Rothbard Chapter 2: Direct Exchange Part 1

Long ago, I posted on the original chapter on Rothbard. This continues his Austrian magnum opus.

Interpersonal Action

The first chapter of Rothbard explained how individuals act in isolation to achieve ends. Now, he moves on to actions involving more than one person.

Rothbard starts with violent action. This is unique in the second chapter of a treatise/textbook. For most of MES, Rothbard is explaining action in a free-market. In order to understand voluntary exchange, it separated from other types of exchange.

Violent action requires that the gains for one individual come at the expense of the another. Actions under violence are fundamentally different from free exchange. Rothbard's logical deduction (praxeology) assumes a voluntary contractual society.

Exchange

All action is exchange. Chapter one dealt with intrapersonal exchange. However, most of MES is the study of interpersonal exchange.

"The major form of voluntary interaction is voluntary interpersonal exchange. A gives up a good to B in exchange for a good that B gives up to A. The essence of the exchange is that both people make it because they expect that it will benefit them; otherwise they would not have agreed to the exchange. A necessary condition for an exchange to take place is that the two goods have reverse valuations on the respective value scales of the two parties to the exchange." (emphasis in original- Pg 85)

The last sentence is important to remember. In a voluntary exchange, each party at the time of exchange values the good he is receiving above what he exchanges. This is a necessary condition for exchange.
However, it is not sufficient. Both parties must know that the other party is willing to trade. This requires knowledge of the other person's assets and subjective ordinal rankings. With knowledge and inverse rankings, an exchange will occur.
The diminishing law of marginal utility explains when the trading ends. A marginal unit trades if each actor receives something with a lower ranking than what he gives. Other units do not matter. Only the marginal unit matters. Rothbard constructs a chart that is similar to a supply and demand graph. In dealing with direct exchange, we need two charts, because both goods must have a supply and demand that intersect.

from page 88 of MES

The x's represent the ranking of the item being given up by person A and B, respectively. The circles are the item received. The third exchange does not occur, because person B (on the right graph) does not value the marginal unit in the third exchange above the lowest ranking of the item he has.

Exchange-Value and Production

In chapter 1, Robinson Crusoe only values means because of the ends they directly satisfy. They have use-value. With exchange, goods can have exchange-value.

"The existence and possibilities of exchange open up for producers the avenue of producing for a “market” rather than for themselves. Instead of attempting to maximize his product in isolation by producing goods solely for his own use, each person can now produce goods in anticipation of their exchange value, and exchange these goods for others that are more valuable to him." (pg. 89)

Now an actor can produce for use or exchange. Rothbard stresses that in either case, since all valuation is about satisfying ends, it is the consumer who drives production. All value, ultimately, comes from consumption. If consumers suddenly stop valuing wine, producers will lower the exchange value ranking of wine. This might lead to fewer producers, but it was the consumer's changing use value that initiated everything.

Division of Labor

Up to this point, Rothbard has implicitly assumed that both parties are exchanging different goods. In order for them to exchange different goods, they must have relatively specialized in obtaining those goods. This specialization can result from differences in nature-given factors or differences in the desirability and skill of labor. If I do not mind farming corn and it is easy for me, it makes sense for me to, again relatively, specialize in corn production if you hate it.

The odd situation is when you are better at both type of production than I am. Here it pays for you to specialize in the production where you have the greatest relative advantage. Ricardo had a simple proof of this two hundred years ago. Rothbard quotes Kenneth Boulding, but I like the Michael Jordan story. Even if he is a great typist, it does not pay for Jordan to type. He is better at playing basketball or underwear commercials.

Rothbard stresses how this simple idea of comparative advantage, derived from the action axiom, explains the existence of society. Again, this is uncommon ground for my friends who only read Varian and MWG.

"Thus, in explaining the origins of society, there is no need to conjure up any mystic communion or “sense of belonging”
among individuals. Individuals recognize, through the use of reason, the advantages of exchange resulting from the higher
productivity of the division of labor, and they proceed to follow this advantageous course." (pg. 100)

Conclusion

It is incredible how different the feel of MES is than MWG or Stigler, even though nothing contradicts each other.

It makes some sense, since Rothbard is writing a treatise. However, Rothbard believes MES can be a textbook, but economics cannot be separated from the rest of social thought. It can be highlighted but never separated.

In one sense, this is good. Rothbard is explicit about the rest of his social philosophy. He openly assumes voluntary society. In MWG, this is assumed and not mentioned. As always, Rothbard's approach has an opportunity cost.

The most striking difference here from MWG and Stigler is Rothbard's introduction of knowledge. Here he stresses the importance knowledge. In the opening of other texts, agents are assumed to know about possible gains from trade and exploit them. Austrians have always had a unique emphasis on knowledge and learning.

The most frustrating part in MES is how basic it is. Of course, trade only happens when both parties think they will benefit and know about the opportunity. I understand that Rothbard is building up a theory and the foundation is important. Also, this book is meant to be used by laymen and these basic tools for modeling are important and sometimes forgotten.

For example- We all have wondered why an exchange does not happen. "Why don't they just do this?" Rothbard tells why. There are only three obstacles.

  1. One of the parties is not aware of the gain, in which case it is in the interest of the knowing party to spread his knowledge.
  2. The parties do not have reversed valuations of the two goods, in which case the third-party who is wondering does not know what he is talking about.
  3. Some sort of violence (state-sponsored or not) is inhibiting the exchange, in which case the theory Rothbard explains does not hold.

Keeping these three things in mind when wondering "why not" will help us all clear our thinking.

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