Article summary: “Money and its institutional substitutes: the role of exchange institutions in human cooperation”, Cameron Harwick

Summary of JOIE article “Money and its institutional substitutes: the role of exchange institutions in human cooperation”, by Cameron Harwick (George Mason University, USA). The full article is available on the JOIE website.

The question “why does money exist?” has a very long pedigree. But it also has no answer without a background framing: “as opposed to what?” Standard models of the emergence of money answer the latter question with, “as opposed to exchanging goods directly”, which suggests an answer to the first question: “because direct barter is difficult to manage, so money reduces the friction.” This is a fine answer for certain purposes, mainly in economics and monetary policy. But as anthropologists are fond of pointing out, direct barter has never been a viable alternative to monetary exchange. Looking back into history at the actual exchange institutions that preceded monetary exchange, framing the first question with “as opposed to autarky” or “as opposed to time-separated multilateral exchange within a tribe” or “as opposed to exchange on the basis of custom and status” suggests a quite different answer.

Our first alternative – why exchange at all rather than autarky? – gives a sense of the basic problems that any exchange institution has to solve. One insight that will guide us here comes from Adam Smith, that “the division of labor is limited by the extent of the market” – or in other words, that the number of people you can trade with determines how much specialization an economy can sustain. If we’re starting with no exchange and trying to get exchange, we can’t assume that our would-be traders have differentiated goods to trade.

The first exchanges, therefore, were likely services, like grooming, that require no specialization. We see a lot of this in primates, for example. But this sort of exchange presents a problem: how do you make sure the other party performs the service he promised, whether effectively or at all? And how does he make sure you do the same, if you’d really rather go swimming than return the favor?

This is the problem that the exchange institution of the tribe solves. The earliest and simplest mode of human organization is actually a quite complex multilateral arrangement where each member puts pressure on each other member to keep his promises.

This suggests two basic functions that an exchange institution has to solve: first, to keep track of obligations in order to make sure people are holding up their end of the bargains they make, and second, to punish people who fail to do so. At a tribal scale, from a few dozen to a couple hundred people, this is relatively straightforward. The accounting can be done in people’s heads, since everyone knows everyone else, and punishment consists of social pressure.

This becomes more difficult as the exchange community expands to the point that everyone can’t know everyone else. It’s at this point in history that we begin to see cities, and later, small empires – and writing. The earliest records of writing, indeed, were inventories and receipts, suggesting that it’s substituting for personal knowledge in keeping track of obligations. States also begin to arise around this time, taking care of the punishment in a less personal way than the tribe had been able to do.

As empires grew, a number of changes occurred. First, writing began to be used for literary purposes rather than just accounting, suggesting a diffusion from the administrative class to the wider public. Second, comprehensive systems of weights and measures began to appear. Silver began to be used as a medium of exchange, and took over the unit of account function from cattle. Third – and somewhat puzzlingly – the complexity of the accounting recorded on cuneiform tablets actually declined. In light of the first two changes, I suggest this reflects the growing necessity of decentralized accounting, rather than relying on the palace functionaries that had managed resource distribution in early Mesopotamian cities.

The use of indirect exchange with a system of numerical accounting – monetary exchange – is a powerful institution that supports exchange at vast scales, and therefore also a very fine division of labor. The medium of exchange is able to serve an accounting function, and all the punishment necessary is that no good shall be exchanged without sufficient monetary consideration. One must produce in order to consume.

Nevertheless, the use of money was for a very long time largely out of the reach of the masses, mainly due to innumeracy, but also in early medieval Europe because of the scarcity of metals. These strata tended to continue to rely predominantly on exchange on the basis of custom and status. The real breakthrough for monetary exchange came with the advent of mass literacy and numeracy following the Reformation, along with improvements in coinage. Recalling Adam Smith’s dictum that the division of labor is limited by the extent of the market, the incorporation into the money economy of so many previously excluded social strata ignited an industrial revolution in Europe and three centuries of historically explosive and more or less uninterrupted economic growth.

I should not give the impression here of an overly linear progression story. The movement from tribal exchange to mass monetary exchange proceeded at different paces in different places, took circuitous routes in some, suffered setbacks in others, and even still is hardly the norm outside the developed world. In contrast to orthodox models of the origins of money, there is nothing inevitable about it. Any observed exchange institution is an equilibrium strategy at a given social scale, and will tend to perpetuate itself. Nevertheless, on the basis of Adam Smith’s dictum about the division of labor and the extent of the market, we can tell a broad story of the progress of exchange institutions as enabling increases in the extent of the market in the same way that we can tell a broad story about the progress of the division of labor over time. Indeed, the variety of structures and strategies that humans use to solve the problems of accounting and punishment teaches us just how remarkable our fluid and monetized society is, where exchange can be organized on the basis of choice rather than custom and status.

Cameron Harwick (George Mason University, USA)

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