How Two Different Perspectives of the Free Market Lead to Different Outcomes
The currency system and policies such as taxation depend on how you view the economy.
There are two ways of viewing the free market at a very fundamental level. These viewpoints are in regards to the nature of the fundamental interactions that take place in the economy. The first viewpoint is what I call the bartering paradigm, which is the view that what people are actually doing in the economy is exchanging goods and services for other goods and services. However, the inefficiency of this exchange process in its raw form means that money will develop as people look for particular commodities that are more readily acceptable for exchanges. These highly saleable commodities become money, and people generally begin to exchange goods and services for money. If you want to know more about how these commodities become money, I invite you to read Carl Menger’s work on The Origins of Money. The introduction of this commodity money causes a shift in people’s viewpoint from the bartering paradigm to the second viewpoint, which I call the purchasing paradigm, where people view the market as a place to exchange goods or services for money.
The significance of how these viewpoints shape the economy as it develops cannot be understated. These viewpoints shape the structures that develop in the economy, and policies implemented by governments. Our modern economy is based on the purchasing paradigm, and its attributes, such as the currency system and taxation, are really an outcome of this specific viewpoint of the economy. If the bartering paradigm had been preserved, we would have a very different economy with a different currency system and no taxation. It is my view that we need to reset the economy, and return to the bartering paradigm. Since no one has seen a large scale economy based on the bartering paradigm, I will try to show you some of the features that make it different. I won’t cover everything in this article but I hope to give you an idea of some of the benefits. I will show how these two paradigms lead to different solutions for the same problem in a scaled down economy. Then I will show what these solutions scale up to in a large scale economy, so you can compare the result of the purchasing paradigm, which looks like our economy, to the result of the bartering paradigm, which I believe is a more efficient and effective economy.
The first thing to try and understand is the fundamental origin of these two paradigms. The way to understand them is to examine the fundamentals of barter, which is where everything begins. I will do something slightly different from most economists though. When economists think of barter, they think of two people exchanging goods or services within a larger economy. There are some implicit assumptions made there, as the larger economy means that there are people and resources that the two parties who are involved in the exchange can tap into. I will instead consider the most basic economy you can have: an economy made up of just two people, living on an island. You might ask, what has this two-person economy got to do with the real world? The answer is: everything. The practices in this micro-economy scale up to entire nations and even the whole world.
When you start off with a larger economy, and you have people bartering in this context, then the bartering paradigm precedes the purchasing paradigm, which only comes up when money is developed. In the scenario I am going to construct with just two people on an island, they can’t start off by bartering because that would require that they somehow always want goods or services from each other at the same time. Instead, they will have to make a choice between the two paradigms. They are very likely to choose the more obvious but less efficient solutions presented by the purchasing paradigm.
To understand where the two paradigms come from, we need to examine the most basic economic interaction between the two people on the island, who I will call P and Q. The most basic interaction is not barter as you might initially think. Rather, it is one half of the complete barter interaction, and occurs when for example, P wants a good or service from Q, but Q does not need anything from P at this time. This is actually the most likely scenario for the economic interactions that take place on the island, and in fact is true of interactions in our economy. When you want some goods from the grocer, you will generally find that the grocer does not need any goods or services from you. This poses a problem for executing an exchange, and the two paradigms offer different solutions.
The purchasing paradigm is based on what I call raw barter, which requires two people meet and exchange goods or services at the time of their meeting. There is a requirement that items of value be exchanged, and that the exchange be completed immediately. So you’ll have Q providing the good or service that P wants, and P giving something of value back to Q. But Q of course does not need anything from P at this time. So whatever P gives to Q as payment for the good or service provided must be a highly saleable commodity, such as gold, so that Q can use it in future to purchase something from P. This is fundamentally how money arises in the purchasing paradigm. Note that this does not refute Menger’s theory on the origin of money but rather supports it, even on the smallest scale. Thus, the solution offered by the purchasing paradigm is the creation of commodity money, i.e., money with intrinsic value. This solution is quite obvious, and gives the islanders the efficiency they need to conduct their exchanges.
The solution offered by the bartering paradigm is not as obvious, but you can get the same efficiency as the purchasing paradigm offers, and in my opinion an even better outcome. The bartering paradigm allows for what I call enhanced barter. There is no longer the requirement that the two people complete the exchange at one meeting. Instead Q can provide P with the good or service he needs, and then at some point in the future when Q needs something from P, P can then provide that good or service to Q, thus completing the exchange. This splits the complete barter exchange into two halves which can be executed with some time delay. This enhancement may not seem that significant at first glance, but it really changes everything. It provides the same efficiency as the use of commodity money, but you don’t have to find that highly saleable commodity to use as money. Since there is a delay between the two halves of the exchange, P and Q will have to keep track of who owes what, otherwise they might forget. The simplest solution would be to use some kind of token, like an IOU. The IOU tokens do not need to have intrinsic value like commodity money does. If Q provides P with something, but Q does not want anything at the time, then P gives Q an IOU token which Q can later use to redeem goods or services from P, and complete the transaction. P might want to keep a record of tokens he’s given to Q, and vice versa, so there is no counterfeiting. This scales up to a solution that looks like our current currency system, except that you have multiple privately issued currencies instead of a government issued one. I will explain in future how government issued currency comes into the picture. That needs more than two people on the island. Just as a side note, there is an alternative to using the IOU tokens, which is P and Q both keeping a record of their transactions and using those records to determine what they owe each other. That scales up to basically what the cryptocurrencies are doing today with blockchain. I prefer the tokens because though they require some level of trust, they are simpler and I think more elegant.
To recap, we had the problem of the most basic interaction in the economy, where one person needs something from another person but the other person does not need anything in return. The question was how do they execute this exchange? The two paradigms offer solutions that are generally similar but differ in details. They both solve the problem by creating money, but the purchasing paradigm creates commodity money, which has intrinsic value, while the bartering paradigm creates IOU tokens, which do not have intrinsic value, as money. It is clear though that the solution offered by the purchasing paradigm offered an easier path for our ancestors. The bartering paradigm requires record keeping, which may not have been well developed in early civilisation.
To finish this article, I want to give another example of how the two paradigms differ. We use the same scenario of P and Q on the island. This time though, they do not have any gold, or other commodity which is highly saleable. How do they execute the basic economic interaction? If you use the purchasing paradigm, which requires commodity money, you’ll find that they are in a bind, because that paradigm does not offer a solution within the island’s economy. They would have to find another island economy which has gold, and either export some of their resources to the other island in exchange for gold, or borrow gold from the other island in order to conduct their activities. It is obvious at this small scale that this doesn’t make sense. Our islanders have all the resources they need on the island, and merely need to exchange them between themselves. Why should they have to go into debt, or transfer resources to another island, just to gain the ability to exchange resources they already have? But this is what the purchasing paradigm suggests, and it is actually happening on a large scale in our economies. Countries, notably African countries which have significant resources, are constantly borrowing money to implement public projects. Like our islanders, they have all the resources they need, and merely need to move those resources from one use case to another. They don’t need to borrow money to do this, and you see that clearly in the bartering paradigm. Our islanders, if they follow the bartering paradigm, would not need to borrow gold from another island, but can create their own tokens to keep track of their transactions and thereby move resources around.
In the bartering paradigm, you understand that you do not borrow money, rather you borrow resources you don’t have. If the islanders have all the resources they need, they should not have to borrow money from another island. On a larger scale, a country shouldn’t have to borrow from another country unless it lacks resources that the other country has. If hypothetically, they borrow money from another country, then that money should be used to purchase resources from the lender country, because it is really the resources that the borrowing country needs, not the money. But it should be clear that borrowing should be a last resort for any country. If a country lacks some resources, those resources can be brought in through the import-export process, i.e, the country can exchange resources it has for resources it needs, without a need for borrowing. Further to this argument, it makes no sense for a country to borrow money from a bank, including the IMF and the World Bank, because the banks have no resources that the country needs. Borrowing from a bank means the country is merely borrowing money for the purpose of reallocating resources that they already have. They don’t have to go into debt to achieve this if they follow the bartering paradigm.
I hope this gives an idea of what the two viewpoints on the economy are, and how they lead to different solutions which when scaled up can lead to economies that are vastly different in how they operate. There are other differences. For example, while under the purchasing paradigm, taxation is the obvious solution to paying for public goods and services provided by government, the bartering paradigm offers a different viewpoint where taxation is not necessary. In a future article, we will see the true purpose of taxation, and you will see that taxation itself is a terrible way to achieve that purpose.
