Studying markets’ natural evolution

By Andrew Sheng, special to The China Post

Man is a social animal. The 19th century sociologist and philosopher Georg Simmel argued that trade and exchange is “one of the purest and most primitive forms of human socialization.” Last month, while traveling through remote parts of West Timor, in Indonesia, I was able to study first-hand how rural markets operate. I could not help wondering why so-called primitive markets such as these work so well when complex financial markets can be so dysfunctional?

Rural markets in East Timor are wonders of trade. Men and women in tribal costume converge on different villages on different days of the week. Everyone knows when to go to which village for these markets, which typically start at dawn — when produce is fresh — and often finish by 11 a.m. Economists would surely call this scene of bustling rural commerce a “concentration of liquidity.”

As the late Stanford economist John McMillan argued, the market is a human construction — a tool. The market has features to make it work smoothly: mechanisms to organize buying and selling; channels for information flow; laws that define property rights, and self-regulating rules that govern behavior.

Most rural markets are much more complex than they appear. They sell everything needed for daily life and have their own hierarchies. The stalls of wealthier, established traders are sheltered and in the best locations, while poorer traders just spread their wares on the ground. Specialization is evident even in this basic setting — there are designated places to buy textiles, fresh meat or fish, vegetables or household goods. These markets also function efficiently as information exchanges. Prices differ depending on who you are and what you know. Tourists pay more because they do not know the local language or rules, while locals bargain vigorously.

In these basic markets, you can observe the entire range of business evolution, from simple production to wholesaling to final sale. Everything is designed for convenience and to reduce transaction costs. For instance, there are no roadside gas pumps. Instead, gasoline is sold in small bottles because the most common modes of transport are motorbike taxis which carry as many as three passengers — plus the occasional precarious chicken or bag of rice. The permeation of technologies like mobile phones and the Internet even into these remote rural areas has accelerated the speed at which information travels through these markets. This means even lower transaction costs between business, between consumers, and from businesses to consumers. In some instances, use of websites like eBay and Alibaba has eliminated geographical space by allowing transactions in such markets to be done online.

With technology ending the isolation of rural markets and linking them to global markets, the production and marketing game is changing beyond recognition. A similar phenomenon occurred in the airline industry. Budget airlines use the Internet to sell forward excess capacity at below-average cost, thus filling their planes to capacity and maximizing profits. This created a new market because before, many people could not afford to fly.

You see the effect of high transportation costs clearly in rural markets. Here, locally produced goods are ludicrously cheap, but imported good are very expensive.

The study of modern, sophisticated supply chains enables us to appreciate the fact that producers do not necessarily make most of their money in the product-to-consumer chain. The rule of thumb is that if a product costs US$1 to make, the distribution and transportation costs may account for US$3 of the US$4 final sale price to the consumer. Common conceptions of innovation still focus largely on creating new products, whereas services or process innovation are probably much more profitable and add more value than is generally understood.