unequal exchange, explained

(Thanks to Matthijs Krul for noting that some of the language was overtechnical. I’ve tried to clean it up a bit, but since there are no guarantees I’ve succeeded, please don’t hesitate to cite particular sections as in need of more explanation. If you’re really in the dark, start here if you like text and here if you prefer video.)
What is unequal exchange, and why do Third Worldists talk about it so much?” It’s when different countries exchange commodities which differ wildly in value. “Isn’t that just because some countries are more productive than others? And if not, how can this come about?” Sort of. Not really. And: good question.

According to the law of value, commodities exchange for their equivalents in value, or the amount of labor typically required to produce them – or at least they do so in equilibrium. After all, any time they do not, this creates arbitrage opportunities: if a teacup takes two hours to produce on average and a basketball one, and they both sell for $1, then smart capitalists will move production from teacups to basketballs until the increasingly (decreasingly) crowded basketball (teacup) market causes their value-price ratios to equate. Of course the real world is never in equilibrium, but there is always a hypothetical market equilibrium which we can describe actual prices as deviating from and tending towards, and at this teleological point in price space, price is equal to average socially necessary labor time. Right?

Not quite. Because the production process of commodities involves not just (variable capital (direct labor) and circulating capital (the physically consumed inputs or wear and tear on machinery), but also fixed capital (the amount of labor embodied in external aids which are not consumed,) we see a deviation between these general equilibrium prices – in Marxian terms, the prices of production – and values. Capitalists choosing between industries in which to invest their capital choose those with the highest rates of profit – that is, ratio between total amount invested and revenue secured. This is why the rate of profit tends (under normal conditions and a few assumptions) to decline – in real terms, the amount of labor required to reproduce the means with which it produces tends to rise. And it also means that the commodities produced by more capital-intensive industries tend to sell above their value, and the commodities produced by more labor-intensive industries to sell below it.

A Simple Example

Suppose an economy in which three commodities are produced: guns, butter, and spherical cows. Spherical cows are the means of production, while guns and butter are articles of consumption, and all else being equal consumers prefer an even mix between the two (but will each as a partial substitute for the other.) One worker laboring for one time period (an hour, let’s say) with the aid of five cows consumes one cow and produces two guns or two cows, while a worker spending one hour with the aid of ten cows can consume one cow to produce two sticks of butter. To reproduce their labor power workers consume .25 guns and .25 sticks of butter per period. Thus the value of each commodity is 1 hour, the value of labor power is 30 minutes, and the rate of exploitation is 100%.

yeah, why the hell not

Suppose, then, that we start off with what seems like a natural equilibrium: if the economy has 100 workers, 50 produce spherical cows, 25 work in armaments, and another 25 produce butter, so that net output is 50 guns and 50 sticks of butter, while total fixed capital is 750 spherical cows (with turnover of 50 cows/period.) Suppose also that prices start off equal to values, so that a gun, a stick of butter, a spherical cow, and two hours of labor each cost the same amount of money – let’s say $1. Is this actually a stable situation? No! Because profit rates are not equal.

The spherical ranching industry has $250 (250 cows) in assets, operating expenses of $75 (50 hours of labor at $25 plus 50 cows slaughtered) per period and revenues of $100 (100 cows born) per period. The firearms industry has $125 (125 cows) in assets, operating expenses of $37.50 (25 hours of labor at $12.50 plus 25 cows slaughtered,) and revenues of $50 (50 guns) per period. And the condiments industry has $250 in assets (250 cows,) operating expenses of $37.50 (25 hours of labor at $12.50 plus 25 cows slaughtered) and revenues of $50 (50 sticks of butter.) To get access to a revenue stream of $1/period costs $10 in ranching or armaments and $20 in butter. A small butter firm can double its profits by switching to cattle or weaponry.

So this is not equilibrium. Assuming investors are stupid and just algorithmically move money from low-profit firms to high-profit ones, the route to equilibrium is wacky, with the price of cows and size of the ranching industry falling and then returning to its original size (since in the end, under these technological conditions, there must always be as many ranchers as gunsmiths and butterwrights together.) Where equilibrium is precisely depends on interest rates and the substitutibility between guns and butter, but at it there are more gunsmiths than butterwrights – and a stick of butter costs more than a gun, even though they have the same value (requiring 30 minutes of ranching and 30 minutes of other labor to produce.)

In real terms, this can be understood as killing the golden goose – burning up society’s store of spherical cows in order to fund a temporary bonanza of consumer goods, but leaving everyone worse-off in the long run – a sort of First Five-Year Plan in reverse. We can understand this to be a product of (in a sense) social short-mindedness, with the caveat that any particular individual with long time horizons is still incentivized to engage in goose-slaughtering; and we can understand it as a real limit to the capitalist development of the forces of production, with the caveat that in principle a socialist economy could make the same choices. As is so often the case: individually optimal, globally suboptimal.

We see, then, how and why equilibrium prices (or “prices of production”) systematically deviate from values. The higher the organic composition of capital, or capital intensity – taking into account that different inputs will themselves experience deviations – the more positive the deviation.

In an open labor market, these deviations wouldn’t matter much for workers – . Indeed, it doesn’t matter much from the perspective of individual capitalists either. Sticks of butter in the above example sell above their value and guns below them, but shareholders earn equal profits in each, and workers in each earn equal wages – if not, there would be arbitrage opportunities. Indeed, from a neoclassical perspective nothing much interesting is going on at all.

A Trivial and Uncompelling Example of Unequal Exchange

Now consider another two countries, with different levels of technology and fixed capital. They don’t know of each other, but in each country they produce identical widgets. In Utopia a widget takes one hour to produce, while in Barbaria it takes two. Then one fine day a Utopian “discovers” Barbaria. On a lark they decide to exchange widgets – hey, why not? And in doing so, the Barbarians have lost an hour of labor for each widget exchanged – giving two, receiving one.

Shock! Horror! Exploitation! Unequal exchange! Are you as incensed by this example as I am, dear reader? Probably, because I don’t find it particularly enraging. Certainly from a utilitarian or humanitarian perspective, one might say that the Utopians, purely by virtue of the country of their birth, benefit from a higher standard of living and ought to help the poor beknighted Barbarians. But one could not hold Utopia responsible for this state of affairs in any way, or to state it a bit more forcefully – because individual human agency is a small thing and collective agency, some say, not a thing at all – one cannot draw a connection between the high Utopian standard of living and the low Barbaric one. The one simply does not depend on the other.

In fact, what we have again is a case of non-equilibrium. The situation with the Utopians and Barbarians is very much like – perhaps even exactly like – the situation in which a firm adopts a new technology. Such a firm earns superprofits – with its new, more efficient methods, the commodities it produces sell above what it takes to produce them, until the techniques spread and the value of the product falls. In time, Barbarian firms will adopt Utopian techniques. The Utopians are their benefactors, really. If this is unequal exchange, it’s hard to see why anyone cares.

Yet Another Fanciful Example Which Has Nothing To Do With Reality

Now suppose another two countries, Dystopia and Anti-Utopia, meet. When they do so, they’re identical, or nearly so, guns-butter-sphericow economies. But let’s say that Dystopia has a comparative advantage in gun production (its citizens being honed gunsmiths from living in a post-apocalyptic wasteland) while Anti-Utopia has a comparative advantage in butter (its mysterious authorities subsidize butter to make people fat and complacent, and besides, guns protect Are Freedoms and we can’t have that.) Suppose also that the villainous clique running Anti-Utopia bans immigration and emigration, the better to protect its people from new ideas. Suppose also that class struggle happens and workers organize to extract concessions from their employers at the firm or national level. What happens then, relative to a no-trade alternate universe?

Anti-Utopia is better off, certainly. Global production has increased because of the magic of comparative advantage, with each country able to specialize in the industry it’s slightly better at, and due to its embuttered specialization, it is now rich in cows and producing more revenue per hour of labor than is gunny Dystopia. And Dystopia? The absolute effects are ambiguous, because whether the gains in global production offset the change in global distribution towards Anti-Utopia depends on factors that can’t be seen from the armchair. But hey, it’s not so bad:

  1. During the reshuffling period when all those cows moved to Anti-Utopia, the Dystopians were fairly compensated for them by the Anti-Utopians.
  2. At the very least, Dystopia has less to lose from ending trade than Anti-Utopia does. If they went to the negotiating table, they’d be able to extract concessions from the Anti-Utopians. They are, after all, a sovereign nation.
  3. While this is perhaps not so much a consolation, it is good to keep in mind that comparative advantages are given by nature for all time into convenient geographic borders, or maybe just to national “cultures” or biological races, and that while the mysterious leaders of Anti-Utopia hatch many nefarious plots, securing a comparative advantage (relative to Dystopia) in capital-intensive goods is surely not one of them. So the baseline for comparison should indeed be the no-trade status quo ex ante, rather than a hypothetical world where the superior techniques in which various firms specialize is more evenly spread.

I think you can see where this is going.

Imagine a Cow-Shaped Cow

The global capitalist economy is a vast, diverse array of interlocked production processes, whose factor intensities vary tremendously. From the beginnings of the modern world economy, decisive comparative advantage in capital- and skill-intensive industries within the core or global north was brought into being by political means as well as self-reinforcing “neutral” economic processes, including:

  1. the reluctance to invest capital where it could be most readily seized, either by rebellious subjects or rival colonial powers;
  2. the reluctance to invest capital in high-coercion labor regimes, where it was not unlikely to be abused out of spite;
  3. the effect of expected lifespan and mortality rates on effective time horizons, and thus optimal levels of savings and indirectly remunerative skill development;
  4. selective migration laws;
  5. network effects in graduate education and technological development;
  6. the concentration of core-nation protectionist policy in goods produced by the most actively unionized workers, who also tended to be the highest-skilled and in the most capital-intensive industries;
  7. the reacharound of racist ideology onto the international division of labor that spawned it, through effects on perceived potential skill level;
  8. the calcification of industry-specific regional comparative advantages through specific skill development, networks, reputation, and the building of local laws and customs around them;
  9. the imperfect mobility of capital;
  10. especially when combined with (9), the association between savings rates and income;
  11. the associations between women’s education and fertility, and between child mortality and fertility;

and many, many others. With the ease with which we imagine spherical cows, we might imagine too that production everywhere must feature similar declining marginal returns to capital, and thus that capital intensity will tend towards equality – that basic market processes might make the world flat, as America’s best prose stylist once put it. But in actuality what has been observed is polarization. And this polarization, segmentation, and specialization – both in its “neutral” market mechanisms and in the political interventions upon which the continuation of these mechanisms depend – is the natural behavior of capitalism. Europe had hardly taken the lead when it began to plunder the Americas, and indeed would actually take some time before it became wealthier than east Asia; nothing was inevitable in its being the center, and the record of its crimes in getting there, viewed alongside the rest of our species’ awful history, reveals nothing particularly depraved about its people. The core could well have been China or somewhere else. But the factors guiding capitalist development would have been the same. If you are living in the core, you are getting subsidized by the periphery, most probably as an accident of your birth but not (at sufficient level of abstraction) of history.

thanks, kids!

It seems fair (and quite obvious) to say that unequal exchange isn’t the sole mechanism of northward value transfer. But it’s also, I think, fair to say that it is the most fundamental, and not unrelatedly the most isomorphic to the Marxian concept of value extraction under capitalism in general. I say this as way of prolegomena to this: you should really read Zak Cope’s Divided World, Divided Class. It is super good! Not so much for original insights, but for stating the Third World position crisply, comprehensively, forcefully, and with plenty of documentation. I have some reservations on some particular points – which are worth discussing, but not worth not adding it to your reading list.

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3 Responses to unequal exchange, explained

  1. David Koen says:

    Having a bit of trouble with conclusion that the cows will be burned up: It seems to me like the ranching and arms industries have higher profit rates, and hence wouldn’t cow and arms production increase?

    I think am I am certainly missing something, probably a crucial concept or a link in the logic chain. Thanks for your help!

    • Matthias says:

      Yup, the immediate response for an unreflective capitalist should be to move from dairy into ranching and/or arms – but every time one does so, a bunch of cows become available on the market, which drives down the price of cows, and thus the profit rate of ranching.

      The long-term size of the ranching industry is essentially fixed by the (here, technically determined and constant) rate of capital turnover. In the meantime, the transition is governed by the higher profit rate of arms than dairy, which itself “produces” lots of cows. So my guess would be that there’s some sort of chaotic process likely involving the size of ranching spiking, dropping, and then eventually returning to equilibrium – its exact course as likely determined by “animal spirits” as anything.

      • David Koen says:

        Ah I think understand it now: Initially more arms and cows are produced due to the investment in them, but then as their price falls the investor reallocate towards arms and butter, triggering a rapid depletion of the cow stock, and the process starts again.

        My calculus trigger happy neoclassical trainings seems to be intuitively urging me that there will be optimal stable solution to the problem, but perhaps the time dimension forbids this? Or perhaps there are multiple equilibria and and ever so small shocks make the system violently shift between them? (makes me think of chaos theory). Perhaps something else?

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