Two weeks ago, I wrote a post about the Capitol Hill Babysitting Co-operative: The Wisdom of Babysitters. Or something. And I wrote about it for two reasons:

  1. It’s interesting; and
  2. Economists use it as an analogy to justify government intervention in a recession.

To summarise:

  1. Some Capitol Hill families were part of a baby-sitting co-operative.
  2. Baby-sitting hours were traded through the use of baby-sitting coupons, issued by the co-op organisers.
  3. There were plenty of members in the group that wanted to baby-sit (there was supply of babysitters);
  4. Seeing as these people were members of a group for baby-sitting, there was obviously demand for it.
  5. But for some unclear reason, these forces just didn’t seem to coincide. No one was going out.
  6. The organisers of the co-op imposed a rule to force couples to go out at least twice a year – but that didn’t help.
  7. In fact, it was only when the co-op started issuing out more coupons that the baby-sitting economy got underway. That is: quantitative easing saved the day.
  8. And even though this did eventually lead to an inflationary spiral and consequent collapse, let’s not let real life get in the way of a great story.

The situation is fully Keynesian – the economy wasn’t working on its own, and it needed some intervention.

I wrote about this “toy economy” because I recently listened to a Tim Harford lecture. Tim Harford is great for this kind of obscure factoid – but I’ve now heard him talk about baby-sitters on a number of other podcasts. And let me just say: recycled wit, he’s not afraid.

Anyway, I mention it because he always talks about the babysitters in conjunction with a more neoclassical parable about prisoner of war camps. So here’s the counterargument.

The Economic Organisation of a P.O.W. Camp

Robert A Radford was an economist that spent much of the Second World War in a german prisoner of war camp. After the war ended and he was rescued, he went to work for the newly-established International Monetary Fund (IMF), where he wrote about his economic experiences during the war (I’ve linked to his article in the heading above).

The prisoners in the camp would receive food parcel rations from the Red Cross, comprising “tinned milk, jam, butter, biscuits, bully, chocolate, sugar, etc. and cigarettes”.

Then, in Radford’s own words:

Very soon after capture people realised 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 of cigarettes or food. ‘Goodwill’ developed into trading as a more equitable means of maximising individual satisfaction.

Starting with simple direct barter, such as a non-smoker giving a smoker friend his cigarette issue in exchange for a chocolate ration, more complex exchanges soon became an accepted custom. 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 parcel in addition to his original cheese and cigarettes: the market was not yet perfect. Within a week or two, as the volume of trade grew, rough scales of exchange values came into existence. Sikhs, who had at first exchanged tinned meat for practically any other foodstuff, began to insist on jam and margarine. It was realised that a tin of jam was worth ½ lb. of margarine plus something else; that a cigarette issue was worth several chocolate issues, and a tin of diced carrots was worth practically nothing.

By the end of a month, when we reached our permanent camp, there was a lively trade in all commodities and their relative values were well-known, and expressed not in terms of one another – one didn’t quote bully in terms of sugar – but in terms of cigarettes. The cigarette became the standard of value.

Within a very short space of time, a fully-fledged barter economy had emerged and then transitioned into a monetary economy where the medium of exchange was a cigarette.

The economy soon expanded and began to engage in foreign trade: where the coffee rations would trade “over the wire” and be “sold for phenomenal prices at the black market cafes in Munich”.

The economy was susceptible to demand and supply shocks: the influx of the freshly captured would cause prices to spike, and deliveries of Red Cross parcels would cause prices to fall. A futures market developed, as did the extension of credit:

Credit entered into many, perhaps into most, transactions, in one form or another. … 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.” 

There was also currency debasement: cigarettes would be rolled between the fingers to sweat out some of the tobacco. Eventually, operating in accordance with Gresham’s law, the fatter cigarettes were kept for smoking, and the cigarettes that were used as currency became thin.

The Role of “Government” Intervention

The P.O.W. camp had developed a fully-functioning and efficient economy, with terms of trade and sophisticated financial operations. And the price mechanism was very fluid: adjusting both to structural changes in the economy (arrival of prisoners, change in rations, etc) and projected structural changes (a rumour about the war ending could send prices plummeting).

With time, a Shop and Restaurant emerged. These became the centralised points of exchange, and the major buyers and sellers of goods. The noticeboards that listed the exchange rates of goods came under their control. Fairly soon, the Senior British Officer that backed the shop decided that it was high time that someone brought prices under control. The Shop began to halt trades outside a set price range, and loudly discouraged any private exchanges in those products.

At first, this worked. Public opinion was strongly in favour of “a just and stable price”.

But then the Red Cross cut cigarette rations, and the “Authorities” were too slow to adjust the scale. Eventually, public opinion turned, and the scale collapsed. But in the interim, there was a distortion of prices and shortages as no one would trade at the official exchange rates.

The Moral Of The Story

The P.O.W. economy functioned perfectly well when left to its own devices. Once a popular authority sought to exercise some control, it disrupted trade and caused shortages. And therefore, government intervention should be limited.

That said, there is probably a more important moral in all of this. In early 1945, the Red Cross stopped sending food parcels. And while the economy reacted efficiently to this non-supply of food (prices rocketed sky-high), the fact remains: when there’s no food, people die, no matter how efficient your economy.

Fortunately for the prisoners, the 30th US Infantry Division arrived on April 12th, 1945 – ushering in an age of plenty. So I guess there’s something to be said for Foreign Aid…