The Golden Rule of Economics: People Want Stuff

One expects science to make progress, but since at least the 1930s, the science of economics has been stuck between two rival and largely contradictory paradigms, with no end in sight.  Much of the confusion revolves around money rather than wealth, and so by taking money out of the equation, things can be made much simpler.

Many people equate wealth with money, but this is often a mistake.  I read that trillions of dollars of wealth were destroyed when the real estate market or stock market collapsed.  Where did it go?  The houses and the factories are the same.  In fact, the "lost" wealth was never there to begin with.  The markets were for a time overvalued by the over-creation of money, giving people the illusion of greater wealth than they in fact possessed.  This led them to make incorrect decisions, as was poignantly demonstrated when Harvard University was forced to sharply curtail its grandiose plans for expansion across the Charles River into Boston, because its (overvalued) endowment fund "lost" billions of dollars.

So let's talk about wealth, rather than money.

In short, people want stuff.  Things like food, clothing, shelter, health care, and entertainment.  An infrastructure is necessary to provide these; this includes transportation, communication, education, and security (police, armed forces, judicial system, etc.).

Where does this stuff come from?  Ultimately, a lot of it comes out of the environment, in one way or another: agriculture, mining, lumber, etc.  But I wouldn't be able to do much with a hunk of cowhide.  A great deal of our wealth -- in fact, an increasing fraction as the centuries roll by -- comes from our ability to transform one kind of stuff into another that is more highly desired.  A hunk of cowhide can be transformed into a nice pair of shoes.  A thimbleful of sand can be transformed into a computer chip, controlled by software that was created from nothing except someone's mind.

Work creates wealth by transforming less desirable stuff into more desirable stuff.  Work is worthwhile to the exact extent that it accomplishes this function.  Our productivity is of course related to how long and energetically we work, but said productivity is also, to an increasingly great extent, related to how efficiently we work, thanks to the efforts of others who have preceded us.  No matter how energetic you are, you can make a lot more shoes in a shoe factory than if you made them by hand, thanks to the people who invented and constructed shoe-making machinery.

It is a universal observation that wealth is unequally distributed.  Some people, and some nations, are far wealthier than others.  People and nations can be poor for a wide variety of reasons: because they lack resources (e.g., arable land or good health) or because they are unable to exploit the resources (e.g., lack of schools or security).  Also, some people are willing to work harder than others, and the former group thereby tends to acquire more wealth.

Willingness to work hard is closely related to delay of gratification.  Clearly, the guy who get hungry at ten o'clock and wanders away from his shoe-making machine to grab a bite to eat is unlikely to become as wealthy as the guy who works through lunch in order to get a bonus or promotion (other things being equal!).  Ability to delay gratification also allows some people acquire wealth and, instead of using it immediately to obtain stuff, invest that wealth in the hopes that they will have even more wealth, but at a later date, and perhaps pass it on to their children.  Other people do the opposite and borrow wealth from the future in order to have more stuff in the present.

Borrowing is not always bad.  You can borrow to build a shoe factory, which can be a good thing -- but borrowing to pay for present consumption is usually not.  A person, and a country, should be careful about borrowing, because debt needs to be repaid, in one way or another, sooner or later -- and this can result in a decrease in future wealth.  Recent events in various parts of the world make this clear.

So the purpose of government is to facilitate the creation of wealth by encouraging people to work with maximal productivity.  This entails an adequate infrastructure: transportation, communication, education, and most of all security that one's wealth, once earned, will not be lost to foreign countries, criminals, legal swindling of various kinds, excessively onerous taxes, and so forth.  The guy who runs the shoe factory needs to be confident that his factory, and the wealth that he derives from it, won't be taken away in one fashion or another...otherwise, he might not bother.

In the words of Adam Smith: 

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

Some people say that government can only absorb wealth; it can never create it.  This is not true.  If building a bridge or a courthouse facilitates people's ability to transform less desirable stuff into more desirable stuff, said construction may be a wise use of resources.  But all too often the new bridge or courthouse is unnecessary.  This is harmful, as it extracts resources from other parts if the economy -- i.e., from other people.

As perhaps the example of Hong Kong so vividly demonstrates, human capital is the most valuable of all resources, so a waste of human capital is the most damaging to a nation's wealth.  There are countless ways to waste human capital: a lack of infrastructure; a lack of motivation, as we saw in the former Communist countries; and obviously, unemployment.

Full employment is a very good thing, but once again to the exact extent that the workers convert less valuable stuff into more valuable stuff.  Having one set of workers destroy things only to have another set of workers repair them does not increase the net wealth of a society.  On the contrary, a system like that reduces wealth, to the exact extent that the resources needed to support these workers, as well as the effort of the workers themselves, could be better directed at transforming less desirable stuff into more desirable stuff.  This was demonstrated by Bastiat 150 years ago.  War never creates wealth; it destroys wealth.

A government can create wealth by creating jobs, but only to the exact extent that those jobs are carefully chosen to improve the infrastructure and thereby facilitate the creation of wealth.  A government that borrows wealth from the future should be especially careful that the money is used wisely, to improve the infrastructure, so that future generations will be enriched.

Now we can see exactly where we have gone wrong.  Borrowing from future generations to build the Erie Canal, the Hoover Dam, and land-grant universities was a wise use of resources that enrich us, the descendants of those who made these decisions.  But far too much of the present borrowing is clearly unwise, directed to unproductive jobs and, even worse, present consumption.  To the exact extent that this is true, our children will be impoverished.

Several European countries -- particularly Greece, as well as many states in our own country -- are at an impasse.  They have borrowed heavily for present consumption while letting their infrastructure deteriorate.  Where will they find the wealth to repay these debts?  Either they will default, or the larger entities (EU in Europe, federal government here) will have to inflate the currency.  In both cases, the result is the same: those who have saved and invested, perhaps by purchasing sovereign bonds, will lose out.  Wealth can never be created by clever financial tricks, but only by extracting resources from the environment, and through work transforming these resources into something more desirable.

One expects science to make progress, but since at least the 1930s, the science of economics has been stuck between two rival and largely contradictory paradigms, with no end in sight.  Much of the confusion revolves around money rather than wealth, and so by taking money out of the equation, things can be made much simpler.

Many people equate wealth with money, but this is often a mistake.  I read that trillions of dollars of wealth were destroyed when the real estate market or stock market collapsed.  Where did it go?  The houses and the factories are the same.  In fact, the "lost" wealth was never there to begin with.  The markets were for a time overvalued by the over-creation of money, giving people the illusion of greater wealth than they in fact possessed.  This led them to make incorrect decisions, as was poignantly demonstrated when Harvard University was forced to sharply curtail its grandiose plans for expansion across the Charles River into Boston, because its (overvalued) endowment fund "lost" billions of dollars.

So let's talk about wealth, rather than money.

In short, people want stuff.  Things like food, clothing, shelter, health care, and entertainment.  An infrastructure is necessary to provide these; this includes transportation, communication, education, and security (police, armed forces, judicial system, etc.).

Where does this stuff come from?  Ultimately, a lot of it comes out of the environment, in one way or another: agriculture, mining, lumber, etc.  But I wouldn't be able to do much with a hunk of cowhide.  A great deal of our wealth -- in fact, an increasing fraction as the centuries roll by -- comes from our ability to transform one kind of stuff into another that is more highly desired.  A hunk of cowhide can be transformed into a nice pair of shoes.  A thimbleful of sand can be transformed into a computer chip, controlled by software that was created from nothing except someone's mind.

Work creates wealth by transforming less desirable stuff into more desirable stuff.  Work is worthwhile to the exact extent that it accomplishes this function.  Our productivity is of course related to how long and energetically we work, but said productivity is also, to an increasingly great extent, related to how efficiently we work, thanks to the efforts of others who have preceded us.  No matter how energetic you are, you can make a lot more shoes in a shoe factory than if you made them by hand, thanks to the people who invented and constructed shoe-making machinery.

It is a universal observation that wealth is unequally distributed.  Some people, and some nations, are far wealthier than others.  People and nations can be poor for a wide variety of reasons: because they lack resources (e.g., arable land or good health) or because they are unable to exploit the resources (e.g., lack of schools or security).  Also, some people are willing to work harder than others, and the former group thereby tends to acquire more wealth.

Willingness to work hard is closely related to delay of gratification.  Clearly, the guy who get hungry at ten o'clock and wanders away from his shoe-making machine to grab a bite to eat is unlikely to become as wealthy as the guy who works through lunch in order to get a bonus or promotion (other things being equal!).  Ability to delay gratification also allows some people acquire wealth and, instead of using it immediately to obtain stuff, invest that wealth in the hopes that they will have even more wealth, but at a later date, and perhaps pass it on to their children.  Other people do the opposite and borrow wealth from the future in order to have more stuff in the present.

Borrowing is not always bad.  You can borrow to build a shoe factory, which can be a good thing -- but borrowing to pay for present consumption is usually not.  A person, and a country, should be careful about borrowing, because debt needs to be repaid, in one way or another, sooner or later -- and this can result in a decrease in future wealth.  Recent events in various parts of the world make this clear.

So the purpose of government is to facilitate the creation of wealth by encouraging people to work with maximal productivity.  This entails an adequate infrastructure: transportation, communication, education, and most of all security that one's wealth, once earned, will not be lost to foreign countries, criminals, legal swindling of various kinds, excessively onerous taxes, and so forth.  The guy who runs the shoe factory needs to be confident that his factory, and the wealth that he derives from it, won't be taken away in one fashion or another...otherwise, he might not bother.

In the words of Adam Smith: 

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

Some people say that government can only absorb wealth; it can never create it.  This is not true.  If building a bridge or a courthouse facilitates people's ability to transform less desirable stuff into more desirable stuff, said construction may be a wise use of resources.  But all too often the new bridge or courthouse is unnecessary.  This is harmful, as it extracts resources from other parts if the economy -- i.e., from other people.

As perhaps the example of Hong Kong so vividly demonstrates, human capital is the most valuable of all resources, so a waste of human capital is the most damaging to a nation's wealth.  There are countless ways to waste human capital: a lack of infrastructure; a lack of motivation, as we saw in the former Communist countries; and obviously, unemployment.

Full employment is a very good thing, but once again to the exact extent that the workers convert less valuable stuff into more valuable stuff.  Having one set of workers destroy things only to have another set of workers repair them does not increase the net wealth of a society.  On the contrary, a system like that reduces wealth, to the exact extent that the resources needed to support these workers, as well as the effort of the workers themselves, could be better directed at transforming less desirable stuff into more desirable stuff.  This was demonstrated by Bastiat 150 years ago.  War never creates wealth; it destroys wealth.

A government can create wealth by creating jobs, but only to the exact extent that those jobs are carefully chosen to improve the infrastructure and thereby facilitate the creation of wealth.  A government that borrows wealth from the future should be especially careful that the money is used wisely, to improve the infrastructure, so that future generations will be enriched.

Now we can see exactly where we have gone wrong.  Borrowing from future generations to build the Erie Canal, the Hoover Dam, and land-grant universities was a wise use of resources that enrich us, the descendants of those who made these decisions.  But far too much of the present borrowing is clearly unwise, directed to unproductive jobs and, even worse, present consumption.  To the exact extent that this is true, our children will be impoverished.

Several European countries -- particularly Greece, as well as many states in our own country -- are at an impasse.  They have borrowed heavily for present consumption while letting their infrastructure deteriorate.  Where will they find the wealth to repay these debts?  Either they will default, or the larger entities (EU in Europe, federal government here) will have to inflate the currency.  In both cases, the result is the same: those who have saved and invested, perhaps by purchasing sovereign bonds, will lose out.  Wealth can never be created by clever financial tricks, but only by extracting resources from the environment, and through work transforming these resources into something more desirable.