The Development of Trade Networks, Network Effects, and Security Costs

In my last post, I rambled about transport costs, trade, the development of trade networks, and the role of infrastructure. This post will be somewhat of a continuation on the previous topic: it'll be about how different political systems treat, use, build around, protect, and develop these trade networks. The previous post's primary focus was on economics; the topic of this post will primarily be geopolitics.

As I discussed in my previous post, transport costs and infrastructure are a critical factor in the development of trade. We know that the cheaper the cost of transport, the easier it becomes to facilitate trade. However, there are other factors: network effects and the protection of trade. Transport costs may be low, but if you can't protect your stuff from getting stolen, it really doesn't matter how low transport costs are. So the security aspect of trade plays a huge role in the development of trade networks. Before I get into how the network effects play out and the protection of trade, I'll first talk about the development of trade networks.

Development of Trade Networks:
Recalling from my previous post, we know that trade by land is about 50-100 times the cost of trade by water. So the most obvious trading networks are trading networks that're supported by navigable rivers and large lakes or seas if we just take into account transport costs. The most obvious examples would be rivers like the Nile, Rhine, Oder, Mississippi, and others. Wealthy populations generally tend to be built on navigable rivers/waterways or around Seas--particularly before the advent of deep-water navigation simply because of transport costs. For example, the Roman Republic was built around the Mediterranean, the Middle Eastern civilizations were built around the Tigris and the Euphrates, the Egyptians near the Nile, and the list goes on.

There can also be other trade networks formed with infrastructure. If there's a portion of a river that's not navigable, but you build canals around and through it, you now have created a new trade network. Similarly, we can link cities/city regions/city-states with other cities/city regions/city-states by building roads/bridges and rail lines. However, these networks can only be established if the total trade created (and other benefits) from the newly-created network can offset the cost of building and sustaining the trade network. Obviously, we would expect the benefits to the creation of these trade networks to be highly nonlinear and they always are. In other words, the benefits of constructing the first rail line or road that links two city-states will be much higher than the 10,000th road and rail line.

In my post about economic basics and the accumulation of real wealth, I spoke about the importance of economies (on any scale) to be able to substitute inputs while diversifying across inputs and outputs. I also (lightly) touched on how this implies populations must cluster in certain regions for this to happen. In other words, they must accumulate in cities or city regions (I'll refer to them as city-states for the rest of this post). In order to substitute inputs and outputs, these city-states must be connected to other city-states. For the accumulation of real wealth, city-states must constantly be engaged in volatile trade with other similar places.

So the development of trade networks requires the linking of city-states with other city-states. Rivers, navigable waterways, seas, etc. make the linking of city-states simple and allow for the development of volatile trade between these city-states. However, these city-states can also be linked with infrastructure like road/rail networks, canal systems, and other projects. These are less natural, but can still be easily developed relatively easily.

Now that we have some basics down on the development of trade networks, I'll get into the economic network effects and security aspects of trade networks.

Network Effects and Security Costs of Trade Networks:
Since we have development of trade networks, it becomes important to understand that--understandably--network effects develop. The primary network effects that develop are in the protection of trade, the economic benefits of trade, and the cost of the protection of trade. Basically, one of the reasons we see the formations of centralized governments is to protect trade, protect basic property rights, enforce contracts, and protect the people/groups that stretch across trade networks. In order to understand the network effect that develops in the security costs of maintenance of the trade network, I'll use a simple model/example to show the point I'm trying to make.

Model/Example: Suppose we have a large lake or sea with many city-states surrounding it. Let's assume that the lake/sea is easy to trade over and that each city-state gains economic benefits by engaging in trade with one another. Let's also assume that we have 8 city-states evenly distributed around a circular lake with each city-state being the same size and structure. Suppose you also have three republics/empires fighting for control over this trade network with one republic/empire having 4 city-states, with one having 2 city-states, the third having one, and the final city-state in question being independent.

If the final city-state is suffering from security issues or is having difficulty finding trading partners, it can join any one of those empires. However, it can have trade with 4 city-states, two city-states, or one city-state. Obviously, trade with 4 city-states creates more of an economic benefit than trading with two or with just one. Also note that the empire with 4 city-states now has 5 city-states on the same region, but the economic links don't expand from 4 to 5. The first amount of economic linkages was 6, but now the total amount of economic linkages are 10. If the republic gains another city-state, the economic linkages expand from 10 to 15. In other words, the amount of economic activity for the ruling government expands NONLINEARLY at a rate of O(n^2) as n becomes large (comment down below if you want me to explain the math behind my calculations). So there's an obvious network effect in the economic benefits, but there's also security benefits.

From a security perspective, the more of the sea you control, the less someone else controls and the less power they have to boss you around/tell you what to do/dictate where and how your trade has to flow. If you have 2/8 city-states next to each other in the same governmental network while someone else has 6/8, there's a very high risk of your trade being in danger. If you control 6/8 next to each other with someone else having the other 2/8, there's much less of a risk AND there's more of an economic effect that allows you to fund a military to protect it. Similarly, control over the entire network drops security costs by a lot because there's no one else to take your stuff.

Notice that in my model, I made a lot of assumptions with the primary assumption being that all else is equal. Obviously in the real world, all else is not equal and the real world is (much) more complex. However, using this simple model, we can see how network effects develop. We can also see how natural monopolies can come into place in these regions. The more of the network you control, the more economic benefits you gain while your security costs drop. Military costs, in other ways, also drop, but that's a different topic for a different day.

Conclusion and Implications:
In the real world, we see costs like infrastructure development and other factors (ex. weather, food transport, water transport, natural resources, environmental costs, etc.) that factor in to this equation. However, we can clearly see how it's easy for one government to control entire trading networks. Particularly when if we add in the assumption that it's impossible/extremely difficult for capital and real wealth to be accumulated in areas that don't have large populations.

What this implies is that governments can come about as ways to protect and let economic systems develop by taking advantage of network effects. Even though the model above assumes a sea, there can be natural trade networks across land where we see similar effects including the development of infrastructure--particularly if the trade would go to zero without the infrastructure.