A "middleman" buys cheap, sells dear, and does nothing to improve the product in the meantime. Middlemen are everywhere and probably have been since the very first exchanges started to improve the lives of primitive humans. Marco Polo and his family were middlemen. So is Ebay. Between them, in time and complexity, lie millions of highly specialized, highly profitable actions and transactions. But are middlemen good for market systems? Or are they just parasites?

My Own Good Name

It's all there, in my name. "Munger" comes from "monger," a dealer or trader, often in illicit or smuggled goods. The name has very old roots: in the Saxon writings of the 11th century, we find it as "mancgere." According to the Etymology Dictionary, the Latin noun was "mangonis," a trader or merchant (often, sadly, in slaves). And mangonis, in turn, has its roots in a Greek word manganon, a war machine or contrivance for deceiving an enemy. The Trojan Horse was a manganon. Given that origin, it is not surprising that traders were seen as deceivers, thieves, and parasites. So, there is little to place on the positive side of etymological ledger, at least until 1000 A.D. or so.

By that time, the river of meaning had forked: There were war machines (such as the medieval "mangonel," or catapult), and traders in the market (the mancgere). Sharon Turner's remarkable three-volume History of the Anglo-Saxons (1836), quoting an old source from the 11th century, states:

In the Saxon dialogues, the merchant (mancgere) is introduced: "I say that I am useful to the king, and to ealdormen, and to the rich, and to all people. I ascend my ship with my merchandise, and sail over the sea-like places, and sell my things, and buy dear things which are not produced in this land, and I bring them to you here with great danger over the sea; and sometimes I suffer shipwreck, with the loss of all my things, scarcely escaping myself."

"What things do you bring to us?"

"Skins, silks, costly gems, and gold; various garments, pigment, wine, oil, ivory, and orichalcus*, copper, and tin, silver, glass, and suchlike."

"Will you sell your things here as you brought them here?"

"I will not, because what would my labour benefit me? I will sell them dearer here than I bought them there, that I may get some profit, to feed me, my wife, and children."

(pp. 115-6; original in MS. Tib. A 3; * brass)

Quite a drama: risk, greed, profit. But the "mancgere" of 1050 AD was no parasite, at least not in his own eyes. In fact, he claims he is "useful." Can that be right? The mancgere 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 he can get for it. We'd be better off without him, wouldn't we? Isn't the trader simply preying on people's needs for goods and providing nothing of real value himself?

No. Not even close. Without middlemen, we couldn't have modern markets. And the story about why that's true is one of the most important, and most misunderstood, in all of economics. I am going to consider two classic accounts of middlemen, from R.A. Radford and F. Bastiat, to illustrate how markets work through middlemen.

Middlemen in Action I: WWII Prison Camp

From R.A. Radford's "The Economic Organisation of a P.O.W. Camp"

One trader in food and cigarettes, operating in a period of dearth, enjoyed a high reputation. His capital, carefully saved, was originally about 50 cigarettes, with which he bought rations on issue days and held them until the price rose just before the next issue. He also picked up a little by arbitrage; several times a day he visited every Exchange or Mart notice board and took advantage of every discrepancy between prices of goods offered and wanted. His knowledge of prices, markets and names of those who had received cigarette parcels was phenomenal. By these means he kept himself smoking steadily—his profits—while his capital remained intact.

Sugar was issued on Saturday. About Tuesday two of us used to visit Sam and make a deal; as old customers he would advance as much of the price as he could spare us, and entered the transaction in a book. On Saturday morning he left cocoa tins on our beds for the ration, and picked them up on Saturday afternoon. We were hoping for a calendar at Christmas, but Sam failed too. He was left holding a big black treacle issue when the price fell, and in this weakened state was unable to withstand an unexpected arrival of parcels and the consequent price fluctuations. He paid in full, but from his capital. The next Tuesday, when I paid my usual visit he was out of business.

Credit entered into many, perhaps into most, transactions, in one form or another. Sam paid in advance as a rule for his purchases of future deliveries of sugar, but many buyers asked for credit, whether the commodity was sold spot or future. Naturally prices varied according to the terms of sale. A treacle ration might be advertised for four cigarettes now or five next week. And in the future market "bread now" was a vastly different thing from "bread Thursday." Bread was issued on Thursday and Monday, four and three days' rations respectively, and by Wednesday and Sunday night it had risen at least one cigarette per ration, from seven to eight, by supper time. One man always saved a ration to sell then at the peak price: his offer of "bread now" stood out on the board among a number of "bread Monday's" fetching one or two less, or not selling at all—and he always smoked on Sunday night.

During World War II, British economist R.A. Radford was captured and placed in a German P.O.W. camp. Radford noticed the universality of exchange in the various camps in which he was imprisoned. Being an economist, he knew that exchange, in the presence of full information and in the absence of coercion or fraud, always makes both parties to the exchange better off. The interesting thing about the prison camp setting is that each prisoner had precisely the same endowment or total wealth. Each prisoner received (a) daily rations from what Radford delicately calls "the detaining power;" and (b) sporadically, the contents of a Red Cross packet: tinned milk, jam, butter, biscuits, tinned beef, tinned carrots, chocolate, sugar, treacle (molasses), and cigarettes.

What I mean by "makes both parties better off" is this: If I like two carrots more than, say, one milk, and you like one milk more than two carrots, we can trade. This is actually quite important: There is no increase in the total amount of food in the area, but the total welfare of the group is improved. It seems like magic, because it has such a big impact, but we never give it a second thought. Whenever you have different preferences, but similar endowments of resources, then voluntary exchange can make everyone better off. In this case, because the main source of trade goods was the Red Cross packages, endowments were identical. So, barter and exchange made everybody happier.

And people don't have to be told this. They recognize it quickly. As Radford puts it, "Very soon after capture people realized that it was both undesirable and unnecessary, in view of the limited size and the equality of supplies, to give away or to accept gifts.... 'Goodwill' developed into trading as a more equitable means of maximizing individual satisfaction." There's the first point I want to make: Trade is more equitable than relying on gifts or charity because voluntary trades always leave both parties better off.

So, let's accept that trade and exchange are good. But what about middlemen? Aren't they a problem? The prisoners in the camp thought so. Radford mentions a (possibly apocryphal) story of a priest with a sharp eye for exchanges. "Stories circulated of a padre who started off round 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."

There is the second, more important point, a truly fundamental paradox: middlemen profit by making other people better off. The padre never made a fraudulent claim or misrepresented what he was offering to trade. The commodities were standardized and interchangeable (one tin of cheese is just like any other; cigarettes are machine-made, and indistinguishable; a tin of jam is always the same). At each and every step, in every transaction, the exchange with the padre made the other party better off. And yet, the padre accumulated "profit" of a full Red Cross parcel, a small fortune in the setting of the camp.

For a definition of arbitrage, see Program Trading, by Dean Furbush, in the 1st edition of the Concise Encyclopedia of Economics.

It might seem that the wandering padre only took value, buying cheap, selling dear, and changing or improving none of the products he exchanged. But just like the Saxon "mancgere" in 1050, the padre created value at every step in the process. He did this by finding A, who would pay six (or fewer) cigarettes for a tin of beef, and then finding another man B, who would sell a tin of beef for three (or more) cigarettes. Of course, if these two traders had happened to meet each other, they would have exchanged directly. But finding just the right person to trade with is time-consuming and may take a little luck. The mancgere/padre, by searching across trades, arbitraged the difference: He could sell the beef to A for five cigarettes after buying it from B for four cigarettes. Thus, both A and B are better off by at least one cigarette and the padre "profits" one cigarette by finding the exchange opportunity.

Although I don't want to overstate the importance of one example, the positive role of the middleman is universal. And the parable of the itinerant padre is the starkest form of the argument that I have ever found. Remember, the question is this: If every exchange makes both parties better, how can the padre have produced any profit? Shouldn't profit always be a sign of exploitation, especially in a setting in which nothing new is produced, as here?

Middlemen in Action II: Bastiat and the Stomach that is Hungry

To resolve the paradox, let us turn to the other example, from the work of Frédéric Bastiat, first published in 1850. The entire essay, "What Is Seen and What Is Not Seen," is full of insight, but I want to focus on just Section 6, "The Middlemen."

From Bastiat, "What is Seen and What is Not Seen," Section 6: The Middlemen:

While the exaggerated development of public services, with the waste of energies that it entails, tends to create a disastrous parasitism in society, it is rather strange that many modern schools of economic thought, attributing this characteristic to voluntary, private services, seek to transform the functions performed by the various occupations.

These schools of thought are vehement in their attack on those they call middlemen. They would willingly eliminate the capitalist, the banker, the speculator, the entrepreneur, the businessman, and the merchant, accusing them of interposing themselves between producer and consumer in order to fleece them both, without giving them anything of value. Or rather, the reformers would like to transfer to the state the work of the middlemen, for this work cannot be eliminated. [Regarding the famine of 1847,] "Why," they said, "leave to merchants the task of getting foodstuffs from the United States and the Crimea? Why cannot the state, the departments, and the municipalities organize a provisioning service and set up warehouses for stockpiling? They would sell at net cost, and the people, the poor people, would be relieved of the tribute that they pay to free, i.e., selfish, individualistic, anarchical trade."

... When the stomach that is hungry is in Paris and the wheat that can satisfy it is in Odessa, the suffering will not cease until the wheat reaches the stomach. There are three ways to accomplish this: the hungry men can go themselves to find the wheat; they can put their trust in those who engage in this kind of business; or they can levy an assessment on themselves and charge public officials with the task.

While this quote is rather lengthy, the gist of Bastiat's argument is easy to state: There are three ways of getting food from farm to market. First, every consumer goes off on his own, with a cart. This is inefficient and too slow to answer the needs of the hungry (as David R. Henderson illustrates in his discussion of price controls in the aftermath of World War II, German Economic Miracle). Second, middlemen can buy, transport, and resell the products. Third, the state can buy, transport, and resell the products, or give the products away for free.

Bastiat notes that many claim that the state can always perform the function of middlemen more efficiently because the officers of the state are motivated by public service, not by profit. But this is disastrously wrong. First, agents of the state are not, in fact, motivated by the public interest. They are no better than anyone else and act to benefit themselves. Second, without the signals of price and profit provided by middlemen, no one knows what products should be shipped where, or when. In short, without middlemen, the state would act more slowly, less accurately, and at the wrong times.

Once again, the point seems paradoxical. It is because of profit that middlemen create value. And the seeking of profit by middlemen, buying cheap and selling dear, ensures that, as Bastiat put it, the "wheat will reach the stomach" faster, more cheaply, and more reliably than any service the state could possibly create. The system of middlemen performs what seems like, to Bastiat and to me, a miracle: "Directed by the comparison of prices, it distributes food over the whole surface of the country, beginning always at the highest price, that is, where the demand is the greatest. It is impossible to imagine an organization more completely calculated to meet the needs of those who are in want..."

Final Thoughts

The merchant, the middleman, the mancgere. Many people tend to think of him as a necessary evil, raising prices and exploiting nearly everyone. But this is quite wrong, and is wrong in a way so fundamental that it makes one wonder why most people seem to have no conception of how real economics works.

The fact is that middlemen are the means by which markets become "perfect" or, at least, approach perfection, where perfection means a single price and reliable quality. Arbitrage is the discipline that reduces differences in price, providing accurate signals on relative scarcity and engendering enormous flows of resources and labor towards their highest-valued use.

In fact, now that I think of it, I'm proud to be a Mancgere!

References

Bastiat, Frédéric. 1850, Paris: France. "What Is Seen and What Is Not Seen." Available online at Selected Essays on Political Economy, Library of Economics and Liberty.

Dictionary.com, "monger," in Online Etymology Dictionary. Douglas Harper, 2001. Accessed: January 19, 2009.

Henderson, David. "German Economic Miracle."Concise Encyclopedia of Economics, Library of Economics and Liberty, Liberty Fund, Inc.

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. Radford, R.A. 1945. "The Economic Organisation of a P.O.W. Camp." Economica. V. 12.

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

* Michael Munger is Chair of Political Science at Duke University.