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2. Direct Exchange

3. Exchange and the Division of Labor

In describing the conditions that must obtain for interpersonal exchange to take place (such as reverse valuations), we implicitly assumed that it must be two different goods that are being exchanged. If Crusoe at his end of the island produced only berries, and Jackson at his end produced only the same kind of berries, then no basis for exchange between them would occur. If Jackson produced 200 berries and Crusoe 150 berries, it would be nonsensical to assume that any exchange of berries would be made between them.14 The only voluntary interpersonal action in relation to berries that could occur would be a gift from one to another.

If exchangers must exchange two different goods, this implies that each party must have a different proportion of assets of goods in relation to his wants. He must have relatively specialized in the acquisition of different goods from those the other party produced. This specialization by each individual may have occurred for any one of three different reasons or any combination of the three: (a) differences in suitability and yield of the nature-given factors; (b) differences in given capital and durable consumers’ goods; and (c) differences in skill and in the desirability of different types of labor.15 These factors, in addition to the potential exchange-value and use-value of the goods, will determine the line of production that the actor will pursue. If the production is directed toward exchange, then the exchange-value will play a major role in his decision. Thus, Crusoe may have found abundant crops on his side of the island. These resources, added to his greater skill in farming and the lower disutility of this occupation for him because of a liking for agriculture, might cause him to take up farming, while Jackson's greater skill in hunting and more abundant game supply induce him to specialize in hunting and trapping. Exchange, a productive process for both participants, implies specialization of production, or division of labor.

The extent to which division of labor is carried on in a society depends on the extent of the market for the products. The latter determines the exchange-value that the producer will be able to obtain for his goods. Thus, if Jackson knows that he will be able to exchange part of his catch of game for the grains and fruits of Crusoe, he may well expend all his labor on hunting. Then he will be able to devote all his labor-time to hunting, while Crusoe devotes his to farming, and their “surplus” stocks will be exchanged up to the limits analyzed in the previous section. On the other hand, if, for example, Crusoe has little use for meat, Jackson will not be able to exchange much meat, and he will be forced to be far more directly self-sufficient, producing his own grains and fruits as well as meat.

It is clear that, praxeologically, the very fact of exchange and the division of labor implies that it must be more productive for all concerned than isolated, autistic labor. Economic analysis alone, however, does not convey to us knowledge of the enormous increase in productivity that the division of labor brings to society. This is based on a further empirical insight, viz., the enormous variety in human beings and in the world around them. It is a fact that, superimposed on the basic unity of species and objects in nature, there is a great diversity. Particularly is there variety in the aforementioned factors that would give rise to specialization: in the locations and types of natural resources and in the ability, skills, and tastes of human beings. In the words of Professor von Mises:

One may as well consider these two facts as one and the same fact, namely, the manifoldness of nature which makes the universe a complex of infinite varieties. If the earth's surface were such that the physical conditions of production were the same at every point and if one man were ... equal to all other men ... division of labor would not offer any advantages for acting man.16

It is clear that conditions for exchange, and therefore increased productivity for the participants, will occur where each party has a superiority in productivity in regard to one of the goods exchanged—a superiority that may be due either to better nature-given factors or to the ability of the producer. If individuals abandon attempts to satisfy their wants in isolation, and if each devotes his working time to that specialty in which he excels, it is clear that total productivity for each of the products is increased. If Crusoe can produce more berries per unit of time, and Jackson can kill more game, it is clear that productivity in both lines is increased if Crusoe devotes himself wholly to the production of berries and Jackson to hunting game, after which they can exchange some of the berries for some of the game. In addition to this, full-time specialization in a line of production is likely to improve each person's productivity in that line and intensify the relative superiority of each.

More puzzling is the case in which one individual is superior to another in all lines of production. Suppose, for example, that Crusoe is superior to Jackson both in the production of berries and in the production of game. Are there any possibilities for exchange in this situation? Superficially, it might be answered that there are none, and that both will continue in isolation. Actually, it pays for Crusoe to specialize in that line of production in which he has the greatest relative superiority in production, and to exchange this product for the product in which Jackson specializes. It is clear that the inferior producer benefits by receiving some of the products of the superior one. The latter benefits also, however, by being free to devote himself to that product in which his productive superiority is the greatest. Thus, if Crusoe has a great superiority in berry production and a small one in game production, it will still benefit him to devote his full working time to berry production and then exchange some berries for Jackson's game products. In an example mentioned by Professor Boulding:

A doctor who is an excellent gardener may very well prefer to employ a hired man who as a gardener is inferior to himself, because thereby he can devote more time to his medical practice.17

This important principle—that exchange may beneficially take place even when one party is superior in both lines of production—is known as the law of association, the law of comparative costs, or the law of comparative advantage.

With all-pervasive variation offering possibilities for specialization, and favorable conditions of exchange occurring even when one party is superior in both pursuits, great opportunities abound for widespread division of labor and extension of the market. As more and more people are linked together in the exchange network, the more “extended” is the market for each of the products, and the more will exchange-value predominate, as compared to direct use-value, in the decisions of the producer. Thus, suppose that there are five people on the desert island, and each specializes in that line of product in which he has a comparative or absolute advantage. Suppose that each one concentrates on the following products:

A ..... berries
B ..... game
C ..... fish
D ..... eggs
E ..... milk

With more people participating in the market process, the opportunities for exchange for each actor are now greatly increased. This is true even though each particular act of exchange takes place between just two people and involves two goods. Thus, as shown in Figure 7, the following network of exchange may take place: Exchange-value now takes a far more dominant place in the decisions of the producers. Crusoe (if A is Crusoe) now knows that if he specializes in berries, he does not now have to rely solely on Jackson to accept them, but can exchange them for the products of several other people. A sudden loss of taste for berries by Jackson will not impoverish Crusoe and deprive him of all other necessities as it would have before. Furthermore, berries will now bring to Crusoe a wider variety of products, each in far greater abundance than before, some being available now that would not have been earlier. The greater productivity and the wider market and emphasis on exchange-value obtain for all participants in the market.


It is evident, as will be explained further in later sections on indirect exchange, that the contractual society of the market is a genuinely co-operative society. Each person specializes in the task for which he is best fitted, and each serves his fellow men in order to serve himself in exchange. Each person, by producing for exchange, co-operates with his fellow men voluntarily and without coercion. In contrast to the hegemonic form of society, in which one person or one group of persons exploits the others, a contractual society leaves each person free to benefit himself in the market and as a consequence to benefit others as well. An interesting aspect of this praxeological truth is that this benefit to others occurs regardless of the motives of those involved in exchange. Thus, Jackson may specialize in hunting and exchange the game for other products even though he may be indifferent to, or even cordially detest, his fellow participants. Yet regardless of his motives, the other participants are benefitted by his actions as an indirect but necessary consequence of his own benefit. It is this almost marvelous process, whereby a man in pursuing his own benefit also benefits others, that caused Adam Smith to exclaim that it almost seemed that an “invisible hand” was directing the proceedings.18

Thus, in explaining the origins of society, there is no need to conjure up any mystic communion or “sense of belonging” among individuals. Individuals recognize, through the use of reason, the advantages of exchange resulting from the higher productivity of the division of labor, and they proceed to follow this advantageous course. In fact, it is far more likely that feelings of friendship and communion are the effects of a regime of (contractual) social co-operation rather than the cause. Suppose, for example, that the division of labor were not productive, or that men had failed to recognize its productivity. In that case, there would be little or no opportunity for exchange, and each man would try to obtain his goods in autistic independence. The result would undoubtedly be a fierce struggle to gain possession of the scarce goods, since, in such a world, each man's gain of useful goods would be some other man's loss. It would be almost inevitable for such an autistic world to be strongly marked by violence and perpetual war. Since each man could gain from his fellows only at their expense, violence would be prevalent, and it seems highly likely that feelings of mutual hostility would be dominant. As in the case of animals quarreling over bones, such a warring world could cause only hatred and hostility between man and man. Life would be a bitter “struggle for survival.” On the other hand, in a world of voluntary social co-operation through mutually beneficial exchanges, where one man's gain is another man's gain, it is obvious that great scope is provided for the development of social sympathy and human friendships. It is the peaceful, co-operative society that creates favorable conditions for feelings of friendship among men.

The mutual benefits yielded by exchange provide a major incentive (as in the case of Crusoe above) to would-be aggressors (initiators of violent action against others) to restrain their aggression and co-operate peacefully with their fellows. Individuals then decide that the advantages of engaging in specialization and exchange outweigh the advantages that war might bring.

Another feature of the market society formed by the division of labor is its permanence. The wants of men are renewed for each period of time, and so they must try to obtain for themselves anew a supply of goods for each period. Crusoe wants to have a steady rate of supply of game, and Jackson would like to have a continuing supply of berries, etc. Therefore, the social relations formed by the division of labor tend to be permanent as individuals specialize in different tasks and continue to produce in those fields.

There is one, less important, type of exchange that does not involve the division of labor. This is an exchange of the same types of labor for certain tasks. Thus, suppose that Crusoe, Jackson, and Smith are trying to clear their fields of logs. If each one engaged solely in the work of clearing his own field, it would take a long period of time. However, if each put in some time in a joint effort to roll the other fellow's logs, the productivity of the log-rolling operations would be greatly increased. Each man could finish the task in a shorter period of time. This is particularly true for operations such as rolling heavy logs, which each man alone could not possibly accomplish at all and which they could perform only by agreed-upon joint action. In these cases, each man gives up his own labor in someone else's field in exchange for receiving the labor of the others in his field, the latter being worth more to him. Such an exchange involves a combination of the same type of labor, rather than a division of labor into different types, to perform tasks beyond the ready capacity of an isolated individual. This type of co-operative “log-rolling,” however, would entail merely temporary alliances based on specific tasks, and, would not, as do specialization and division of labor, establish permanent exchange-ties and social relations.19

The great scope of the division of labor is not restricted to situations in which each individual makes all of one particular product, as was the case above. Division of labor may entail the specializing by individuals in the different stages of production necessary to produce a particular consumers’ good. Thus, with a wider market permitting, different individuals specialize in the different stages, for example, involved in the production of the ham sandwich discussed in the previous chapter. General productivity is greatly increased as some people and some areas specialize in producing iron ore, some in producing different types of machines, some in baking bread, some in packaging meat, some in retailing, etc. The essence of developed market economies consists in the framework of co-operative exchange emerging with such specialization.20

  • 14. It is possible that Crusoe and Jackson, for the mutual fun of it, might pass 50 berries back and forth between them. This, however, would not be genuine exchange, but joint participation in an enjoyable consumers’ good—a game or play.
  • 15. Basically, class (b) is resolvable into differences in classes (a) and (c), which account for their production.
  • 16. Mises, Human Action, pp. 157 ff. On the pervasiveness of variation, also cf. F.A. Harper, Liberty, A Path to Its Recovery (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1949), pp. 65–77, 139–41.
  • 17. Kenneth E. Boulding, Economic Analysis (1st ed.; New York: Harper & Bros., 1941), p. 30; also ibid., pp. 22–32.
  • 18. Those critics of Adam Smith and other economists who accuse the latter of “assuming” that God or Nature directs the market process by an “invisible hand” for the benefit of all participants completely miss the mark. The fact that the market provides for the welfare of each individual participating in it is a conclusion based on scientific analysis, not an assumption upon which the analysis is based. The “invisible hand” was simply a metaphor used in commenting on this process and its results. Cf. William D. Grampp, “Adam Smith and the Economic Man,” Journal of Political Economy, August, 1948, pp. 315–36, especially pp. 319–20.
  • 19. See Mises, Human Action, pp. 157–58.
  • 20. Such specialization of stages requires the adoption of indirect exchange, discussed in the following chapters.
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