What is the first thing that comes to your mind when the term “modern economy” is mentioned? Computer? eBay? Apple (as in Apple Inc. of course)? Agricultural machinery? Space exploration?
An artificially illuminated planet, Earth. A view that would be deemed the act of divine entities even a few hundred years back. This is Earth in the time of our modern economy.
Image source: http://www.theguardian.com/science/gallery/2012/dec/06/black-marble-images-earth-in-pictures
There are hundreds of thousands or even millions of things that can evoke the thought of our modern world, or modern economy (to be relevant to the topic of our discussion). Now, all those that you can think of at the moment are, without doubt, logical (thus, justifiable) and relevant because the mere mention of the word “economy” already covers, I dare say, everything in the universe. Grass offers aesthetic value and is a legit product being sold on the market. Even air, the polluted air, you breathe in and out daily is the product of our modern economy that promotes industralization (which have resulted in numerous externalities, and air pollution is one of them). So, whether or not an economic study has been conducted on a topic is a matter of time and interest of economists as well as how relevant the topic is to the current state of our economy. For instance, at the moment (and I presume), there might be no economic paper written about human settlement on Mars and the bountiful resources to be unlocked on exo-planets (planets orbiting stars other than the Sun), but that is because we have yet to advance to that stage where the so-called world economy within our mother earth is considered closed economy, where the definition of open economy is changed to one that is cross-planetary. Crazy as it sounds, the present science has advanced beyond our wildest imagination, and we are getting closer and closer, little by little, to actualizing our human ambition to reach the stars and interact with them. Though it seems off-topic, now that we have arrived at this point, I do encourage you to pay close attention to the development within the scientific world. Even though, far detached in profession and field of learning, the simple fact that everything is connected is enough of a reason to explain to you why the basic inter-disciplinary knowledge is important to the in-depth understanding of your own area of specialty.
Anyway, we have digressed further and further away from our subject of discussion. Let us step on the brake and turn back to the matter at hand. Now, like I said, when talking about modern economy, various thoughts arise.
The heart of modern economy known as “Transaction”
But, regardless of whatever you came up with, there is one thing, one thing that has always been in the core of our economy ever since its inception. That one thing is transaction, the means of transaction to be precise, the ways we exchange goods and services with one another. For this to make sense, let us hop onto our wagon of imagination and go back in time to a few millions years back.
Why? Because ultimately, what I want to convey to you, my dear readers, is that how we have evolved as a species is not just a biological phenomenon, but also a social evolution that shapes the way we live, think and interact with one another and our surrounding environment (which in return, helps tweak and improve the biological aspects, both physical and intellectual, of our evolution).
Let’s go back to the time of our forefathers, roughly 2.8 million years ago (wikipedia banzai!), when we, humans, were roaming the earth as a bunch of chimps (I think this sounds more plausiable than the idea that god/goddess created us with a wave of his/her finger. I mean, come on!). Back then, Probably, to survive, our ancestors picked fruit from trees, hunted animals, and digged other edible stuffs from the ground, and maybe, one only ate what one could find in nature. Maybe, back then, instinctively, our ancestors learned to share within group, from mother to her offsprings and the like. However, the concept of transaction, exchanging goods and services, probably had not surfaced yet at such an early stage of human development. This is just a conjecture though. After all, I wasn’t there, you know. But, I do hope it sounds logical enough to swallow.
Moving forward through time to the era of modern human (in scientific term, Homo Sapiens Sapiens), which began at around 200,000 years ago, our forefathers began adopting modern human behavior, a more sophisticated way of living. Now, there are different arguments; some say this particular behaviour only emerged 50,000 years ago, but let’s just assume that it happened somewhere in between. That time was the time humans began to see the value of life beyond mere daily survival. It was the first time we began to actually explore the many possibilities our world has to offer. We started hunting not just for meat, but also for the skin, teeth and bones which can be made into clothes and tools that aid us in life. Then, at the dawn of civilization, I imagine, we started to specilize in production, to divide the available and accessible resources and labour of men and women into groups, each producing certain goods and services (like clothes, weapons, shelters, sculptures, body ornaments, tables, chairs, pottery, rope, agricultural tools, teaching, governing, etc), while the tasks of hunting for meat and farming for crops are left to other specilized groups called hunters and farmers.
But, what is at the core of all this amazing surge in the variety of productions and diversity of professions, the sophistication of human society? What was it that enabled labour to be divided into specialized group, that allowed civilization to become more efficient, productive, and flourished? Depending on your academic discipline, you might derive different answers from mine, and sometimes, even within the same discipline, people are not necessarily of one mind. With that in mind, we proceed. For me, in my very own perspective, I strongly believe that there is one economic aspect of life that tied everything together into a coherent whole, into an efficient system that has been growing and thriving ever since. Can you guess what that is?
It is “transaction” which has now become a part of human nature in the modern world. Why? How? Because without transaction, without someone saying “Hey, we actually can exchange stuffs with each other!“, specilization would not have been born. Think about it. How could the other groups of pots and pans producers survive if they themselves did not have/produce food? How could the hunters hunt if they themselves did not have/produce weapons? How could the farmers farm if they did not have tools? My answer is “because they were able to procure all those things they needed”. How could they have acquired them if they did not produce them? Simple. Through transaction, they exchanged what they produced for what the other produced.
Now, you might argue that they could just produce everything they need themselves. But, that is inefficient and if it had been the case, there would not have been great civilizations as we learned from our history books. Just imagine you growing your own veggies, raising chickens, producing your own bike, making your own books and pens, building your own home, all while trying to live a good life. It is too difficult for one person to handle all roles and responsibilities of life, and you would not be doing all those things efficiently and effectively or be producing high quality products and services as those who are specialized and doing the same thing everyday. This is no different from our modern society where we don’t grow our own food but simply work to earn money and purchase our food from the store. You get the idea.
Or, you might argue that our forefathers were more humane and generous if compared to us. In other word, you might say “Hey, but they probably shared what they produced“. This idea is not all impossible. It is, in fact, a plausible argument, but if and only if our ancestors lived in a small group, a tribe, instead of a metropolis, an empire that rules over millions. I think I would rather not explain too much, and let you imagine you doing that with your own community. Live by sharing. Think about all the conflicts that would arise. You know what I mean.
So, that is why transaction, the act of exchange goods and services with one another has been vital to our growth as a species, a society.
Still, have you ever wondered how our ancestors traded with one another? How did they pay for bread and meat? How did we transact in the past?
Transaction of the ancient world: Barter Economy
First, we bartered. Yes, in the earliest stage of our economy, we began with what is known as “Barter Economy”. It is the act of exchanging one’s goods and services with another person or group’s goods and services without the involvement of a medium of exchange (known as Money in our modern time). Imagine you being a carpenter. You have made a chair and you want clothes for your family. Great, go find the person who produces clothes for trade. But, with no money or medium of exchange of any other forms, here comes the problems that we would encounter in a barter economy (and probably our forefathers did):
+ First, the existence of what is known as double coincidence of wants is a pre-requisite for transaction in the barter economy to occur. What do I mean? Think about it. For you, who have a chair for trade, to obtain clothes, you have to go through and satisfy 2 tedious conditions. First, look around for the person who produces clothes. Second, for transaction to occur, that person must want to trade clothes for chair. Not everyone who produces clothes is in dire need of a chair. They are more likely to prioritize food security. And, even if there are people who want the chair you have made, it is very likely they have no clothes to trade with you. Life would be hell if this was the case, if we lived in barter economy of the ancient world.
+ Second, indivisibility. Let’s say… after a whole month, you have at last found the godsent person who happens to have clothes and want chair. But, here comes another drag. That person has only produced a pair of pants. Are you willing to trade a chair for a pair of pants? Well, it’s a deal or no deal situation. The less obvious problem is that you might only be willing to trade 1 chair for at least 3 pairs of pants. After all, that is a simple practice of pricing. Thus, that implies 1 pair of pants for 1/3 of the chair. Then, you realize you cannot cut the chair into 3 pieces, or else, it would be completely worthless. Then, the transaction will probably fail, and the search for that right person to trade with will go on. It would be a never-ending struggle.
+ Third, it has to do with portability. My god, a chair is heavy enough to walk around with. What if you have made a boat? How are you going to drag that thing along with you? Well, you can set up a store, but that doesn’t solve everything. You would probably be willing to sell your boat off only at a price of 100+ pairs of pants. Now, imagine someone, who is looking to buy a boat, having to make more than 100 pairs of pants while having to search for food to ensure their survival at the same time. Hell.
+ Fourth, the depreciation/deterioration of value. Accounting people would know exactly what I mean here. A chair or a boat are things that will deteriorate over time. They will require maintainance just to keep their original value afloat. And, for those who produce food, they face even greater challenge because food is perishable and quick to be spoiled. So, barter economy makes it difficult to store the value of your effort.
+ Fifth, probably the worst thing to come out of barter economy is pricing. It literally has to do with the number of relative prices (i.e. the price of one thing in terms of another) we have to come up with in transaction in barter economy. Imagine the following:
– With 2 products, A and B, you have a single price. Say, A = 2B (i.e. B = 1/2A)
– With 3 products, A, B, and C, you have 3 prices. Say, A=2B, B=1/2A, A=C.
– With 4 products, A, B, C, and D, you have up to 6 prices.
See the illustration below:
I shed sweat and tears making this. It is the first ever image ever originally created by Economind. I know it looks great, so you’d better appreciate it.
Now, let’s see what happens if we have 1,000 products. Employing the exact same formula, we arrive at 499,500 prices. With just 10,000 products and services (way way way below the number of products and services our current economy are producing), we would have to wrack our brain to come up with 49,995,000 relative prices. That means that if you sell apples, you have to figure out its relative price to every other products available in the economy. With just 499,500 prices to figure out, if you spent just 1 minute on a single price, it would take you almost a whole year (347 days) to price your apple. You have to figure out how many apples for one car, how many apples for one computer, and the list goes on for the rest of the 499,498 products. This is simply unimaginable for us living in today’s economy where hundreds of millions of products are available and accessible through various channels, some at your finger tip.
So, how did people back then solve the problem?
Notice the recurring word I used in the last two paragraphs. What is it? It is “relative price”. Yes, because we have many products, we have many relative prices. Since the pricing was then done by using all the other products as the respective units of price of your own product, you ended up with many prices for a single merchandise. That is to say, since we had to price a chair in terms of many different units of account, like orange unit (ex: 1 chair = 50 oranges), pen unit (ex: 1 chair = 30 pens), shirt unit (ex: 1 chair = 15 shirts), pig unit (ex: 1 chair = 1/20 pig), etc., we ultimately have countless number of prices for just 1 product or service.
Modernized transaction: the emergence of Medium of Exchange
What did we miss? What did we lack back then? Our forefathers might have asked themselves this question. Then, probably someone realized that the one thing (yes, literally one thing) that they did not have was a standardized unit of measurement, a unit residing in the middle of every transaction, that allows all prices to be measured in that single unit term. Then, we innovated and created “the medium of exchange”.
First, we started with things like stone, gold, etc. On a side note, have you ever heard of Yap island in the pacific? Did you know how large stone money over there is? See the pic below:
Yep, it’s bigger than what one person can carry. The people on the island used to transport these stones (money) on their boats. Sometimes, they simply did not bother moving the stones around. It simply switched from one owner to another, just like you buy a plot of land or something like that.
Image source: http://www.npr.org/sections/money/2011/02/15/131934618/the-island-of-stone-money
Later, we used coins made by gold, silver and other precious metals. Then, not long after the birth of “Bank”, we started using “paper notes” as money. At first, they were based on real and super scarce commodities such as gold and silver. Later, however, this particular system was abolished, and we arrived at something called “Fiat Money” that is literally based on faith (Fiat Money is flesh and bone what the money we spend nowadays is). You heard me right. Faith. I will further elaborate about banking and money in the next post. For now, see the illustration below to understand how money-based economy helped us solve the problem of pricing as encountered within barter economy:
With this illustration, I even shed blood. So, make sure you take a good and careful look at it.
See it? See how money solved the problem we once faced in barter economy? Simple, yet brilliant. Money is the common middle point against which every product or service can be measured. We no longer have to measure apple in terms of orange. With money as our medium of exchange, we simply price the apples we produce in either euro, dollar, peso, yen, baht, riel, or any other denomination your country officially uses. Now, let’s say we have 1,000 products. Whereas in barter economy where 1,000 products is translated into 499,500 prices, in money economy, 1,000 products simply mean 1,000 individual prices. By this logic, 1,000,000 products mean 1,000,000 prices. Simple!
This enables the economy to grow and flourish into the current economy we know of. It allows company to expand and makes life much easier for professions crucial to the operation of businesses such as accounting and finance.
The characteristics of money
Just to leave you with something substantial, be aware that in our modern world, money, the one we know and love, carries the following characteristics:
– Medium of exchange: It acts as a standard of measurement of value that facilitates the transfer of goods and services from sellers to buyers.
– Store of value: It is made artificially scarce, durable, portable, consistent, and legally approved/accpeted.
– Unit of account: It is divisible and countable.
All in all, money speeds up transaction and reduces transaction cost. It enables exchange of goods and services to be processed in an efficient and effective manner. Of course, modern technology has progressed at exponential rate leading to the creation of electronic money. This further speeds up transaction and helps secure ownership of money. It opens up new ways to do businesses, purchase, trade, and invest. It creates new channels of cashflow that has boosted growth at unprecedented rate. Of course, new challenges tag along with new inventions and ideas. Things like economic bubble (leading to problem of boom and bust, inflation, debt crisis, etc) also comes faster as the ease of transaction is augmented. Nevertheless, humans have worked to implement counter-measures fast. We, as a species, have come a long way, biologically, technologically, and socially. Probably, the hidden message in this article is that every little thing counts, and that sometimes, the simplest thing is the most impactful.
Food for thought…
You might argue that prominent historical figures like Newton and Galileo, the major players in the revolution of science, were the ones who pioneered many inventions of our time and led to the world to its current stage. And, I couldn’t agree more. These are individuals that I view with awe, that I deeply admire. But, mark my words, that their discoveries and inventions were also made possible because proper social framework (that involved well-functioned economy as its major component) had been established. They were able to do what they did because they were able to live without having to hunt everyday to survive. They were able to benefit from the labour of the farmers and hunters made available through economic specialization and transaction. For this reason, they had time to sit and contemplate the universe, the earth and the stars beyond. Modern economy has, since its inception, greatly enhanced lifestyle and expanded the number of possible careers or professions. They allowed scholars, the profound thinkers of the past and the present, to live, invent and discover new ideas because they could trade their products of thought and knowledge for food, shelter, healthcare and other necessities and amenities of life.
A long article it is. This is not the end, still. If you want to talk about the birth of our modern economy and how it evolved, we have to look deeper and expand our scope. Of course, we will do just that. In our next articles, the plan is to focus on two sectors: Government and Bank. We will see how these two have played very crucial roles through the course of time in the development of humankind.
For now though, this is the end of the first part. I hope you enjoy it. Good morning, good afternoon, good night to you, wherever you are.
Cheers,
Economind
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References:
https://en.wikipedia.org/?title=Human_evolution
https://en.wikipedia.org/?title=Timeline_of_human_evolution
https://en.wikipedia.org/wiki/Medium_of_exchange
https://en.wikipedia.org/wiki/Anatomically_modern_humans
http://blog.milesfranklin.com/the-seven-characteristics-of-money