipping company would have cost me 20 days of labor more than what I had to pay for renting a truck. And that is assuming I would have employed a shipping company with a criminal record, mind you. If I would have employed a credible company, it would have cost me ~50 days of work.
Now instead I vaguely owe Torbjörn something on the order of 2 days.
= My network of trust was 10 to 25 times cheaper than markets.
I didn't think much about it at a time. Asking friends to help you move is common enough.
But then my wife noticed something: the roof of our new house was leaking.
Contacting a few carpenters, selecting those that had good reviews online, we got some price figures. The carpenters could solve the problem at a cost of ~2 years of median salaried work. Was that reasonable? The material would cost something like 3 months' salary. Retiling a roof is a fairly fast operation. Two weeks? Three? No, my back-of-the-envelope calculation tells me that 2 years salary is not a reasonable price.
But what to do?
My wife emailed a hippie. Rumor had it that the hippie and his crew sometimes did construction work – but only if they liked your vibe. I put on my knitted sweater.
And this might not align with your notion of hippies – but after meticulous studies, he unveiled a construction design with improvements of the 10X variety that start-ups would kill for.
Organic materials. Reduced heating costs. Four times longer life expectancy! Half the price.
The foreman of the hippie construction company explained that his anti-market business model (giving ridiculously good prices, but only to people he knew or predicted would reciprocate the kindness) allowed him and his employees to support their families on 15 hour work weeks.
That immediately raised two questions.
1. How can I find more hippies?
2. Why are markets so expensive?
Let's look at the second one. (I look at the first one here.)
Safeguards and asymmetries
I won't pretend to know all of the reasons why market transactions are more expensive than transactions between friends. But two obvious ones are costs for safeguards and information asymmetry.
By reducing the amount of trust needed to enter into a transaction, markets have connected people that otherwise probably would have considered piercing each other on spears. Like me and criminal truckers.
This is a feat. But it is not a free lunch. Making sure that we respect people we don't trust is expensive.
In Debt, the late anthropologist David Graeber notes that the creation of markets, as a realm separate from our network of trust, is made possible by the existence of several resource-intensive institutions:
Economics assumes a division between different spheres of human behavior that, among people like the Gunwinngu and the Nambikwara, simply does not exist. These divisions in turn are made possible by very specific institutional arrangements: the existence of lawyers, prisons, and police, to ensure that even people who don't like each other very much, who have no interest in developing any kind of ongoing relationship, but are simply interested in getting their hands on as much of the others' possessions as possible, will nonetheless refrain from the most obvious expedient (theft).
In a non-market society, services and gifts were exchanged in complex networks of relationships. Extracting the market out of those relationships takes work; work is not free.
When laboring as a software consultant, it felt like 50 percent of my time was wasted in meetings with clients. They drew up legal documents. We had endless follow-ups where they tried to make sure I was doing what I had promised. And on top of that, we had insurance to cover for mistakes and potential disagreements. And both parties paid heavy taxes to support a justice system that could keep the other party in line.
Those safeguards were expensive. And I don't need them when I code with friends.
The other thing that makes market transactions expensive is information asymmetry.
Asymmetries of information are fundamentally a good thing. If you know something that I don't, we can pool our knowledge and achieve things that are too complex for a single mind. When dealing with parties we trust, asymmetries of knowledge create complementarity: you know how to do something that I can't, that's why we transact.
With friends, this is usually the end of the story. But when dealing with strangers, asymmetries of information is also a cost center. By strategically withholding information others can mislead and exploit you. That pushes prices up.
When we were redoing our roofs, the hippies were friendly – they revealed what they knew. We had a better understanding of the situation after talking to them.
The professional carpenters, on the other hand – though they looked as friendly! – were not an inch above proposing designs that would break, and quoting prices uncorrelated with their costs. Because why wouldn't they? Really.
Someone who has done an intro class to economics could probably argue that the markets would correct for this. Isn't crooked carpenters a great opportunity for honest ones to increase their market share?
No. Not if the consumer never realizes what happens, which they usually don't – because of asymmetries of information. Usually, the customer only sees the wholesome, friendly-looking attitude – and gives a rave review after being exploited.
So market transactions are salted with costs for safeguards and salted because we get manipulated. Therefore it is often better to stay away from the market.
A Coasian theory of networks
For some reason, companies seem to be much more sensitive to this fact than individuals, at least if one is to believe Coase's theory of the firm.
According to Coase, firms expand until the cost of producing in-house matches the cost of arranging the legal work, etc necessary to outsource it.
(A firm can in this context be seen as a network of trust. It is a set of relationships that are defined by non-market transactions – colleagues making requests to each other, counting on goods and services being provided without payment, for the greater good of their firm or something.)
But for some reason customers don't do this. They don't try to figure out what is better served by non-market transactions within their network, and what transactions it makes more sense to do in the market. They just mostly outsource everything. (And the few things they do produce in-house – say food – might not even be the things where they have a comparative advantage.)
So what is the optimal balance between markets and mutual aid? It depends on who your friends are. Warren Buffet famously never trades with people that require lawyers to draw up contracts.
There are a lot of areas where you can save time and money by helping a hippie commune harvest in exchange for a new roof, or giving a friend investment advice in return for shipping your furniture. I don't know how far you can scale that until you hit diminishing returns. But much further than most people do.