The role of traders and arbitrage

The analysis of demand and supply has so far assumed that producers deal

directly with consumers. As we know, this is far from being the usual case. The ex factory price often amounts to only a fraction of the final retail price paid by the

consumer. The difference between price ex-factory and price over-the-counter to

the consumer represents payments to the ‘middleman’: wholesalers, agents,

accountants, transporters, retailers. Is this margin between the two prices a reflection

of inefficiency, or exploitation, or does it simply represent a fair reward for

the effort and risks of distributing goods?

Some people regard trading and arbitrage as somehow inferior to ‘real’ work,

such as actually producing a good. The tendency to deprecate the role of the

distributive sector has a long pedigree. The Physiocrats of the eighteenth century,

for example, viewed agriculture as the only true source of a country’s wealth, with

distribution playing a derivative role. Adam Smith himself, normally a rock

of common sense, made a distinction between productive and unproductive

labour which sounds very contrived to modern ears:

The sovereign, for example, with all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers. ... In the same class must beranked, some both of the gravest and most important, and some of the most frivolous professions; churchmen, lawyers, physicians, men of letters of all kind; players, buffoons, musicians, opera-singers, &c. ... Like the declamation of the actor, the harangue of the orator, or the tune of the musician, the work of all of them perishes in the very instant of its production.

He justified this view on the grounds that service workers did not produce a physical surplus which could be reinvested. Not only did service sector workers not

add to the surplus, their wages were paid out of it, reducing the amount available

for accumulation.

From a market perspective, classifying the service sector as unproductive or

second class makes no sense. The reason was explained by Professor Alfred

Marshall as follows:

It is sometimes said that traders do not produce: that while the cabinet-maker produces furniture, the furniture-dealer merely sells what is already produced. But there is no scientific foundation for this distinction. They both produce utilities, and neither can do more: the furniture-dealer moves and rearranges matter so as to make it more serviceable than it was before, and the carpenter does nothing

more.

If the end of all economic activity is consumption, then the production of wholesale

and retailing services is as ‘useful’ in economic terms as the production of

goods. The information industry is a case in point. It includes activities such as the

compilation of massive financial databases, stockbrokers’ information sheets for

clients, reports on firms, industries and economic surveys. There are consumer

guides of various types, ranging from the Which? magazine reports of the

Consumers’ Association to travel guides, designed to help the consumer make

informed decisions. All this activity helps to make the market operate more efficiently. Advances in communications technology have played an important role

in easing the problem of asymmetric information. This problem arises when one

party to a transaction possesses more information of its true value than another.