This book is founded on more than 30 years of reflection on the use and abuse of economic theory. During these years, I have considered myself to be a critical observer of developments in economics and in economic theory in particular. The impetus for my view of economics presented here was given, initially, during my studies as an economics student at Tilburg University and,
subsequently, during research for my dissertation. My dissertation addressed the modelling of institutional constraints in Edgeworthian barter processes. During these initial years as a researcher in economics, I already found myself at odds with the main hypotheses put forward by leading economists. In particular, I lamented the state of general equilibrium theory and its singular focus on perfectly competitive markets, which I believe to be much too limiting. During my subsequent career at Virginia Tech I turned my attention to several other areas in economic theory. Again, I found the practice in these other fields in economic theory lacking in critical self-reflection. I made several contributions to the general equilibrium theory of the provision of collective goods-better known as public goods. With my coauthors Dimitrios Diamantaras and Pieter Ruys, we have been able to apply this theory to understand the emergence of trade institutions, in particular market systems, that are subject to establishment and maintenance costs. Our conclusions from this research resulted in explanations that were different from the established theories in mainstream neo-classical economics. Subsequently, I investigated the formation of networks and hierarchical authority organisations with various coauthors. In particular, I focused on the role of trust in the formation of networks under mutual consent. The main insight from this research is not only that trust removes ambiguity about networking decisions, but also that trust guides the various economic agents to form a social network with strong stability properties. I first met Xiaokai Yang during a visit to Tilburg University in 1999. My reading of his 2001 book on the social division of labour triggered my interest in incorporating some of my own ideas in Yang’s framework. It took a long time to truly understand the working of Yang’s theory and its full potential. Only v
years after his death was I able to fully realise this potential in a mathematically correct theory of wealth creation through a social division of labour. The results have been beyond my expectations, and I have realised that this framework could unify many of my ideas from my previous research and introspection. Immediately following the financial crisis of 2008, I returned from the USA to Europe and took up a professorship at Queen’s University in Belfast, UK. The crisis strengthened my resolve to turn multiple strands of research and teaching material into a comprehensive vision of the functioning of an economy. This theory should be able to explain the crisis and make it possible to understand its effects. During the past decade at Belfast I have developed and taught my emerging vision of the network-institutional nature of economic wealth creation through a social division of labour. This vision is presented in two volumes. This first volume discusses the network-institutional foundation of economic wealth creation through a social division of labour. The theory put forward emphasises the role of socio-economic institutions in guiding the social division of labour. It brings together my thoughts on how institutions structure our economy and facilitate the production of goods and services. I discuss how this allows us to understand the financial panic of 2008 and what happened recently in the global economy. It also allows for a comprehensive understanding of the nature and role of trust and entrepreneurship. Both are essential elements in the functioning of wealth creation processes in a social division of labour. While the nature of the first volume is very much in the realm of political economy, I turn to mathematical models of economies with a social division of labour in the second volume. There I am able to build on the framework laid out in the first volume to develop insights in the functioning of these economies. In particular, these theories explain that, if economic wealth is generated through a social division of labour, there is in principle no contradiction between the classical labour theory of value and the neo-classical market theory of value. This only emerges if institutions are assumed to implement a state of perfect competition and mobility: institutional imperfections allow the emergence of middlemen in the networks that make up the trade infrastructure of the economy. This, in turn, creates positions of power that can be exploited to create inequalities and deviations from the underlying value of the traded commodities.
ACKNOWLEDGEMENTS This book could not have been written without the helpful input of many of my colleagues and students. Many discussions over the years have shaped the research and philosophy presented here. Starting with my dissertation research at Tilburg University in the Netherlands in the 1980s and subsequently my work at Virginia Tech in Blacksburg, Virginia, and Queen’s University in Belfast, UK, I have had many opportunities to shape my thoughts through
interactions with colleagues and students and through lecturing to attentive audiences. Above all, I acknowledge the contributions of my mentor, Pieter Ruys, to the material presented here. We have been debating the nature of the relational economy for 30 years and we continue this debate today. In the early days of my dissertation research at Tilburg University, Pieter gave me the freedom to find my own way and investigate networks and hierarchies well before these became fashionable. Pieter then gave and still gives me the inspiration to ask the hard questions and to demand that economists, and economic theorists in particular, should provide answers to these questions even though the search is tremendously difficult and demanding. Second, I acknowledge the contributions of Dimitrios Diamantaras to the ideas and concepts presented here: Dimitrios was my coauthor in developing many of these theories. We spent a lot of time together to develop the demanding mathematical models and proofs that are required to address these questions properly. I thank Dimitrios and his student Marie Shorokey for detailed corrections and feedback on this first volume. More recently, my work with Dimitrios and Marialaura Pesce on the endogenous emergence of a social division of labour in different institutional environments has been inspiring and is a major part of the ideas presented in the second volume. I thank Marialaura for hosting me in Naples these past years to develop these ideas more fully. I also thank my former students, many of whom are now close colleagues and collaborators. In particular, working with René van den Brink and Emiliya Lazarova has given me much inspiration. We wrote many papers together, with René on hierarchical organisations and with Emiliya on the relational economy and institutions. With Sudipta Sarangi I developed one of the most important concepts and models in this research programme, the model of network formation under mutual consent. Our model of trusting behaviour and the game theoretic solution forms in many ways a cornerstone of my research programme. This research extended into our work with Subhadip Chakrabarti on the many applications of networks in game theoretic models of economic behaviour. Working with Kate Johnson has been a real inspiration. Together we explored the notion of social capital, Grameen banking and experimental game theory. Many of our discussions are hopefully reflected in this text. Most recently, Owen Sims has contributed most prolifically to the discussion of how the social division of labour develops and, particularly, our understanding of entrepreneurship in such economies. Our debates and joint research has resulted in many ideas that are presented in this first volume. Chapter 5 on entrepreneurship is a joint work with Owen. His interest in historical cases of entrepreneurship matched my own and resulted in very insightful analysis that is used throughout this volume and Chap. 5 specifically. I thank Owen very much for these contributions. Without him this project would be much less complete.
I would also like to thank my former students Willy Spanjers, Kyungdong Hahn, Narine Badasyan and Zhengzheng Pan. Over the years, they gave me much motivation to keep on track with my work on the research programme that has resulted in these two volumes. Finally, I thank my wife Jelena for putting up with my idiosyncratic state of mind and work ethic during the endless hours of working on this manuscript. I am very grateful to her for allowing me a more practical perspective on the functioning of the social division of labour through her lens of supply chain management. She complements me in more ways than I can express. Belfast, UK January 2018
Robert P. Gilles
1 The Principles of Economic Wealth Creation 1.1 Formulating a Theoretical Framework 1.2 Fundamental Principles of Economic Wealth Creation 1.2.1 Human Sociality and Organisation 1.2.2 The Nature of Socio-Economic Trust 1.3 The Social Organisation of Economic Wealth Creation 1.3.1 Increasing Returns to Specialisation in Production 1.3.2 Gains from Trade 1.3.3 The Social Organisation of Economic Wealth Creation 1.4 The Functioning of the Social Division of Labour 1.4.1 Two Views on Economic Wealth Creation 1.4.2 The Relational Nature of Economic Interaction 1.4.3 Transaction Efficiency and the Extent of the Market 1.4.4 Economic Development and the Entrepreneurial Function 1.5 Bringing it Together: A First, Simple Model of Wealth Creation 1.5.1 Institutions and Wealth Generation in a Hunter-Gatherer Economy 1.5.2 The Consequences of Ricardian Development 1.5.3 Smithian Development in a Social Division of Labour 1.6 Some Further Considerations Appendix: The Nature of Markets References
2 Of Bubbles and Crises: A History of Wealth Creation 2.1 Institutional Waves 2.2 A Very Short History of Economic Wealth Creation 2.2.1 Development Before Capitalism 2.2.2 The Institutional Development Leading to Capitalism 2.2.3 The Rebirth of the Platonian Economy 2.2.4 The Capitalist Economy 2.3 Bubbles and Crises in the Platform Economy 2.3.1 Setting the Scene: Two Major Crises of Capitalism Before 2008 2.3.2 The Run-Up to the Great Panic of 2008 2.3.3 The Subprime Mortgage Provision System 2.3.4 Some Direct Causes of the Great Panic of 2008 2.4 Looking to a Possible Future: The Network Economy References
83 84 89 91 94 97 100 113 115 117 120 126 134 137
3 A Framework for Modelling Wealth Creation 3.1 The Structure of a Socio-Economic Space 3.2 Governance: The Role of Institutions 3.2.1 A Typology of Socio-Economic Institutions 3.2.2 An Illustration: Comparing Three Institutional Trade Infrastructures 3.3 Interaction Infrastructures 3.3.1 Forms of the Social Division of Labour 3.3.2 A Primer on Network Analysis 3.3.3 Commodity Markets as Trade Networks 3.3.4 A Network Perspective on the Laws of Demand and Supply 3.4 The Entrepreneurial Function 3.4.1 Individual Entrepreneurship 3.4.2 Collective Entrepreneurship References
143 146 148 148
4 Economic Relationships and Trust 4.1 The Behavioural Economic Perspective of Trust 4.2 Trust as a Duality 4.2.1 Institutional Trust as the Dual of Embeddedness 4.2.2 Daily Life: Operational Confidence 4.3 A Reconstruction of Embeddedness and Trust 4.3.1 Reconstructing Embedded Economic Interactions 4.3.2 The Tripolar Reconstruction of Trust as a Duality 4.4 What Constitutes Economic Activity? References
217 220 227 228 233 236 239 251 259 263
158 176 178 182 193 197 201 204 210 213
5 The Entrepreneurial Function 5.1 Established Perspectives on the Entrepreneurial Function 5.1.1 The Deficiency of the Neo-Classical Perspective 5.1.2 The Schumpeterian Theory of Entrepreneurship 5.1.3 The Burtian Theory of Entrepreneurship 5.2 Institutions and the Entrepreneurial Function 5.2.1 Institutional Entrepreneurship: A Literature Survey 5.2.2 Entrepreneurship in the Socio-Economic Space 5.2.3 Institutions and the Unique Network Positions of Entrepreneurs 5.3 Case: The Entrepreneurship of the House of Medici 5.3.1 Restructuring the Institutional Matrix: The Ciompi Revolt 5.3.2 Giovanni de’Medici as an Institutional Entrepreneur 5.3.3 The Political Entrepreneurship of Cosimo de’Medici 5.4 The Interaction of Networks, Institutions and Entrepreneurs References
Schematic of the network of US mortgage provision (1950s) Schematic of the network of US mortgage provision (2007) Stylistic representation of a socio-economic space An example of a lateral network A Platonian production network for bread A neural network for information processing A production network for bread with power relationships A hierarchical network A strict hierarchy An organised market A network representation of a matching market Graphical representation of an embedded relationship Basic tripolar representation of an economic interaction Reconstruction of the actualisation of an economic interaction Introducing the notional relationship in the tripolar reconstruction A fully developed tripolar reconstruction of economic interaction Trust as the dual of reconstructed interaction A network with strong and weak ties The role of bridges in a network Marriage network of Florentine houses, c. 1429 Lending (red), partnership (blue) and patronage (black) relationships between Florentine houses
History of financial panics Basic rankings of homesteads for different citizens A “jungle” equilibrium based on a discrete social hierarchy Illustration of the SWF for a discrete social hierarchy Equilibrium in a barter system corresponding to Table 3.1 Basic monetary willingness-to-pay values Step 1—excess demands at zero prices Step 2—excess demand analysis Step 3—excess demand analysis Step 4—excess demand analysis Step 5—excess demand analysis Step 6—excess demand analysis Allocation α—an equilibrium allocation after price adjustment Allocation β—an alternative equilibrium allocation
“What are the causes of the human ability to create economic wealth?” This is one of the key questions that have occupied economists from the onset of their reasoning about economic activity and performance in a human society, exemplified by the title of the magnum opus by Adam Smith (1776), An Inquiry into the Nature and Causes of the Wealth of Nations. The response to this fundamental question is not only the oldest, but also the most established economic theory: wealth is generated through a social division of labour that is encapsulated in a social trade infrastructure. Productive tasks are spread out among a multitude of individuals, who achieve collectively a higher output than when all of them remain non-specialised. Thus wealth generation is founded on “Increasing Returns to Specialisation”. Through a social trade infrastructure these specialised productive individuals are brought together to exchange, barter and trade the fruits of their labour to allocate the collective output for consumptive purposes. A social division of labour, therefore, divides and integrates simultaneously. In order to access the identified Increasing Returns to Specialisation, productive tasks have to be divided; similarly, these divided tasks can only be functionally implemented when they are integrated into a social environment that embodies an effective trade infrastructure. Human needs give rise to the double coincidence of wants that can only be resolved through such a trade infrastructure. The ability to create such a complex social organisation and to let this organisation be sufficiently flexible is uniquely human. In fact, the human condition is exemplified by this unique social ability. Our hominin species Homo sapiens sapiens evolved biologically as well as socially to respond to environmental conditions in a cooperative manner, this is known as the “social brain hypothesis” (Dunbar 2003). The social brain hypothesis leads to the conclusion that this uniquely human characteristic naturally evolved into such a social division of labour.
That the social division of wealth-generating tasks cannot be separated from its integration through a social trade infrastructure gives rise to questions about how a human society accomplishes such a difficult and complex objective. In this work I adopt the hypothesis that such an organisation is conducted and coordinated through socio-economic institutions. These institutions are understood as fictional narratives that build a parallel fictional reality in which humans interact and cooperate (Harari 2014). Such an institutional perspective is, therefore, inalienable from the idea that wealth is generated through a social division of labour. This has been accepted by many social philosophers and economists, but has been neglected more recently in market-centred thinking about the human economy. I argue here that a return to a more institutional perspective is necessary to make economics relevant again and to address contemporary issues in the global economy in the twenty-first century. The institutional perspective taken in this book is a very broad one, capturing many forms of the fictional narratives that guide human interaction. I include all forms of conventions, collective behavioural rules and forms of governance in the category of institutions. Institutions range, therefore, from simple human gestures, facial expressions and language to advanced governmental institutions and sophisticated financial instruments in our contemporary global economy. In this chapter, I set out an axiomatic structure to underpin a thought framework in which one can meaningfully reason about the human economy centred around a social division of labour. Before doing this, I dwell for a short time on the historical roots of the fundamental theory that economic wealth is generated through a social division of labour that is encapsulated in an effective trade infrastructure. Some Historical Theories of the Social Division of Labour The idea or principle that economic wealth generation is conducted through such a social division of labour was already proposed in ancient Greek social philosophical discourse. This is exemplified by the description of the ideal “polis” in Plato (380 BCE) as an urban economy that is structured through a clear social division of labour. This was expounded and expanded upon by Xenophon (370 BCE, 362 BCE), who emphasised the necessity of having a proper functioning institutional environment in which a social division of labour can flourish. Aristotle (350 BCE) developed the conception of economic wealth creation through a social division of labour in its most complete vision during Greek antiquity. He emphasised the importance of specific socio-economic institutions such as property rights and the free exchange and barter of property. This included a treatise on the evolution of money and the foundation of the price mechanism (Aristotle 340 BCE, Book V). The principle that economic activity is structured as a social division of labour was unquestioned through more than 2000 years of philosophical and social thought spanning Plato, Xenophon and Aristotle. Contributions were made
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in Islamic Scholastic and Latin Scholastic thought (Sun 2012, Chapter 2), but only during the period in the run-up to the industrial revolution in the seventeenth and eighteenth centuries was the idea significantly revived. The term “division of labour” was actually coined by Bernard Mandeville in an elaborate analysis of industrial shipbuilding and cloth-making in Volume 2 of his magnum opus, Mandeville (1714). In this work, the concept that economic wealth is generated through a social division of labour became absolute and indisputable. Mandeville also uses metaphors to promote this idea, in particular with his famous fable of the bees. Mandeville brought the ideas of the ancient social philosophers into the world created by the industrial revolution. His contribution also included the introduction of the idea of the channelling of self-interest through the trade infrastructure of the economy. As Prendergast (2016) argues, this was not necessarily founded on an early understanding of “laissez-faire” economic policy by governments of nation-states—that unbridled self-interested decisionmaking leads to collectively optimal benefits under free trade—but rather a more sophisticated conception of the role of public government in the economy. In particular, Mandeville was hesitant about the potential for coercion in the labour markets in a modern industrial economy. Classical Political Economy Although the roots of the emerging field of political economy were already laid prior to his contributions, Adam Smith (1759, 1776) firmly established this new science on the fundamental principle that economic wealth was generated through a social division of labour. This was set out in the first three chapters of Smith (1776), in which he famously expounded on the workings of the division of labour in a pin factory. Smith also developed some theoretical consequences of the hypothesis of wealth generation through a division of labour. In particular, he linked the proper and efficient functioning of a social division of labour to the notion of competition, and developed the notion of the “extent of the market” to describe the limits of the wealth generation process in a social division of labour. This leads him on to an extensive debate about economic policy founding the development of the economy—embodied by the social division of labour— based on economic liberty and self-guidance. This was expressed most forcefully in Smith’s concept of the “invisible hand”: that selfishness and greed guide the social division of labour to its most optimal state. After Smith, David Ricardo (1817) provided the next push in the development of the theory of wealth generation through a social division of labour. Based on the vision promoted by Malthus (1798), Ricardo was very concerned about the limits to economic growth. He introduced the theoretical notions of marginal productivity and an equilibrium as a state of the economy in which the rate of return on capital investments is negligible owing to the balance
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of the forces in the social division of labour.1 Ricardo thus introduced two fundamental ideas into economics—marginalism and equilibration—changing economic thought forever. Ricardo significantly changed the theory of wealth generation through a social division of labour, setting the scene for contributions that considered the incorporation of the division of labour into manufacturing organisations. The first main contribution to the understanding of manufacturing and its effects on the division of labour was made by Charles Babbage (1835). He formulated the “Babbage principle” that in an industrialised economy Increasing Returns to Specialisation are driven by advances in production technology and the organisation of work around mechanised production processes. This laid the foundations for modern economic growth theory. The work of Babbage on manufacturing set the scene for the most comprehensive analysis of the industrial division of labour in the work by Karl Marx (1867, 1893, 1894). Marx fully incorporated the idea that tasks are organised hierarchically in social production organisations—through a manufacturing division of labour. His analysis considered the fact that produced commodities can obscure the way in which production is organised—referred to as “commodity fetishism” (Marx 1867, Chapter 1). For example, when buying a mobile phone, it is not clear how it was produced or where it originated; whether child or slave labour was used in its production; or whether its production process negatively impacted the natural environment.2 Marx’s theoretical framework attempted to reveal the workings and consequences of these obscured socioeconomic mechanisms. Marx set out to develop a complete theory of the capitalist economy. His perspective was very much a nineteenth-century one, centred on the notion of a commodity as a physical bearer of “use value”. His theory distinguishes capitalism from other forms of socio-economic organisation through its focus on capital accumulation—generated surpluses are submitted to the social division of labour with the objective to generate further surpluses. This perspective was fully expounded in a mathematical theory by Sraffa (1960) and Roemer (1981).
1 Ricardo’s argument was innovative and revolutionary: Competition among capitalists will force the rate of return on investments to equalise in the economy. The sector with the lowest marginal productivity will thus determine the overall rate of return in the economy. Ricardo determined this resource to be arable land, the agricultural output of which will diminish with more intensive use. Diminishing returns on less productive land now drives the economy to an equilibrium in which the social division exactly generates enough resources to reproduce itself, thus enhancing the arguments seminally put forward by Malthus (1798). For a detailed discussion I refer to Foley (2006, Chapter 2). 2 For a more complete treatment of Marx’s theory of the social division of labour and the manufacture division of labour I refer to Sun (2012, Sections 5.2 and 5.3) and for Marx’s general economic theory to Foley (2006) and Harvey (2017).
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The Social Division of Labour in the Marginalist Perspective After Marx, economics transformed itself radically from political economy into neo-classical economics based on marginalist reasoning in market environments. In some sense, neo-classicism gave in completely to commodity fetishism and focused solely on the trade of commodities as valued objects, neglecting the production processes through the social division of labour. Indeed, the idea that wealth is actually generated through a social division of labour does not play a significant part of economic theorising about the market: neo-classical economics focused completely on the description of the price mechanism and its power to guide the economy to an efficient state (Jevons 1871; Menger 1871; Walras 1926; Marshall 1890; Pareto 1906). Even though neo-classical economics is firmly founded on a mathematical approach to economic reasoning, there was no push to make progress on mathematical models of economic wealth generation through a social division of labour. The development of neo-classical economic thought was further advanced by the contributions of Friedrich Hayek (1937, 1945, 1960), who considered the role of information and knowledge in a market economy. Hayek emphasised that knowledge plays a key role in the formation of the social division of labour. In particular, the availability of knowledge is localised and is critical for the assumption of socio-economic roles and specialisations by individual agents in the economy. The dispersed knowledge in the social division of labour is transformed into price information through the market mechanism, guiding individual agents in the processes to actually organise themselves into a social division of labour. As such, this knowledge transformation process is bottom up: dispersed knowledge in economic locations is transformed into central price information that guides all economic decisions. Hayek viewed the market or price mechanism as the only socio-economic institution that can transform dispersed information in this fashion. He used it to promote the idea that any well-functioning economy should be founded on such a mechanism, making the market economy the only viable organisation form. Hayek’s view reverses the logic of Marxian commodity fetishism: economic decisions should be based solely on price information, which actually transforms and thus obscures the underlying localised knowledge that is present in the economy. Therefore, this form of commodity fetishism is a good thing rather than a bad one.3 Hayek subsequently used his theory of the division of knowledge as the foundation of his theory of economic self-organisation and the rise of spontaneous economic order. These theories lie at the foundation for neo-liberalism that took hold of policy formation and corporate management from the 1980s. 3 In Chap. 2 I discuss the idea that the 2007/2008 financial crisis was mainly caused by the fact that the prices of most financial derivatives did not reflect the true values and risks related to these products. Hayek’s view does not consider seriously the effects of misinformation and unfounded beliefs in the assessment of the competitive market system as the main allocation mechanism.
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Market Economies with an Endogenous Social Division of Labour Only rather recently has Xiaokai Yang (1988, 2001, 2003) revived an interest in the social division of labour as the main source of economic wealth, and developed a mathematical model that appropriately represents price-guided economic decision-making in the context of a social division of labour. Yang’s main innovation was the introduction of the conceptual notion of a consumerproducer. This mathematical construct describes an economic decision-maker as one who embodies consumptive needs as well as productive abilities— extending the infamous notion of Homo Economicus. Yang and Ng (1993) and Yang (2001, 2003) made the case that the consumer-producer approach can be used to describe wealth generation in an economy in which the competitive price mechanism guides the endogenous formation of a social division of labour.4 Yang and Ng (1993) also argued that other questions about economic wealth generation can be addressed in this framework. As such, this theory is therefore a proper mathematical vehicle to represent Smithian and Ricardian ideas concerning the functioning of a social division of labour and its extent. This mathematical framework has been developed further through contributions by Diamantaras and Gilles (2004), Sun et al. (2004), Gilles (2017a,b) and Gilles et al. (2017). These contributions show that a mathematical theory of the functioning of a social division of labour founded on price guided decision-making by consumer-producers leads to a general framework that can incorporate the ideas of Smith, Ricardo and Marx as well as Walras and Edgeworth. For more details I also refer to Gilles (2018). Toward a Comprehensive Framework Despite these recent advances in the understanding of wealth generation through a social division of labour, some important questions remain unaddressed. The most important question is why the human economy has evolved to be organised through a social division of labour. Neo-classical economics is clearly founded on the principle that the economy is organised through a competitive market system and that the social division of labour is simply an outcome of the proper functioning of that market system. This was not the fundamental hypothesis on which classical political economy was based. Instead, in political economy the social division of labour itself has primacy, while the market system has essentially a supporting role. Here, I set out to develop a comprehensive view to solve this fundamental question. Recent advances in anthropology and evolutionary biologyshow that the human species evolved as a thoroughly social, cooperative species. The unique feature that actually separates Homo sapiens from other hominid species is that humans evolved to solve problems cooperatively and flexibly.
Only very recently in Gilles (2017b) I have formally shown this to be the case for a “large” economy in which individual productive abilities are subject to Increasing Returns to Specialisation. The theory requires a sophisticated mathematical treatment that goes beyond the scope of Yang’s original framework.
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This allowed the human species to embark on a trajectory of socio-economic development. In other words, Homo sapiens is characterised by its economy, organised through a social division of labour. This evolutionary characterisation of the human economy provides a foundation for a comprehensive understanding of how the economy functions and how economic wealth is generated. My argument is that there is a unifying socio-economic view of the human species that explains the emergence of the social division of labour as the primal human generator of economic wealth: Humanity evolved as a species of social networkers that through social organisation exploited their unique ability to learn and be more productive if focused on a limited set of tasks. Thus Homo sapiens combines its ability to socially organise itself with its characteristic that labour is subject to Increasing Returns to Specialisation. This comprehensive viewpoint allows for a proper understanding of how economic wealth is generated, the crucial role of socio-economic trust in the human social organisation and how an economy founded on a social division of labour functions. Central to this viewpoint is the role of institutions in the human economy. Indeed, socio-economic institutions guide human activity and allow human decision-makers to properly interact and cooperate. The competitive price mechanism is just one of these possible socio-economic institutions, but certainly not the only one. From this thesis, a perspective emerges that the global economy is a huge cooperative human project instead of the neo-classical and neo-liberal view that economic interaction is based on competition rather than cooperation. Thus, it follows that economics should provide a better understanding about the wealth creation processes that occur in the global economy; economics should revert to being a “worldly philosophy”—as was indeed the perspective of many classical political economists, including Adam Smith, David Ricardo, John Stuart Mill and Karl Marx, but which has been lost since the third quarter of the nineteenth century with the rise and establishment of neo-classical economics. Neo-classical economists considered—and still consider—themselves hard, high-brow scientists who use mathematical models to understand and especially measure economic behaviour and performance. This scientific project has turned out to be much less successful than as was set out at the introduction of the mathematical scientific method in the 1870s, in what is known as the marginalist revolution. In particular, after the financial crisis of 2007/2008 and the subsequent lasting sluggishness of the global economy, economics has been found wanting. Many voices are calling for a new form of economics; a theoretical, mathematical economics that is open to addressing the pressing questions of our times, without being methodologically constrained and restricted.5 5 The current state of neo-classical economics is that it is held together and defined by its methodology. Indeed, its practice and theories have a common methodology based on the principles of methodological individualism, methodological instrumentalism, methodological equilibration and the axiomatic method (Arnsperger and Varoufakis 2006).
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I will attempt to go back to the roots of our understanding of the generation of economic wealth and justify the concepts used here. This requires me to bring together a number of very old and new ideas to sketch a theoretical understanding of the foundations of wealth creation in our contemporary global economy that is rather different from the one communicated to us by neo-classical economists. Therefore, the perspective set out here has to be understood as an attempt to communicate that the established, neo-classical viewpoint is actually contrived in a political way, and has to be viewed as much more ideological than scientific (Backhouse 2010; Chang 2014). By presenting an alternative vision, I hope to communicate the importance of certain aspects of human socio-economic behaviour and organisation that seem to be neglected in the prevailing economic world view.
FORMULATING A THEORETICAL FRAMEWORK
In this chapter I develop a theoretical framework that is founded on a number of fundamental hypotheses about human economic wealth generation and the logical consequences of these hypotheses. This creates a well-defined and holistic view of economic wealth creation and, consequently, of an economy as a whole. This helps us to understand the processes that we discern in the past as well as the contemporary global economy, setting out a perspective that defines a well-constructed worldly philosophy of human economic interaction. Unfortunately, this does not mean that an all-inclusive and complete perspective on our contemporary global economy emerges; reality remains too complex to comprehend with any set of simple concepts and theories. Most of contemporary economics is centred on the notion of a commodity and its generated values as the main subject of study.6 In my conceptualisation, I start from the viewpoint that the infrastructure of socio-economic relationships founded on the social and hierarchical division of labour should be our prime focal point. Therefore, the commodities are only of secondary importance; they are the objects of economic transactions and conversion processes in the prevailing trade infrastructure, but by no means fully characterise that infrastructure. Indeed, many contemporary socio-economic transactions concern immaterial services. These are fully determined by the social relationship between procurer and provider, in which both procurer and provider are instrumental in the determination and resolution of that service transaction; the service transaction is completely social or “relational”. I consider a simple example of a contemporary service commodity to extend this discussion. If one procures a haircut, it is unusual that the stylist as the provider completely imposes the chosen cut; the selection of the hairstyle is based on the desires of the customer, and the hairstylist acts as a facilitator for
As mentioned, Marx (1867, Chapter 1) already pointed out that the focus on the commodity as the main subject of study obscures a view of the underlying production and trade processes.
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this. As such, the process is mutual and collaborative, rather than one size fits all. A proper interpretation of the haircut is that it is the immaterial bearer of the relational transaction between the procurer (customer) and the provider (hairstylist). Thus the production process is much less obscured than is the case for material commodities such as food stuffs and physical luxury goods. I argue that all commodities should be interpreted in this fashion. So, commodities have to be understood as carriers of the underlying production processes and are recognised as such.7 This fits with the perception that, in our contemporary twenty-first-century economy, economic subjects are very concerned about the impact of their activities on their environment, social as well as natural: consumers care about where their consumed commodities originate; whether the production processes involve corrupt practices such as the use of child and/or slave labour; whether these production processes impose significant externalities on the global natural environment; and whether the label on the product actually represents accurately what substances are used in its production. Similarly, firms are much concerned about certain properties of their supply chains, especially their sustainability and resilience. These concerns, in some sense, characterise our contemporary global economy and its reliance on services and interconnections through complex socio-economic networks. This leads to the conclusion that the main object of economic study should be the social organisation of all processes conducted through the social division of labour and the associated trade infrastructure. The networks that make up this trade infrastructure should be the subject of our investigation and the focus of our modelling, rather than only the outputs that materialise from these (hidden) processes. In that regard, the objective of economics should be to “de-fetishise” these commodities, to use an expression from the Marxian perspective. The theories developed here are, therefore, relational in nature and concern the interaction between social collaborators. This relational perspective has an institutional foundation. The development of this is the main subject of this first volume, while in the second volume (Gilles, 2018) I turn to the development of more quantitative, mathematical approaches to modelling economic wealth creation through a social division of labour. Developing an Axiomatic Framework In this chapter I set out the fundamental principles of my institutional approach. I develop this framework as a formal treatise. I state five fundamental hypotheses on which my approach is founded and derive lemmas from these hypotheses that address the posed questions about the human economy. This thought framework is further developed in subsequent chapters of this book. The second volume (Gilles, 2018) turns
It is common in economic theory to view a commodity solely as a bearer of consumptive and productive properties. Commodities are not considered as carriers of socio-economic processes.
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to mathematical models that develop the classical issues of economic wealth generation and its allocation through an evolving social division of labour. Throughout, it becomes clear that this framework is general enough to capture the capstone ideas of classical political economy, Marxian economics, as well as neo-classical and neo-Walrasian economics. Therefore, this framework aims to provide a proper basis for the further fruitful development of theoretical economics. Of course, any theory is limited and I do not claim that the theory developed in this book is able to do full justice to the complexities of our socio-economic interactions. However, the structure set out here is founded on hypotheses that are inspired by ancient ideas about economic wealth generation as well as recent findings in research in scientific fields such as anthropology and sociology. I introduce and formulate five hypotheses that lay the foundation of a theoretical explanation of the process of human economic wealth creation: Hypothesis 1: The principal axiomatic representation of an economic decision-maker is that of an economic agent and that this agent is principally defined by two characteristics, the social brain hypothesis and the bounded rationality hypothesis; Hypothesis 2: The economic agent embodies productive abilities as well as consumptive needs and desires, being the conductor of all socio-economic wealth creation processes; Hypothesis 3: All productive abilities are subject to Increasing Returns to Specialisation; Hypothesis 4: Consumptive abilities are subject to consumptive smoothing, thus facilitation gains from trade; Hypothesis 5: Founded on (1) the ability to build social networks; (2) Increasing Returns to Specialisation; and (3) consumptive smoothing, economic agents are brought together through an appropriate social organisation to achieve economic wealth generation processes. These five hypotheses support and explain the emergence of the social division of labour (Lemma 1.7) that functions as the engine for economic wealth creation. I point out that the social division of labour only functions in the context of an institutional framework that prescribes how economic decisionmakers interact. Thus wealth creation only emerges in an institutional economy.8 Introducing a Unifying Framework A framework for the analysis of the wealth generation processes in an institutional economy is a so-called socioeconomic space. This represents economic decision-makers in the context of
8 A market economy is one possible incarnation or example of such an institutional economy. However, the assumption that an institutional economy consists solely of market interactions is unrealistic, in particular since a deep social division of labour naturally results in supply chains and networks of socio-economic interactions. So, the most natural incarnation of the institutional economy is actually a network economy.
THE PRINCIPLES OF ECONOMIC WEALTH CREATION
the common institutional framework that guides their decisions and interactions. Thus a socio-economic space consists of economic decision-makers who interact through institutional intermediation and build socio-economic networks—or a trade infrastructure. In such a socio-economic space, markets are explicitly seen as platforms that emerge in these networks. This framework is developed in full detail in Chap. 3. The theoretical framework of a socio-economic space is represented as a mathematical model using the representation of economic decision-makers as Yangian consumer-producers. These consumer-producers can interact in a variety of institutional settings. Human history has explored many institutional organisation forms, and I explore some of these trade institutions in this chapter to further explain the main line of theoretical development. It should be emphasised that institutions are critical in understanding how economic wealth is actually created and allocated: different institutional settings might lead to rather different economic outcomes. The five hypotheses stated here and the thought framework that these hypotheses underpin also provide a foundation for an institutional theory of trust and trusting behaviour that extends well beyond the individualistic perspective that all trust is interpersonal. I argue that trust is fundamentally founded on our social brain and our blind faith in the socio-economic institutions that we abide by. This institutional trust extends to our fellow human neighbours as they are members of the same institutional socio-economic space. So our daily interactions become possible through our blind faith that the people we interact with will abide by the same set of socio-economic institutions that guide our lives. Thus, what is referred to in the literature as interpersonal trust is actually transferred institutional trust, which I refer here to as operational confidence. Further consequences of this theoretical construction are explored in Chap. 4. Wealth Creation and Economic Development The social division of labour that is embodied in a socio-economic space is the main generator of economic wealth. As such, the allocation of this wealth and its creation are closely linked. Inequalities in the allocation of the generated wealth might lead to lower wealth levels in general owing to the adverse incentives that are present in the system. Changes in the social division of labour usually lead to changes in the level of wealth generated, or economic development. The most effective change that causes an increase in the wealth generated is the deepening of the social division of labour. Dividing the tasks executed in some production process into more specialised tasks results in higher output levels owing to the fundamental property of Increasing Returns to Specialisation in production. Thus, by separating hunting from gathering, and subsequently spear-making from hunting, a tribe can increase overall food production and individual productivity significantly. This implies that there emerges a social division of labour made up of specialised hunters, spear-makers and gatherers. It is the emergence of these innovative socio-economic roles that drives economic growth. The deepening of the social division of labour—and economic growth—is, therefore, closely related to institutional innovation, in particular the emergence
R. P. GILLES
of new socio-economic roles and new commodities that embody the innovative production technologies that are used to allow the further division of labour. This innovation of socio-economic institutions and infrastructures is denoted as the entrepreneurial function in the socio-economic space. The strongest expression of the entrepreneurial function is that of “entrepreneurship”, when an individual “entrepreneurial agent” transforms certain crucial aspects of the governance structure of socio-economic institutions to cause a punctuated change in the social division of labour and to trigger significant economic development as a consequence. The full investigation of entrepreneurship and the entrepreneurial function in the socio-economic space is more fully developed and explored in Chaps. 3 and 5.
FUNDAMENTAL PRINCIPLES OF ECONOMIC WEALTH CREATION
The most fundamental principle on which wealth creation rests is the understanding of humans as social networkers. It has been shown in anthropological research that the human species evolved as a species of social networkers. The large human brain combined with the human ability to walk upright, the voice box, and human dexterity serve the human ability to relate to other humans in an effective and cooperative fashion. Thus human evolution has to be viewed as representing a social developmental process as well as a process of physical adaptation. Our species evolved to deal with pressures on the species from its environment and we evolved specifically to be social networkers to deal effectively with these pressures. Ultimately, we evolved to organise our societies around social divisions of labour that guaranteed an effective use of these human abilities in the generation of economic wealth. Dunbar (2014) and Harari (2014) discuss how human evolution went through a number of stages. Hominid species evolved into hominins and, ultimately, into modern humans, Homo sapiens sapiens. The main evolutionary theory concerning the species of Homo sapiens is centred around two hypotheses, namely the social brain hypothesis and the hypothesis regarding time budgets—or, using more economically familiar terminology, the hypothesis of bounded rationality. Both hypotheses concern the understanding of why humans have evolved such big brains. Both assert that human evolution is in essence social rather than purely physical. Indeed, both hypotheses concern how the evolution of the human brain is driven by responses to the social environment of hominid and hominin species. The Social Brain Hypothesis The social brain hypothesis states that the development of the human brain is directly related to the social organisation of the communities in which hominids and hominins evolved. The most primitive hominid stage of human evolution can be gleaned from the observation of the behaviour and social organisation of (modern) great primate species in their current habitat. Research has indicated that in these species (chimpanzees,