The reading level for this article is Novice
Note: This article is an authorized excerpt from Ryan’s upcoming book, Zero to One Million [more information].
The History of the Market System
By Ryan P. M. Allis
September 18, 2003
One of the most important advances needed for the creation of a market system took place sometime between 12000 and 10000 B.C. with the advent of specialization and the start of the Neolithic Age. Instead of each tribe hunting and gathering their food, different persons within each tribe would become experts at a certain task such as hunting, gathering, cooking, tool making, shelter making, or clothes making. As methods of agriculture improved, the first towns and cities were seen. Dependable food supplies allowed people to build permanent houses and settle in one area. As settlements increased in size, new forms of society such as religious centers, courts, and marketplaces developed. The advent of towns produced further specialization, creating jobs in tool making, pottery making, carpentry, wool making, tool making, and masonry, among others. The specialist created items faster and of a better quality than if each family made its own, increasing standards of living.
The earliest signs of the market system at work can be seen with the advent of bartering within tribes as far back as 6000 B.C. in Mesopotamia. If Tom had twenty cows and Igor had eighty hens, and Tom and Igor agreed that one cow was worth four hens, then the trade could take place. The problem with the barter system, however, was that in order for a trade to take place, both parties had to want what the other party had. This ‘co-incidence of wants’ often did not happen. The demands of growing business and trade caused a money system to be developed. Silver rings or bars are thought to have been used as money in Ancient Iraq before 2000 B.C. Early forms of money would usually be specie, or commodity money. Examples range from seashells, to tobacco leaves, to large round rocks, to beads.
While the money system still had much development to go through (credit and paper money did not yet exist), its invention over four thousand years ago was of crucial importance to the world we live in today. The use of an accepted medium to store value and enable exchange has greatly enhanced our world, our lives, our potential, and our future.
In the year 1100, the prevailing system in the Western World was feudalism. It was a world of kings and lords, vassals and serfs, kingdoms and manors. Long distance trade was expanding and new worlds of foreign spices, oriental treasures, and luxurious silks were discovered. Three hundred and fifty years later, after weathering a Black Death and the Hundred Years War, Europe emerged by expanding trade to new levels and building the foundation for the start of the competitive market economy we know today.
With a population spurt starting around 1470, cities, markets, and the volume of trade grew. Banking, initially started by Ancient Mesopotamians, grew to new heights and complexities, the guild system expanded, and the idea that a business was an impersonal entity, with a separate identity from its owner, took hold. Silver imports from the new world drove expanded trade and bookkeepers created standardized principles for keeping track of a firm’s accounts based on Luca Pacioli’s advances. Early entrepreneurs, called merchants and explorers, began to raise capital, take risks, and stimulate economic growth. Capitalism had begun.
It began with much resistance, however. The idea of gain was shunned and shamed. The practice of usury, charging interest on loans, was banned by the Church. Jobs were assigned by tradition and caste. Innovation was stifled and efficiency was forcefully put down, punishable by death. In sixteenth-century England, when mass production in the weaving industry first came about, the guildsmen protested. An efficient workshop containing two hundred looms and butchers and bakers for the workers, was outlawed by the King under the pretense that such efficiency was improper. Makers of innovative buttons in France in the late 1600s were fined and searched and the importation of printed Calicos cost the lives of 16000 people.
The world would soon see, however, that innovation was generally a good thing that made lives better and that efficiency was a path toward a higher standard of a living. As Robert L. Heilbroner says in The Worldly Philosophers, "The precapitalist era saw the birth of the printing press, the paper mill, the windmill, the mechanical clock, the map, and a host of other inventions. The idea of invention itself took hold; experimentation and innovation were looked on for the first time with a friendly eye."
With the advent of a complex marketplace and capitalists, the battle of ideas raged to explain the sources of wealth and to explain the workings of market. Between approximately 1550 and 1800, a philosophy called mercantilism was at the forefront. The mercantilists had the misguided notions that a country’s wealth was solely based on how much treasure and gold it could obtain and how much more it exported than imported. Monopolies and tariffs were promoted and competition and trade were discouraged. They had gotten it all wrong.
Fortunately for Europe, new schools of thought sprung up in the 18th century that promoted commerce, and not the hoarding of gold, as the source of wealth. Adam Smith further backed this idea and was the first to capture and explain the essence of the marketplace. He did so in his famous 1776 work An Inquiry into the Nature and Causes of the Wealth of Nations, slaying the mercantilist dragon in the process. Within, Smith outlines certain laws of the market, that are worthy of mention.
Smith explains that self-interest acts as a guiding force toward the work society desires. As Smith notes in Wealth, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self-interest." While one would naturally assume that everyone following only his or her self-interest would not create a very good society, there is another force that prevents selfish individuals from exploiting the marketplace. That regulator is competition.
This principle can be explained best with the following excerpt from The Worldly Philosophers.
A man who permits his self-interest to run away with him will find that competitors have slipped in to take his trade away; if he charges too much for his wares or if he refuses to pay as much as everybody else for his workers, he will find himself without buyers in the one case and without employees in the other.
Those workers will go to the competitor who is willing to pay more and those customers will go to the competitor who charges less. The wonderful paradox of the market, through the interaction of supply and demand and competition, creates a price that properly allocates industry so as to produce the proper quantities of goods and services. No intervention, planning, or forethought is needed to create exactly what society desires, in the exact amount it desires. What a wonderful contraption the market is! As long as society can promote competition and innovation, standards of living will continue to grow and wealth will increase. So the theory goes.
Unfortunately, our world cannot be simplified to quite this degree. Such things as crime, corruption, and market failures do exist. There are some cases where the government should be involved, and there are other cases when the government should have less involvement. This topic will be dealt with in a later section of this chapter.
Now that we understand the basics of how the market system works, let’s progress with its history up to the present day. Following Smith there were many other economists, ideologists, sociologists, and philosophers that pontificated on the workings of the increasingly complex marketplace. Ricardo outlined the all important principles of trade while Malthus predicted overpopulation and doom. Mill contemplated on liberalism while Bentham promoted utilitarianism. Marx painted a bleak picture of forced labor and surplus value while Keynes later showed there sometimes was reason for an active government.
By the of Smith’s death in 1790, the nascent Industrial Revolution had already reared its head. The effects of the Renaissance, the humanist movement, and the new focus on science and empiricism would translate into the launch of movement that would impact the world as none before it had. It was this revolution, often harsh and cruel, that prompted thoughts of communism, created robber barons and titans, and led to the development of the innovations, technology, and standards of living we have today.
From the Industrial Revolution, the concept of mass production and economies of scale came about. Bigness, trusts, and horizontal integration became the key to riches in the day. It was Andrew Carnegie and J. P. Morgan in steel, John D. Rockefeller in oil, and Henry Ford in automotives. While many of these titans often had questionable ethics, no one can deny that they were innovators. They forged alliances, developed new ways of doing business, and created efficiency across industries.
Out of necessity, regulatory organizations such as the Environmental Protection Agency, Antitrust Division of the Department of Justice, the Securities and Exchange Commission, the Food and Drug Administration, the Financial Account Standards Board, and the Federal Trade Commission would soon be created in the United States while similar organizations were created across the developed world. Theodore Roosevelt would go on his trust-busting and anti-monopoly campaigns while Franklin D. Roosevelt created new laws relating to the distribution of wealth. John Maynard Keynes would go on about public spending while Milton Friedman and Frederick A. Hayek would fight large government in the name of freedom. Lyndon Johnson would forge his Great Society while Reagan lowered taxes. The Berlin Wall would fall and the Internet as well as increased trade and flow of capital would create profound change in business. The markets would go dot com crazy and then crash and burn. We’ve gone from hunting, gathering, bartering, and grunting to specialization, miniaturization, internationalization, mass-production, and six sigma—all due to the invisible hand, innovation, and industry. And such is the history of the market system.