Applying Radford’s ‘Economic Organization’ to economists

Since the days of Adam Smith, more nonsense has been written about capitalism than any subject except religion.

During the 19th century and the first half of the 20th century, economists from David Ricardo to Alfred Marshall raised the status of the free market, guided by its miraculous “invisible hand,” to something like a beneficent secular priest that was supposed to rule worldly lives.

Beginning in the latter part of the 20th century, things got even worse.

Ivory-tower economists started developing a host of “rigorous” quantitative models that claimed to show how markets actually work. Tagged with such intimidating names as “The Efficient Market Hypothesis ,” “Modem Portfolio Theory,” “The Capital Asset Pricing Model” and “The Black- ScholesĀ­ Merton Option Pricing Model,” they focused primarily on markets for common stocks and other financial securities assumed to represent the closest real-world approximation to the free market ideal.

And they were all wrong. They were based on a misapplication of Gaussian statistics, epitomized by that overworked bell-shaped curve, which supposedly demonstrates that female college students have less aptitude for math and science than males. For good measure, they also used antiquated principles of Newtonian physics that had long been discredited.

But these theories still became conventional wisdom among Wall Street rocket scientists during the 1980s and ’90s. Not to mention winning for several of their developers the Nobel Prize in economics, despite the havoc they raised for the financial firms that actually tried to put them into practice.

It may come as a surprise to many, but markets are not artificial hothouse entities. They are, in fact, entirely natural and instinctive products of everyday human pragmatism.

Nowhere is this illustrated more clearly than in the informal markets that developed among American and British bomber crews in German prisoner-of-war camps during World War II. It’s the basis for a fascinating article by British economist R.A. Radford titled “The Economic Organization of a P.O.W. Camp.”

Prisoners received weekly food parcels from the International Red Cross that typically included Spam, powdered milk, jam, chocolate bars, soap and five packs of cigarettes. With lots of time on their hands and regular weekly deliveries of identical parcels, the POWs began trading these goods among themselves.

In a surprisingly short time, each barrack became a hotbed of informal “barter markets.” These activities soon expanded to include trading between barracks and even featured “bid and offer” notes for various goods that aggressive POWs looking for trading action would pin to the bulletin boards in each barrack.

As volume grows, the barter system is an awkward way to conduct trading activity. But human ingenuity quickly solved this problem by pricing all goods in terms of a single good, known formally as the “medium of exchange”- in other words, money. The POWs instinctively chose cigarettes as their money, since each Red Cross parcel contained five packs, with 20 cigarettes in each pack.

Once the POWs had a reliable and widely accepted form of money, their trading activities increased by leaps and bounds. Soon they allowed for credit, futures markets, arbitrage, investment, entrepreneurship, rules and institutions to facilitate market activity, and- because there were nonsmokers- savers. There was something universal and spontaneous about the development of a market economy.

After the war, these thoughtful members of the greatest generation went to college on the G.I. Bill and built highly successful careers. The descriptions of markets in their college economics courses bore little resemblance to how markets actually worked naturally in their POW camps. From which we can learn a great deal about how markets really work in a world of full-blooded human beings.

originally published: August 10, 2013

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