EconTalk |
Michael Munger on Middlemen
Oct 27 2008

Munger.jpg Mike Munger of Duke University talks with EconTalk host Russ Roberts about the often-vilified middleman--someone who buys cheap, sells dear and does nothing to improve the product. Munger explains the economic function of arbitrage using a classic article about how prices emerged in a POW camp during World War II. Munger then applies the analysis to the financial crisis.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Oct 27 2008 at 1:59pm

Admittedly, I have not listened to the podcast quite yet! Since it’s Munger, this one will be saved for the afternoon workout. But I know how the priest did it. Here’s what happened. The priest has the advantage of information, from the confessional. He knows what extra stuff people have that they can’t use and what they want. So he uses this information to hook up trading partners and takes a commission. While a zero-sum analysis would portray everyone else as worse off, they are actually, on the whole, better off because instead of having surpluses of things they don’t want or can’t use, they have adequate supplies of things they do want after the trades.

So, having solved this puzzle, I think the next obvious puzzle is to guess what Dr. George will say. Might he conclude that intermediation should be the role of government, which can realize the profits of intermediation as taxes?

Roger Avalos
Oct 27 2008 at 2:04pm

In regards to the question Prof. Roberts posed at Cafe Hayek

You are being a little deceptive when you say everyone else, as a group, has “less.” Less what? Less objects, sure, but less value, no. They have more value. Gains from trade can be realized simply because individuals value goods differently. Tinned beef may have no value to a Sikh, but moving the beef to someone who does value it increases the sum of value enjoyed by all the prisoners. The larger pile of goodies that the Padre had at the end of the day shows the value that he received for performing the service of aligning goods with those who value them the most.

I have not listened to the podcast yet, but I suspect that this is similar to some of the points made by Prof. Munger.

Roger Avalos
Oct 27 2008 at 2:12pm

Apparently my typing is five minutes slower than BoscoH’s typing. Darn your frantically fast fingers! Although, I would say my story does not depend on the Padre having an institutional advantage over his fellow prisoners. His increased welfare need only come from his hard work and ability to help others.

Oct 27 2008 at 2:35pm

I’m very late to the party, but I think that an example of how this works would be to imagine two people each given the same ration. Here’s the ration: 1 cigarette, 3 peanuts. Now here are the people: Julie is a non-smoker. Jim is smoker who is alergic to peanuts.

Jim & Julie each have the same physical quantity of stuff, but each assesses the value of the stuff differently. Jim assesses no value to the peanuts while assessing value to the cigarette. Julie assesses no value to the cigratte, but assesses value to the peanuts. By trading, the physical quantity of stuff has not increased. But the assessed value has. Now Julie has 6 peanuts which she values, and Jim has 2 cigarettes which he values. Everyone has increased the value of their stuff.

When you only have one other person to trade with, it’s easy to figure out who values what. But when the number of participants gets large, you have two choices, either:

a) Everyone has to know what everyone else values and doesn’t value, or

b) A middleman alleviates everyone’s requirement to know everyone else’s values by aggregating them. For this knowledge everyone else pays a small stipend to the middleman. But everyone is better of because the assessed value of the things they end up with is more than the assessed value of the things they gave up.

Do I pass?

Jake Russ
Oct 27 2008 at 3:22pm

An economist’s definition of “better off” usually deals with levels of utility. Example: If one person ends up with less of some good, but more of some other good that they value more. Then their utility is increased. So if the priest redistributed the goods available to the people that valued them higher than others did and was able to pocket some stuff for himself, then yes he made everyone better off. Each person’s desired consumption bundle is different, thats why we “gain” from trade even though we’re not actually increasing the total number of goods available to all.

scott clark
Oct 27 2008 at 4:20pm

THere are lots of times in life where its way more valuable to have less stuff. In fact, I pay people to haul away my excess stuff twice a week. Most of that stuff has no value to anyone, but some of the stuff in there probably does, but its not worth my time to find the person to whom it is valuable and then coordinate with them to get them the stuff. (I’ve throw away lots of stuff that could go up on Craiglist or EBay but even those minimal transactions costs of listing the stuff, replying to the people, shipping the stuff or arranging shipping just pummels lazy old me). The good Padre was just doing what comes natural. Don’t kids at school trade lunch items anymore? (Wouldn’t surprise me if school admin’s had banned the practice, actually)They get a fixed endowment, then are able to negociate for what the value more. No econ lessons needed either.

So their is really no paradox, “more is preferred to less” means more SUBJECTIVE VALUE, is preferred to less SUBJECTIVE VALUE, the amount of mass in those configurations is irrelevant.

Flash Gordon
Oct 27 2008 at 4:22pm

I see you don’t have a link to “The Economic Organization of a P.O.W. Camp” and I was wondering if this link is to the correct article:

It seems to be.

[The article is under copyright. Out of respect for the copyright holder, we are not comfortable sanctioning versions of the article that may have been reproduced without appropriate permission.–Econlib Ed.]

Oct 27 2008 at 5:24pm

Looks like several people beat me to it, but I came to say essentially the same thing.

Having the things I want is much more valuable than having some amount of things. I am willing to pay (especially if the payment is some of those things I don’t need) in order to have my “things” rearranged, to be the ones I want, and not the ones I find useless.

Oct 27 2008 at 6:08pm

Could it be related to this post on Greg Mankiw’s Blog a few weeks ago?

Greg Mankiw’s Blog: Consumer Surplus

Could he also be another ancestral “mancgere”?

Oct 27 2008 at 6:52pm

I’d say the priest in this example is performing a service similar to that performed by a matchmaker.

The job of a matchmaker is to find a suitable bride for a potential groom and visa versa. For this they collect a fee. Matchmakers are classic middlemen, in that they don’t manufacture brides and grooms, nor do they generally do much to make their clients more desirable to a potential mate. And of course the thing they trade in, love, is one of the last things people would ever want to turn into a “commodity” to be traded on the open market. Yet matchmakers generally aren’t subject to the opprobrium that falls on other sorts of middlemen because we understand that the matchmaker is providing a real service by helping people find each other. It may be that Bob and Margaret would be perfect for each other, but unless they happen to meet randomly they could live blocks apart from each other and never know it. Matchmakers help to connect people who otherwise would have trouble finding love for whatever reason, and many people find the resulting increase in happiness that comes from two people finding each other to be well worth whatever fee the matchmaker charges (today, of course, matchmaking is typically done through computers).

Likewise, in Radford’s prison camp, different people valued the various items in their Red Cross parcels differently. One might be a vegetarian who has a sweet tooth. He would gladly trade all of his tinned beef (which are otherwise useless to him) for even a little extra chocolate. Another might prefer the beef to his allotment of chocolate, and gladly trade the one for the other. If these two prisoners knew who each other were, they could easily trade their items, to the mutual benefit of both. If they lack this information, however, there may be no realistic way for them to realize this benefit. A man who wanted to trade his beef for chocolate might search the camp for someone who wanted to trade his chocolate for beef. But this would be time consuming, and it might be that there was no direct way to make the trade he wanted. Prisoner A might prefer chocolate to cigarettes, Prisoner B cigarettes to beef, and Prisoner C beef to chocolate, and so to make the trade work the prisoner would have to have knowledge of all three’s preferences. By making the rounds and trading on the information he has gathered about people’s various preferences (much of it no doubt indirect), the priest is able to improve the lot of the inmate’s to such an extent that he can make them all better off and still take a sizable surplus for himself.

Oct 27 2008 at 7:35pm

Perhaps the explanation is simple, at least in my cynical mind.

Perhaps when the priest went out to trade, he (being known as a priest) found men willing to donate to him in small measures as a sacrifice to their beliefs in his specialness.

So, that no matter how hard he tried to trade, he actually wound up with goods aplenty while losing none of his original intended investment.

Oct 27 2008 at 9:28pm

It isn’t just the average Joe that misunderstands the value of bearing risk. Karl Marx did not appreciate the risk premium. Call him what you will, but he was no dummy. I’m sure that he is rolling in his grave over all the derivative markets in our modern markets. So many middle men not producing anything.

Oct 27 2008 at 10:20pm

Another great podcast. Prof. Munger is one of my favorite guests.

I was amazed during the discussion that neither of you mentioned the One Red Paperclip experiment. A guy was able through trades to start with one red paperclip and end up with a house provided that each trade was for similar value, e.g. the paperclip for a pencil was allowed, but the paperclip for a car was not.

That example ties in nicely with what other people have said about how the padre was able to end up with more stuff. The one thing I don’t remember hearing about the One Red Paperclip example was people complaining about how unfair it was that someone was able to turn a paperclip in a house, which is rather striking when considering other stories of trading.

Prof. Roberts, I do have one request. When creating the podcast, is there a way to make the person’s voice on the phone louder to create more balance between both of your voices? While listening in my car, I can hear your voice clearly, but I have trouble hearing the person you are interviewing unless I turn up the volume on the radio.

Oct 27 2008 at 10:35pm

There was some discussion about the differences between the current financial meltdown, the .com bust, and the POW camp.

– Leverage explains why individual companies may have failed, but not why the debt market has essentially stopped operating.
– Bankruptcy is essentially a transfer of ownership between parties. As the .com bust showed, large and frequent company failures alone don’t necessarily cause the market to stop operating.

I think the reason the market is currently not operating efficiently is counterparty risk. Markets are likely to fail (at least in the short term) when the companies that make markets fail or lose faith in the solvency of their trading partners. Imagine the Padre died and nobody had the knowledge and ability to immediately take his place. For a period of time, the POW camp would lose out on some of the gains from trade.

Also, if assets are illiquid and difficult to value, that doesn’t mean they can’t be valued by an investor, just that there are higher transaction costs and greater uncertainty. Exchanges for many types of derivatives and CDOs would be extremely difficult to operate because many of the assets are unique and not really commodities.

Paul Ganssle
Oct 27 2008 at 11:07pm

I am even later to the party, but I thought I might offer an example of how something like that could happen:

A starts with 1 cheese and 1 tin of jam.

B. Loves cheese but hates chocolate, and he will trade both his 2 chocolates for 1 cheese.

A now has 2 chocolates and 1 tin of jam.

C. Has bread and needs jam. He does not smoke and will give up his 2 cigarettes for 1 tin of jam.

A now has 2 chocolates and 2 cigarettes.

D. Is a lactose-intolerant smoker who is allergic to peanuts and he will trade his 1 cheese and 1 peanut ration for the 2 cigarettes.

A now has 1 peanut ration, 1 cheese and 2 chocolates.

E. Would like some chocolate but doesn’t have any bread, so he has no use for his jam. He will trade 1 tin of jam for the 2 chocolates and an interesting-looking rock that he found.

A now has 1 peanut ration, 1 cheese and 1 tin of jam and an interesting-looking rock.

I guess it’s a bit convoluted but at each step people gave away things that were of no personal value to them in exchange for things that were of personal value to them and in the end the middleman A had an additional item. B, C, D and E all traded with one another and A captured some of the surplus value (the peanuts and the rock). B, C, D and E all place more value on the things they got than the things they gave up even though collectively they gave A one ration of peanuts and an interesting-looking rock for nothing.

In this example, D could have chosen to trade his cheese for chocolate, then his chocolate for jam, then the jam for cigarettes and he would retain his peanuts, but he would have either had to figure out that the B-E-C chain is the way to get cigarettes ahead of time and then undertake three transactions or he would have had to trade away things that he had for things he didn’t particularly want in the hope that he might be able to trade them for what he really wanted in the end.

Russ Wood
Oct 27 2008 at 11:55pm

My first thought was along the lines of the comments before mine. I also really liked the idea of small charitable contributions to the padre in a previous post.

But my main obervation was that this is like the free flow of capital. It goes to where it has it’s highest use (utility, value, etc.) and produces the highest return. In a functioning market, these goods flow to the place where they are valued most. So each man maintains or increases the value of his stuff, even though the quantity of his stuff may decrease.
Before the padre, there was no market. He provided a simple market place. Trade doesn’t necessarily make more “stuff” but it allows the stuff to achieve its highest value so that all participants are better off. Trade grows the pie.

The question involves barter, or simple trade, which removes all the confusing aspects of money. However, the addition of a currency would add a nice twist to the essay question. A currency would not only make trade easier, it could add the element of a store of value. In this way, each member would essentially trade with every other member instantly, instead of one at a time via the padre. One member could trade away all of his stuff in exchange for simple currency. He would have no stuff, but the same value if the currency fulfills its purpose. With no market place, there is one level of wealth among the group. After simple trade there is a higher level of wealth. With a fully functioning market, including a currency, there should be an even higher level of wealth.

Oct 28 2008 at 12:04am

Another excellent podcast, I always try to listen on Mondays when Mike Munger is the Guest. The problem with government co-opting a business after it establishes an efficient business model is not limited to the changing cost dynamic. With or without the typical government inefficiency the consumer will “pay” at least the market price either in the form of market prices or an increase in taxes to cover the government’s cost of inefficiency, if not both. It is unlikely that any government would forgo the opportunity to “profit” from the enterprise.

Oct 28 2008 at 12:13am

Thanks for yet another interesting and entertaining podcast.

Just a thought on Mike’s observation that economics can tell you what not to do. I remember listening to the podcast of Nassim Taleb’s speach at The Long Now Foundationn and he talks for some time on the merits of negative advice e.g. the ten commandments are largely negative advice and they seem to have stuck around. Even if we never figure what exactly caused (whatever that means) this crisis do you think we may be able to learn what we should not do in the future? Although I guess we already knew what not to do – the savings and loans fiasco had already happened but we didn’t take the negative advice that we should have drawn from this experience.

Lastly, Russ what are the chances of another Taleb podcast in the wake of what has occured?

Oct 28 2008 at 4:29am

A nice fictional treatment of the middleman in a POW camp was done by James Clavell in his novel “King Rat”, set in the Japanese POW camp Changi in Singapore during WWII. Recommended.

Interestingly enough, Clavell seems to have been quite a fan of Ayn Rand.

Oct 28 2008 at 6:17am

I hadn’t read the Radford article yet and must say that it is one of the best i have ever read. There are so many things i think about while reading it. It’s basic micro, it’s psychology, it’s institutions, it’s ethics plus a little sauce of political economics.

Richard Sprague
Oct 28 2008 at 10:01am

Blackadder makes a good point about matchmakers as middlemen: how come people don’t think matchmakers are “ripping them off”?

Here’s my guess: matchmakers trade in a good (love) that they explicitly don’t consume themselves. The best matchmakers are old grandmothers who nobody suspects might “steal” the best matches from those who want them.

The reason we are skeptical of other middlemen is that we suspect they are taking the best products of trade (e.g. Crimean wheat, cash profits from derivatives trading, etc.) for themselves, not us.

Oct 28 2008 at 10:16am

The POW scenario seems pretty straightforward to me . . .

Resources are allocated to where they are most highly valued, and the priest is rewarded for providing this service, which itself has value.

Am I missing something?

Oct 28 2008 at 11:54am

I fully expected that a number of readers would come up with the solution to this paradox and I wasn’t disappointed. However, there is another aspect of it that I didn’t see touched on. It is the implication that the priest was taking advantage of the situation and that as a result his reputation as an honest man was not deserved. In fact, his reputation could very easily have facilitated the trading he engaged in. Knowing that each trade left everyone involved at least as well off as before, we can assume that if his reputation as an honest man facilitated trades, it is possible that it increased both his own profits from the trades and the well-being of everyone in the camp. Both the priest and his trading partners were better off because they could trust him.

Oct 28 2008 at 2:56pm

I wonder what roll if any did asymmetric information have on the POW camp? I’m not sure if it did, but an earlier post suggested that the priest could have been the benefactor of some information asymmetry. Does anyone know?

Oct 29 2008 at 12:30am

All the Roberts-Munger conversations are good, but I found this one particularly absorbing. Kudos to both!

Oct 29 2008 at 8:06am

As it’s been pointed out, the priest has added much value here. And his personal gains are not irrelevant: he has earned them. The priest’s profit is a small price for the community to pay for all the value added.

Gary Rogers
Oct 29 2008 at 5:38pm

This has to be one of the best podcasts yet, and after Arnold Kling’s recent hit, that is saying a lot. I enjoyed it very much.

As far as the paradox of the priest, I would say that this is an excellent example of Ricardo’s law of camarative advantage where the values various prisoners place on different commodities made the trade worth while. I could trade something for which I have little use for something of greater value to me but relatively lesser value to someone else and we both are better off.

Keep up the good work!

Oct 30 2008 at 8:17pm

The discussion around middle men and the Webvan example was confusing to me.

Was not Webvan a middleman by definition? Therefore, it must be that they failed because the service they were offering was not valued by their prospective customers and not because they set out to eliminate the “middle man”.

Mike Munger
Oct 30 2008 at 9:31pm

I see your point, Kumar.

But….Webvan advertised their services as cutting out many layers of delivery, stocking, storing, and displaying groceries.

Sure, Webvan is a “middleman.” But their premise was that they could make money by saving on the OTHER costs of extraneous middlemen in the retail delivery system.

And, that is what makes your conclusion so interesting: you are exactly right. It turns out that people did NOT value this service, even if it was cheaper (and it really wasn’t, in fact.)

S the Bond investor
Nov 1 2008 at 3:48am

EconTalk lifts the level of public discourse in our country. Great job, Russ and Michael!

A couple points Munger and Roberts missed when they connected POW microeconomics to mortgage markets:

1. Their analogy on the POWs trading tinned beef vs. trading MBS misses an important point about credit quality: with non-agency MBS, some of the tinned beef (MBS) is already rotten, other tins will be, and still others will become rotten, but then go back to edible. More difficult yet, estimates of how much is/will be rotten change over time. They are usually cyclical, but not in a profitably predictable way.

2. The George Mason conservatism seemed to creep in a few times, with a lot of rhetorical “the government is hopeless as a replacement for profit-seeking middlemen.” I encourage you to think more deeply about the GSEs: without them, would we have ever innovated beyond the Bedford Falls Building and Loan from “It’s a Wonderful Life”? Sure, Jimmy Stewart knew where each and every loan was, which is admirable, and we went too far away from it. But certainly holding forever is not capital-efficient for the loans that he’s pretty confident of. It’s more capital-efficient because the loan is off the books, and the capital is returned to the bank to make another loan — classic multiplier effect.

The government (via Fannie) created conforming loans, a SET OF STANDARDS that encouraged trading, and applied a guarantee to make them fungible. Imagine the POWs trading if the tinned beef came in 10 different sizes and 10 different cuts of beef. The only instance I can quickly think of where private markets arrived at a standard without government help was VHS/Beta, which is a non-essential entertainment good, and concluded with the inferior-TV-quality good becoming the standard! The middlemen need the government to help with standards and fungibility.

3. Lastly, the podcast didn’t cover a very useful re-packaging that Fannie and government provided, which has helped the (North) American uniqueness and our labor mobility: the fixed-rate prepayment-penalty-free 30-year mortgage. Prior to Fannie, Kling mentioned on an earlier podcast that most mortgages were short-term balloons. Note that in Europe most have prepayment penalties. So if a French family wanted to move from Paris to Lyons because of a better job there, they would have to pay a penalty to escape their mortgage on their home in Paris. This is a negative for house sale prices, but more importantly, reduces labor mobility as it makes it significantly more difficult to justify moving to accept a higher-paying job. The GSEs gave us a policy reason for more consumer-friendly mortgages, while computer technology (Russ’ eyes perk up here) provided the number-crunching to estimate the value of the refinance option. While we don’t have a time machine to run counterfactuals, I am skeptical that a private market would have chosen to forgo prepayment penalties, or switch to fixed-rates, on its own.

Lastly, commenter Richard Sprague made a great point on the concern that informed middlemen are cheating punters in commodities while grandmothers setting up their grandsons aren’t cheating. Does that mean that all pork belly traders should be vegetarian, so they have no desire to profit? Isn’t there some value in “putting your money where your mouth is”? We insist on a stock analyst disclosing her position in XYZ stock. If she has none, but is recommending it, why do we not conclude that it must not be a strong recommendation? So I can see both sides.

Habib Kadiri
Nov 2 2008 at 3:42am

Thought I’d congratulate you guys on the recent podcast about Middlemen. Succinctly explained the pros and cons and was really engaging on the ear. Loved all your analogies, especially the POW Camp one and the Bastiat reference. Will be picking up my old economic books again! Keep up the good work.

Nov 2 2008 at 7:10am

1. If it is now feasible to “cut out the middleman”, why not do it? Surely that would be considered an efficiency gain.

2. Economics is supposedly a positive science, meaning that we look at the world and try to explain what happens. We do NOT take a theory and say “this is how it should be” – Economics is not a normative science.

Starting from that basis, the real question, the interesting question you should have aimed at answering is WHY people feel that way about the priest and other middlemen. That would be a POSITIVE argument.

Instead, you try to tell us that people have trouble grasping economic theory, BECAUSE they feel this way. This is a NORMATIVE argument.

3. Personally, I don’t see a trader as being a middlemen in the sense that middlemen just skim off the top. It is quite easy to see how traders (of goods) provide value, especially for anyone with rather basic knowledge of Economics.

I am only half way through the podcast, so it may well come up later – but how about talking about proper middlemen, those who do not add value (when we consider moving goods to people who value it more as adding value, which we should)? Say, hedgefund managers, perhaps?

And your slants against government interventions are getting a bit old. Maybe Econtalk could graduate to discuss more relevant topics that require more than the most basic economic “theories”?


Nov 2 2008 at 2:43pm

Russ and Mike, Thank you as always.

As for the anti-government slant. This is the libertarian perspective. I am quite sure that both Mike and Russ would be honored to be called liberal in economic terms. I don’t expect they will change any time soon.

I would emphasize Coase’s theory of the firm that was a subject of a previous podcast where Russ and Mike explored the conditions when cooperative action was more efficient than individual market action. I would suggest to Russ and Mike that Coase in his writings refers to the government as a super firm that has an appropriate place in the market, and it is indeed the real incentives of the world that yeild the governments that we do have.

On a slight aside a friend of mine complained of the corruption of a Mexican speed trap. I thought I would take a shot of evaluating the efficiency of the the “Corrupt” vs the US speed limit enforcement and the role of the middlemen.

First the facts my freind was traveling at just over 90 mph when he was pulled over by a Federally. My friend was accustom to coming to arrangements with local police but Federallies had a different reputation. The Fed told him that the fine for speeding was $262 US. That he would need to pay the fine tomorrow at local destination and that his car would need to be impounded. My freind noted that he thought the likelihood of returned car after impoundment would be very low.

Since my friend was on his way back to Texas, and would cost him dear to stay the night, risk the failure of the return of his vehicle, he negotiated. He was first berated with a long speech regarding his disrespect of the law, and then they got down to business.

My friend made the offer: Can I pay you and you could take the money to the location where I needed to pay. The Fed was interested. However, my freind only had $60 among his cohort in the car. The Federally protested with another tirade and then agreed to the deal.

Now for the US system. Let us assume the same speeding facts. You get pulled over. The officer comes and talks to you and anyone who does not begin negotiating at this point is missing an arbatrage opportunity. Only in the US system you are better off sticking to lame stories of explanation.

Chances are you are going to get the “your a bad person speech” from the officer. If your story telling did not win the day you will get a ticket with a ridiculous amount like to be in the range of $262 for speeding, which of course is negotiable with a lawyer or your agreement to take a defensive driving course, and the payment of a process fee of $60.

What is amzaing about the story is that the window sticker price of the ticket is about the same. The negotiate price is actually lower in Mexico than in the US and I would suspect the relative living wage of the Federally with negotiation stipend is likely equal to the US police without any stipend. The market forces of setting the price to high for tickets in either country result in economic forces driving the price back down by the fact that if the Federally charges to high a price he will be reported or draw attention to not setting his price to marginal costs.

Nov 3 2008 at 9:03pm

Great podcast. Munger is a great guest. He’s really good at explaining economic theory.

Nov 7 2008 at 6:28am

Dear Russ

Thanks for providing Econtalk. It is one of my favourite podcasts.

Assuming that the priest did not provide a service, such as cutting the hair of the other POWs, he could still have made a profit by selling indulgences, in his role as a middleman with God. The church has a history of acquiring assets in mysterious ways.

Nov 8 2008 at 10:40pm

Some of the comments on the POW camp marketplace seem to be oversimplified. If the tin of beef was truly of NO value to the vegetarian prisoner, he would fling it out the barracks window, like a burned match. A market begins to form when he realizes that SOMEONE would probably like to eat his beef even if he does not.

Perception of value is very idiosyncratic and would be a good topic of study by behavioral economists. At one extreme would be the owner of a “garbage house,” who treasures and hoards his every possession until he is forcefully removed from among his piles of newspapers and empty food packages and broken appliances, and committed for therapy. At the other extreme might be the mendicant monk who has consciously renounced the value of all worldly objects.

Niels Rot
Nov 9 2008 at 10:05am

Very interesting podcast, as usually!

But I think you skip the problem of information assymetry to easily. This significantly influences the outcome of any (!!) market transaction. I wonder how libertarian economic thinking deals with this problem (maybe a suggestion for a podcast). It is a market phenomenon where the profit motive does not lead to an efficient outcome, since it provides incentives for the market participants to abuse the assymetry as to increase their profits. I don’t think government can solve this problem, but I also have not heard the economic solution to it yet.

Shareef Abdul-Kareem
Nov 9 2008 at 6:31pm

Greetings Russ,

I look forward to your Monday morning Podcast. Munger is great, per usual.

Middle men are essential. They find the right products and at the right prices, and they make a profit; “Buy right and sell right”. The Government will never be good at this, because there is no incentive for the civil (public) servant in performing this duty. In Barbados this was tried by various governments; the results: poor quality products and racketeering at the staff level. There is a psychological perception that once it is the government cost is not a factor.

Keep up the good works.


Russ Roberts
Nov 10 2008 at 10:36pm

Niels Rot,

Information asymmetry is a fact of life, like gravity. The fact that it exists is not a source of inefficiency unless there is an easy way to eliminate it that is somehow being stopped or missed.

Middlemen compete for profits and reduce the costs of that asymmetry. If the priest is alone and there is no competition, he profits but even his profit produces benefits in the form of trades that would not have taken place otherwise. With competition from other traders, the profits fall and the prices emerge. The middlemen unintentionally produce the information that benefits others.

J Mann
Nov 11 2008 at 3:23pm

Nice podcast. I would have been interested in some discussion of whether we can ever profitably cut out the middlemen through state action, but maybe that’s a subject for Middlemen 201.

The price boards and exchanges that formed in the POW camps are some examples. Is there ever a time we can just distribute an endowment without significant economic loss? (Say, by requiring disclosure of closing prices of all trades, which otherwise was accrued primarily to the benefit of the middlemen).

Lastly, you left out the best part of the POW article — the story of the bully mark — presumably because it doesn’t have much to do with middlemen.

Basically, the prisoners decided to open up a restaurant/bank, which issued currency — “the Bully Mark.” The BMk was 100% backed by food in the restaurant’s stores at set ratios – X marks for a cigarette, Y marks for a prune, etc.

Ultimately, as the prices set by the restaurant diverged from shifting demand, the restaurant was rendered unviable by people selling food they didn’t want[*] and buying food they did,[*] until the restaurant was depleted of all desirable food.[*]

[*] (at the set price schudule, of course)

I can’t tell if the author is being ironic when he writes:

But the BMk. was sound! The Restaurant closed in the New Year with a progressive food shortage and the long evenings without lights due to intensified Allied air raids, and the BMk.s could only be spent in the Coffee Bar – relict of the Restaurant – or on the few unpopular foods in the Shop, the owners of which were prepared to accept them. In the end all holders of BMk.s were paid in full, in cups of coffee or in prunes.

J Mann
Nov 11 2008 at 3:32pm


Looking back over the comments, I guess I have a question similar to Niels Rots’. One simple information asymmetry is recent closing prices.

Homes in my county have their last several closing sales publicly available on the county’s website, but car sales do not. Given that the car lots are already reporting their sales price to the taxing authorities, presumably the state could publish car sales prices fairly efficiently.[*] Is there any way to analyze whether it’s better to let the real estate brokers and car sales people to profit from that endowment or just to distribute it?

[*] As it is, there are websites where recent buyers publish their prices out of either altruism for fellow buyers or spite against car dealers, but that’s a better story for the Shirky interview.

Gu Si Fang
Nov 13 2008 at 2:43am

Thanks for this great pedagogical podcast! Where can I find a transcript of the Cotton Tiberius?

Nov 17 2008 at 1:40am

Nice defense of middlemen but you could have probably helped your case by taking the critiques more seriously and actually examining the evidence. My guess is that the prejudice against middlemen stems from a pre-industrial past when middlemen had less competition and could more easily take advantage of the uninformed farmhands they were dealing with (the company store and other egregious practices that once existed). Also, there are many to this day who think of such service professions as marginal (whatever the service- doctors, lawyers, programmers!) and only view industrial or labor jobs as real, despite the fact that the US is largely a service economy today. Kumar is right about Webvan, that company was merely a middleman interested in cutting out other middlemen and saving costs in the process, a laudable goal that they were not able to accomplish. I think that vision will prove to be correct one day and there are many more middlemen who will be cut out because of the internet and replaced with more efficient and capable ones, you guys pooh-pooh such talk from the 90’s too readily.

As for the doubt Russ shows about the financial sector and its need for a bailout, I’ve written him about this before but I’ll post it here too: the problem is Fractional-Reserve Banking. There have been numerous bank panics over the centuries because of this inherently unstable system, leading to the government instituting a financial fire department called the Federal Reserve. Any time there is any thing that even resembles a fire, this fire department goes into alarm mode and starts doing weird things like the current Fed auctions and loans to try and prevent the rickety FRB system from collapsing. This is why this sector of the economy is treated so differently when it falters. I think they’re right to worry about a collapse because FRB is so unstable but the real solution is to move to full-reserve banking, not to continue propping up the current wreck of a financial system.

Mike Munger
Nov 22 2008 at 4:41pm

I have looked an looked for the Tiberius ms. in translation, but haven’t found it.

Here is the reference I have:

MS. Tib. A 3, or Manuscript Cotton Tiberius A, part 3 is a reference to a fragment of an 11th century psalter, probably produced at Christchurch, Canterbury.

PARTIAL translation at several points in Turner, Sharon. 1836 (Sixth Edition). The History of the Anglo-Saxons. London, England: Longman, Rees, Orme, Brown, Green, and Longman.

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Podcast Episode Highlights
0:36Intro. Middlepeople. Don't have good historical reputation, seen as making money and providing nothing. Someone who buys cheap, sells dear, without improving the product. Eliminate the middleman is the watchword of fair trade coffee, social movements. Middlemen transport and repackage. We live in a society where it's hard to imagine not having middlemen. Financial problems in NY, Tokyo, everywhere. Those people buy and sell shares but don't take possession: brokers are middlemen. [Taping Oct. 20, 2008] Googled derivation of name, monger--smuggler. Earlier version of word: mancgere. In old Anglo-Saxon texts, kind of caste system in Europe and England; mancgere was a type like a miller or mercer or cooper. Found text written around 1050, Cotton Tiberius: "I say I am useful to the king and to eldermen...." Shipping, at risk; skins, silk, etc. Sell at profit to feed family. Defense and indictment of the mancgere. Origin: around 800; manc can mean missing, slander, missing ethics? Etymological question: costermonger, someone who runs a stall, informal trader.
8:27Economics: Someone who represented himself by trading stocks could say he took risks and provided liquidity. Famous 1945 article by R. A. Radford, "Economic Organization of a POW Camp." Prisoner of war camp, food and some necessities are provided by the "detaining power." Main thing that provided them with stuff was Red Cross packets. Everybody has the same endowments, but people had different tastes. Some people don't smoke, some don't eat beef. Talks about how institutions of trade emerge without any top-down supervision and with resentment of people participating in the trade: we each think that the exchanges we make are voluntary but have a sense that someone is exploiting me. Itinerant Padre, went around and made voluntary exchanges but after a day ended up with two packets plus a little more. Left every person better off; but he ended up with more than he started. Is it that he didn't make people better off? Carrots for treacle, molasses candy. Unseen but valuable. Trade is not a zero-sum game. Insight: by definition the amount of stuff in the camp is fixed. All trading does is rearrange it. By definition, the quantity of material is zero-sum. If anything it gets smaller by a tiny bit by friction. On the surface, trading is a waste of time, moving stuff around. Yet every person traded in hopes of improving their lot. Priest--not dishonest. No fraud--didn't empty one of the tins. Could have extorted, but didn't. Yet everyone got better off. Munger podcast, price gouging, ice brought to Raleigh after hurricane. Test: If you've taken economics or listened for a while: How could it be? 30 minutes and one side of a page, small writing.
17:17Passage in Bastiat, "What Is Seen and What Is Not Seen," section 6, "The Intermediaries," could be translated as "The Middlemen." Hungry people in England, not enough wheat; lots in the United States and lots in the Ukraine, 1800s. Bastiat suggests (written in French)"When the stomach that is hungry is in Paris and the wheat that can satisfy it is in Odessa, the suffering will not cease...." Can't each go get it ourselves. If we leave it to the people who trade how do we know we won't be ripped off. They are doing it for profit. We could have the State do it, getting rid of the middleman, and do it cheaper. Sarcasm; seems like a syllogism. State will not be motivated by profit. What's wrong with that argument? Russ and Bill McKibben debate at U. Vermont on Oct. 28 on the topic of Buy Local. Another solution then is England should grow more wheat. Stark example of problems people see with commercialism: the intermediary's taking of a slice above and beyond the cost could be eliminated by a more benevolent provider of the service--the State or a charity. Two incentives that middlemen have: profit is the trivial one, will be driven to zero by competition. The main thing middlemen do is find ways to reduce cost. Out of greed and self-interest they work on finding ways to transport corn (wheat) as cheaply as possible. The State does not have an incentive to try to reduce cost. Hayekian. Middleman knows what people want, varieties wanted, etc. Almost nothing to do with profit. Motivated by profit, but main effect is to improve variety and quality and cost is driven down. Huge benefit. Unclear why we miss that benefit. Bastiat: the thing that's not seen. If you want to ask the state to do this, they can't do as good a job.
25:11So, what we need to do then is just let the middlemen work for a while. When they discover the best way to do it, we shut them down. What's the fallacy? Cost dynamic. Need to keep costs down at every step. Wagon, hotel, credit card: stop for the night if you work for the State; work later and sleep under the wagon if you work for yourself. Smith: Man of system. Correct in a static world, but it's not just a techical problem. Cost structure is dynamic. Ways to continually improve the cost dynamic. Also, relative prices change. Oats cheap now, but when gasoline gets cheaper you use a car. Not just difficult, but impossible. Why is this missed? Bastiat answer: seen and unseen. Possible reason why it's hard to see: we look at the world around us at a point in time and see a set of stills; movie version is more informative of reality. Best way is not a technical problem but had to emerge from trial and error, mistakes, success. Process is not just finding the square root of 64 or quadratic equation. Hard to aggregate all the separate pieces without a market. Middlemen don't just take a small profit; in a world without competition they might take a big profit; and they have an incentive to limit competition. Form guilds. No way of telling whether one is better than the other. Government can be soft and permeable. Could harm consumers. We've come a long way. Sounds like the public good. Protectionism, union work rules to prevent new labor from coming in. One way to produce profits is to lower costs and provide services more cheaply. Other way is to try to prevent other people from competing with you. Car manufacturer: just takes raw materials and rearranges them. Could sell cars purchased from all different companies.
33:03What is the role of the middleman now? In current financial crisis is not that they trying to protect themselves not from competition but from risk. Fannie Mae and Freddie Mac were supposed to "rationalize" the credit market by buying up bundles of securities with offsetting amounts of risk. Smooth transition of population into home ownership. One of the things middlemen do: sometimes ship hits the rocks, risk justifies some profits. Financial markets like a middleman: re-trade these assets, buy cheap and sell dear. Go to Las Vegas, put money on black 32 on roulette wheel. Want to be more careful. Do it in a way where you are likely to make money. Government agency says: if you win you get to keep it; if you lose, we'll buy the ticket at face value, and maybe we'll buy a whole bunch of them. Politicians who created that unhealthy set of incentives were aware at the time that it was unhealthy. From 1968-early 1990s, Fannie and Freddie played by the rules and helped make the mortgage market pretty friendly. Always takes two regulations. Taking the risk out has pernicious effects; have to have second regulation saying you can't do what you want to do based on the first one. Politicians also have their own incentives. We like to think they have our best interests at heart: regulator will just take care of the general interest. Regulator is a pawn of the politician who is striving to get re-elected. Over time we chipped away at the second regulation. Two sets of regulations away from pure markets. True for Fannie and Freddie, put into conservatorship--not a market failure, it was government-created inherently unstable thing that fell apart. Why did it ripple through the rest of the financial structure? Sense that they could change the product and create more value in a way something like the POW camp. Certain amount of stuff, but by rearranging it, total utility, value, was raised. Derivatives analogous to the Red Cross parcel, taking the different parts, breaking into different components: safe part; risky but high return part. Make a market that didn't exist before--that's what middlemen do. That's why they're called derivatives: asset prices derive from the components. Sold them didn't actually understand the pricing system very well. Right to risk: Black-Scholes model, risk better to make money. Red Cross parcel was actually separable.
42:00POW camp. When I get my parcel in the camp and you get yours, we understand we can be better off by breaking them up and trading pieces. Is there any risk? People made mistakes, lost value, didn't understand the real value of things. Radford article: discomfort people had with the prices. Cigarettes became the currency. Also barter, trading jam for meat. Hard to know what's out there, what's available, what a good price is. What middleman is doing is saving that time and making the system work more effectively through arbitrage. What is meant by "the price"? Blundered if there was another guy next door selling it more cheaply. Still better off than before. Maybe scared or really hungry: made mistake in the sense that there was a better trade available. Bulletin board with "the" price. Wall Street board. As Radford points out: when there would be a sudden increase or decrease in the supply of one item, the price would change. The fair or usual price of beef would change if packets contained less beef. People would buy up a bunch of tins of beef; stored; accused of hoarding. Exchanging with themselves at a different point in time. Service, hoarding against a future scarcity. Makes people uneasy. People had in their mind because after a while a certain price emerged, but then it changed, people get angry. Aquinas, Aristotle, exchange problem, commensurability. Wall Street: folks unbundling these packages and creating derivatives, collateralized debt instruments. Nobody knew the right price. In the prison camp, early on nobody knew what the right price was. Gradually prices became clearer. We never got out of the first stage with derivatives. Ask someone in the business why they would buy these things they didn't understand, answer was the alternative was to be a shoe salesman. That was the game, where the action was. Prices were going up for a while. Another person said he'd never bought them because he couldn't figure out what they were worth. Problem if some did. Suppose price erratic, unpredictable--what difference does it make? No different from jam in the camp. With derivatives, early undeveloped market, buy it only for the sake of speculation. If price going up, doesn't matter what price you buy it at, still make money. Extremely long positions--portfolios had too much of these assets than prudence would have dictated. Hope that in the aggregate problems cancel out. If housing prices start going down, though, problem. If A owes money to B who owes money to C, then C can have a perfectly sound portfolio except if B goes bankrupt. Then fall like dominoes. Like guy who says blacks come up 17 times in a row, so there's a pattern and 18th time black is more likely. In housing markets, though, there could be a pattern, trend. Trend is ex ante. Appeared to be one in housing. People who bought and sold these securities to other banks that may not have recognized that they were toxic. With 10,000 mortgages you can't go to every house. But why did they pay for them in the first place? At the same time they were being rated as AAA. Rating agencies used very conservative default rates, default rates of the Great Depression. Systemic issue: who owes who money, Arnold Kling--thought I was insured and I was, but I didn't realize my insurance company would be bankrupt.
56:02In 2000, Internet was a hot commodity. People figured they'd get out before the bubble burst. Others said it was a sucker's game and it will pop, not all can be profitable. Others said, I'm going to pick the right one: pick Amazon. Different strategies. Then it popped; or hard to anticipate which firms were going to be profitable and some were totally wiped out. Whole range of personal reactions. Some people made a lot of money and got out before prices fell. Some made and lost it. Others jumped in at the end and lost money. But it didn't destroy anything. Bunch of people trading paper on the stock market, created some wonderful companies; some companies gone. Why didn't that happen here--the firms that bought these pieces of paper just go out of business, end of story? Here we have totally destroyed the financial system in response. Maybe this is a very rare case. And interconnectedness. Kling's argument. crash, Louis Borders of Borders' book store, started WebVan. Groceries, eliminating the middle man. Bought huge amounts of warehouses and trucks. Had a revenue source. Bankrupt within 3-4 years, never came close to profitability. Difficult to eliminate middleman in retailing service. Netgrocer, canned goods, niche. Were in competition with the middleman structure. Turns out that you can't do better; but you can't find out without trying. When do we observe middlemen? Only but always when they are providing a valuable social service, even though it seems as though they are not providing a service. Role in creating disasters like we've seen on Wall Street. More to learn about the Wall Street story. Possible we will never understand it, just as we do not understand everything about the Great Depression.
1:04:03Sidenote: Complexity. Great Depression was a collapse of the economic system. Remarkable how difficult it is to know why it collapsed and why it recovered. Many stories to tell and difficult to test those stories against each other. Biases, ideology, theory. Did Roosevelt end the Depression or prolong it? Ex post narratives all over the case, but extremely difficult to find truth or test in a scientific way. Interesting cultural phenomenon, sobering moment for economics. Our stories are very incomplete. Macroeconomics flimsy. Argument has surfaced to take back the Nobel Prize given for the Black-Scholes model. Nassim Taleb, idea of Nobel Prize in economic science is bankrupt. Role of the middle man is really complicated. May tell us about things not to do.
1:07:22Thought experiment: POW camp, priest wandering around, Itinerant Padre, making deals, voluntary trade, but he ended up with more than his share. What is really going on, pull back the veil, see the unseen. Imagine what would happen if people were forced to exchange only with the person next to them, or only once. Sharp dealing, sharp practices. What we do when we allow people to search for profit, prices emerge and also converge. When prices converge, whole group gains information about prices and value. Each of us could go and get our own stuff from Crimea. Infrastructure of information. Key: nobody in POW camp is working, classic classroom experiment but real with endowment. If same parcels week after week, everyone would know the prices, maybe middleman would die out. Dynamism is really the key, world is not a static place. Munger crest: crow standing on three onions.

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