Gaurav non-Sabnis thinks that  the use of the man-from-the-past technique in my Pragati editorial “The Case for Freedom” was hackneyed.  He is free to think so. He also thinks that my introduction was inaccurate. He is free to think so too as long as he doesn’t mind being mistaken.

Gaurav makes two errors – a misinterpretation and a factual error. The misinterpretation is this: He says that “mismatch between supply and demand must be as old as beginning of trade”. Well, duh. Obviously, a famine is a severe mismatch between the demand for food and the supply of food. If I had said that there is now a greater mismatch than before, it would have been an extremely stupid statement.

What I had written is that that the system that coordinates demand and supply has broken down.  The “system”  here of course refers to the market,  but at this point, I don’t want to get into whether it was free or regulated markets that broke down. I also want to emphasise that this is not to admit any sort of failure of the free market. I am simply making a factual assertion – the system that calculates demand and supply and tries to match the two has broken down. This is like claiming that a car has broken down. Did it break down because of a design flaw or bad roads or some combination thereof? We do not know yet, but the factual assertion simply is that it has in fact broken down.

Then Gaurav says that he doubts if the man from the past would have been shocked by the sight of goods lying unsold and queues of unemployed people. In this, he is simply wrong. Unemployment and unsold goods are problems of plenty. Even now in India, poorer you are the less likely it is that you are unemployed. Why? Because the poor simply cannot afford to remain unemployed. Our man from the past would have been used to shortages of food and people starving and dying on the streets. He would have been used to people being dragged away to slavery and overworked.  He would simply not have been used to unemployment and excess inventory. Most importantly, he would not have been used to the sight of people sitting unemployed and the factory that used to employ them sitting idle simultaneously.  I am somewhat disappointed that Gaurav did not understand the significance of this point, because it is important. 

Is the phenomenon of markets breaking down a new one? No and Yes.  No, it is not a new one. I am sure that even in the 10th century, there must have been at least one trader who overestimated the demand for his product one day and underestimated it the next day, leading to ripple effects that caused severe perturbations in his village economy. But when compared to famines, wars and oppressive governments, the problems caused by those misestimations would have been negligible. It is like saying that there is now an “epidemic” of heart disease and diabetes. Did those diseases not exist 50 years back? Yes they did, but in those days, a lot more people used to die of infectious diseases, so lifestyle diseases were a lower priority.

But here is the thing.  Markets used to break down even then, but the complexity, scale and lead times in the markets are of a different order of magnitude now. In the 10th century, how many links where there in the chain between the raw material that was mined, grown or dug out of the soil and the consumer? How many links are there now? Let’s say that you are a software developer. You are developing software for a company who will be using it to develop its products. These products will be used by another company that finally sells its own products to the consumer. Can you, as a software developer even visualize, let alone accurately predict,  how your fortunes will be affected by the changing preferences of this consumer?   Yes, globalization existed even then, but in the 10th century, how many people existed whose day-to-day fortunes depended on shipping products reliably half-way across the globe? And lead times – yes, financial markets existed even then, but could anyone imagine 30-year mortgages at that time?

If we explained the crazy system that we have to the man from the past, his question would not have been why it broke down, but how it worked in the first place at all.  My intent with the article was to make readers think about what it makes the system work. It is easy to forget, or not know at all the complexity involved in this. A case in point is that Gaurav blithely assumes that the man from the past would know of fiat currency.  Would he? If fiat currency were explained to him, he would have been utterly incredulous. How can anyone trust a mortal king’s fiat and treat paper as money? Yes, Akbar happens to be the emperor of most of Hindustan now, but will Salim respect his father’s currency when he ascends to the gaddi, or will he issue a new fiat? What if the local nawab rebels and refuses to accept the currency?

Yes, markets are amazingly resilient. But not all markets are created equal. In particular, financial markets are extremely vulnerable, because it involves trading across time. In a commodity trade, you sell one item and get another (even if it is gold) right then. In a financial trade, you lend out money and expect it to come back in the future. Would you do that unless you knew what the value of the money would be in the future, and unless you had the assurance that in case of default, there would be a system to enforce the agreement?

I also wanted to convey why the system we have now is essential to keep out the disasters that the man from the past has experienced. In developed, and even developing countries, famines are unheard of. Droughts do occur, but they do not lead to widespread starvation. During our man’s time, a crop failure at one place would lead to starvation and large scale deaths. In our time, such localized failures do not occur. We can always import food from elsewhere, because we now have the vehicles, roads and the storage facilities to be able to do so. But to get those vehicles laden with grain moving, there is a need for the invisible infrastructure of the market. It is easy to not see how the infrastructure of banks, letters of credit, crop insurance, and futures contracts are required to keep those visible vehicles moving. And it is precisely for this reason that it is easy to destroy the market in order to regulate it.