The Answer Is Transaction Costs

The Engineers of Exchange: Middlemen, Part Deux

• Michael Munger

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Middlemen are not parasites but essential "engineers of exchange" who create value by connecting buyers and sellers who might never find each other otherwise.

• The word "monger" (and Munger) comes from a Saxon root--Mancgere-- meaning trader or merchant
• Middlemen historically seen as parasites for buying cheap and selling dear without improving products
• 11th-century "mancgere" traders defended their value despite not changing the goods they sold
• RA Radford's 1945 POW camp study shows how middlemen increase beneficial exchanges
• The prison camp padre who traded his way to wealth, while making everyone else better off!!
• Arbitrage improves market efficiency by exploiting price differences, and reducing differences in price so that people can rely on the price they are offered rather than having to bargain or comparison shop. 
• Middlemen only become problematic when they control exclusive information or "rents"

The first "middleman" episode of TAITC:  May 2023....

R.A. Radford, "The Economics of a POW Camp." 

M.C. Munger, "Market Makers or Parasites."


Book'o'da'week: Country Music USA by Bill C. Malone, published by University of Texas Press.

Bonus: a great example of a middleman, from a listener in Oz!



If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Speaker 1:

This is Mike Munger, the knower of important things from Duke University. A middleman buys cheap, sells deer and does nothing to improve the product in the meantime. Middlemen are everywhere and have been since the very first exchanges started to improve the lives of primitive humans. Marco Polo and his family were middlemen. So was eBay were middlemen, so is eBay. Between them, in time and complexity, lie millions of highly specialized and highly profitable actions and transactions. But are middlemen good for market systems or are they just parasites? There's a new twedge. This month's letter plus book it a month and more Straight out of Creedmoor. This is Tidy C. I thought they'd talk about a system where there were no transaction costs. It's an imaginary system. There always are transaction costs. When it is costly to transact, institutions matter and it is costly to transact.

Speaker 1:

Today I'm going to return to one of the most misunderstood and most maligned figures in the architecture of commerce the middleman. Entrepreneurs are the architects and designers, but middlemen are the engineers of exchange. Throughout history, middlemen have been portrayed as parasites, opportunists or mere speculators buying cheap, selling dear and allegedly providing no real value, just raising the price. The truth's more subtle and a little bit more important for understanding how markets function. I'm going to go back to a topic that I talked about in May of 23, my own name, munger, which comes from the Saxon word Mankgear. I'm going to say a little bit about how middlemen increased the number of trades and the welfare of society at large, and I'm going to look at a classic text from RA Radford's famous 1945 article the Economic Organization of a POW Camp. Well, let's start with an important question what is a middleman? I have a stake in this question because my own name, munger, m-u-n-g-e-r, comes from monger, m-o-n-g-e-r, a dealer or trader, often in illicit or smuggled goods. So it's not a noble name. The name has very old roots. Saxon writings of the 11th century we find it as mancer M-A-N-C-G-E-R-E. So according to the etymology dictionary, the Latin noun was mangonus, a trader or merchant, often, sadly in the 11th century, in slaves. Mangonus, in turn, has its roots in a Greek word mangonin, a war machine or contrivance. The Trojan horse was a mangonon. Given that origin, it's not surprising that traders were often seen as deceivers, thieves and parasites. There's little to place on the positive side of the etymology ledger, at least until 1000 AD or so.

Speaker 1:

Now. By that time the river of meaning had forked. There were war machines, such as the medieval manganel or catapult, and traders in the market, the Mancure. Now, in May of 2023,. I talked about this, the definition of the Mancure, but I thought I would say it again because it is an interesting character. So in Sharon Turner's three-volume History of the Anglo-Saxons, which was published in 1836, she cites Salter, an old psalm book from the 11th century, and in a way it's a little bit like the characters in the Canterbury Tales. There is a type, a merchant called the mankir, and the mankir is introduced. Merchant called the Mankir and the Mankir is introduced.

Speaker 1:

I say that I am useful to the king and to the alderman and to the rich and to all people. I ascend my ship with my merchandise and I sail over the sea-like places. I sell my things and I buy dear things which are not produced in this land and I bring them to you here with great danger over the sea. Sometimes I suffer shipwreck with the loss of all my things, scarcely escaping myself. What things do you bring us? Skins, silks, costly gems, gold, various garments, pigment, wine, oil, ivory, or a calcus, which means tin. Or a calcus which means tin, copper, silver, glass and such like, actually. Or a calcus means brass. So will you sell your things here as you brought them there, says the interlocutor. I will not, because then what would my labor benefit me? I, I will sell them dearer here than I bought them there, that I may get some profit to feed me and my wife and children.

Speaker 1:

So notice what this story is. The mankir, the middleman, goes and buys stuff someplace else and brings them, brings these things to a place where people want them and then sells them. Do you improve them will? Will you sell your things here as you brought them there? Well, no, I'm gonna sell them for a higher price. I'm not gonna change them in any other way.

Speaker 1:

But the main gear of the 11th century is not a parasite, at least not in his own eyes. In fact, he claims that he's useful. Now, of course, all parasites are going to argue that they're useful, at least to themselves. They'd like to be able to sleep at night. The Mancure freely admits he does nothing to change or improve the product. All he does is transport it and then sell it at the highest price that he can get. Wouldn't we be better off without him? And the answer is no. Without middlemen, we wouldn't have markets in the first place.

Speaker 1:

The story about why that's true is interesting and important. I wanted to go back to RA Radford's famous prison camp article I said before it was published in Economica 1945. The title of it is the Economic Organization of a POW Camp, and Redford writes, and I'm quoting now Very soon after capture, people realized that it was both undesirable and unnecessary, in view of the limited size and the quality of supplies, to give away or accept gifts. Goodwill developed into trading is a more equitable means of maximizing individual satisfaction. Well, they all got Red Cross parcels, and so each Red Cross box contained items like tinned milk, jam, biscuits meaning cookies chocolate, sugar and, crucially, cigarettes. The prisoners' preferences differed over all those things. Some valued chocolate over meat, some treasured cigarettes. They differed in what they wanted, but all of them had the same endowment. So exchange begins to happen. If we have the same endowments, we all have a box with identical elements, but we like things differently. We will start to exchange.

Speaker 1:

Now there's no middleman there yet, but it's the story of the middleman that Redford describes that I think is most relevant for my discussion today and that's why I'm bringing it up. If one prisoner prefers two tins of jam to one tin of beef and one likes two tins of beef more than one tin of jam. They obviously can exchange, but trade is not always easy. Information's imperfect potential, trading partners are dispersed and timing may matter. That's where the middleman comes in.

Speaker 1:

Redford tells a story of an itinerant padre, a priest whose sharp eye for opportunity made him a legend of camp economics. Redford recounts, quoting now, stories circulated of a padre who started off around the camp with a tin of cheese and five cigarettes and returned to his bed with a complete red cross parcel in addition to his original cheese and cigarettes. So you have a red cross parcel that has 10, 12 different things in it. Padre starts off with a tin of cheese and five cigarettes and starts exchanging, return to his bed with a complete Red Cross parcel in addition to his original cheese and cigarettes. So he profited. All he did was make exchanges. He would buy something and then go sell it, and then whatever he acquired from that sale he would sell again and he managed to make. These are profits. You have to call them profits because he didn't produce anything new. All he did was buy and sell existing things.

Speaker 1:

Now there's no claim that the Padre engaged in deception or coercion. Commodities are standardized. The cigarettes are identical, the tins of food are all uniform At every stage. Each exchange left both parties better off, and yet the Padre accumulated wealth. So here we witness the fundamental role of the middleman. The padre found one prisoner willing to pay, say, six cigarettes for a tin of beef, another one willing to sell one for three.

Speaker 1:

Now, if the two could find each other they could exchange. But they lack information, access to each other or time. But the padre, through his knowledge of the market, orchestrated that exchange, earning a profit in the process. So what that means is that middlemen are brokers. They find people who want to buy and they connect them with people who want to sell, and they charge a fee for that service. And it is a service, because the buyer and seller might not be able to find each other at all. These exchanges might not take place. So what we want mentally is for the exchange to have taken place at the minimum cost to the participants. That's not the way that works. The alternative is the exchange wouldn't have taken place at all, and since every one of the exchanges that the Padre engaged in made both parties better off, we should see the Pad and the middleman more generally as a hero, not as a parasite. It might seem like the wandering padre only took value, buying cheap, selling dear and changing or improving none of the products that he exchanged. But just like the Saxon mankier meaning the monger, I have to admit so I have a stake in this outcome. Still, the Padre actually created value at every step in the process. Each person is better off by at least one cigarette, in my example, and the Padre profits one cigarette by finding the exchange opportunity, profits one cigarette by finding the exchange opportunity. That process is arbitrage, exploiting price differences across markets, which ultimately drives prices towards equilibrium. It improves market efficiency and increases the number of exchanges. Whoa, that sound means it's time for the twedge.

Speaker 1:

This is a joke about a bank robber in South Texas. Jose robbed a bank, fled south across the Rio Grande. Texas Rangers were in hot pursuit. They caught up with him in a small Mexican town. Now, jose knew no English and none of the Texas Rangers spoke Spanish. They found a local resident willing to act as a translator and began their questioning when did you hide the money, they asked in English, and the translator says the gringos want to know where you hid the money. Tell the gringos, I will never tell them. Then he says in English well, jose says he'll never tell you. The rangers all cock their pistols and one of them takes out a rope that's hung in a noose. They all stare at Jose. You tell him, said the rangers, if he does not tell us where the money is hidden, we will shoot him or hang him. The translator says the gringos say if you don't tell them, they'll shoot you. Jose begins to shake with fear. Okay, okay. He says in Spanish tell the gringos, I hid the money by the bridge over the river, under the green rock. And the translator turns back to the Texas Rangers and says Jose says he is not afraid to die. So that is an illustration of the fact that if middlemen have specific information or have access to what economists call rents and they can protect those rents, then it is true that middlemen can be exploitative. In this case, the translator was the only one who actually knew the information about the language and so, as a result, he was able to exploit that and so, as a result, he was able to exploit that.

Speaker 1:

This week's letter from ER In the June 24 Tidy C, a letter was read about Fred Brooks' observation that adding people to a project may not reduce the project time and may even add to time. The letter correctly noted the transaction's cost of training, but there's another important transaction cost in Brooks' book communication among team members. My favorite Brooks quote came from an interview when Brooks, a lively Christian, was asked what he thought of people comparing his book the Mythical man Month to the Bible. Brooks said well, both of them are revered, but in neither case do people do what they say. Them are revered, but in neither case do people do what they say. Now ER says that that's paraphrased. It may not be an exact quote, but it is kind of funny. As a side note, er says I grew up in IBM, starting in the late 60s.

Speaker 1:

I so often heard of Brooks and his famous book. When I taught computer science in the 2000s I had students read most of it. I had the pleasure of meeting him in person when he spoke to a smallish conference in 2011. At 80 years old, he was a delight to listen to and talk with over meals. Still engaged in active research, he wrote another, less well-known book, the Mythical man Month, which I think is in some ways his better book.

Speaker 1:

One challenge in computer science and other fields is how to teach students how to design. There isn't an easy answer. Brooks wrote a book entitled the Design of Design. If you flip through it it can seem almost like rambling random topics, but by the end of it I found it was the best thing I've read on the process of design. End of letter. Well, thanks, er. It is funny that you actually met Brooks. I had not encountered anything about that book until I got the other letter, so this is an advantage of using letters as a way of getting more information.

Speaker 1:

The book of the week. We're spending most of this summer at the beach in Wilmington and so I'm reading books that I've been putting off and wanting to look at. This week I want to recommend Country Music USA by Bill C Malone. It's published by University of Texas Press, was first published in 1968, and since then it's had several editions. Well, the next episode will be released next week, tuesday July 15th. We'll have a new topic, some letters and, of course, a hilarious new twedge. All that and more next week on Tidy C.