Billionaires are Different — Part 2

I concluded the previous part of this piece with the claim that “it is not possible to create wealth without also creating inequality. Inequality in a modern free society is a healthy sign, just as inequality in an un-free society signals disease.”

There are different ways of amassing wealth. In the past, most of what was produced was consumed. That’s because nearly everyone was almost uniformly poor in the past. There wasn’t much left over, and therefore there was not much accumulated wealth.

Still over hundreds of years, wealth in the form of precious metals and gems accumulated in certain parts of the world, which tempted barbarian invaders to do their killing and plundering. That’s the old way to acquire wealth: don’t bother producing any wealth, just take it from others by force.

Then around 250 years ago, some people figured out how to use energy sources (fossil fuels like coal) effectively and wealth production took off. That’s the first Industrial Revolution. That made it possible to produce a lot more wealth and gradually people started climbing out of extreme poverty.

The short version is this. They invented better energy technologies, which led to greater production of stuff (which is wealth), so more people had more stuff. The producers of stuff sold stuff to consumers, and made a profit. Profit is a measure of how much additional wealth has been created.

If it costs $10 to produce something, and it sells for $15, then the profit to the producer is $5. Profits indicate that additional wealth was created. How much additional wealth? The lower bound estimate of the wealth created is $5 — which would occur if the producer was able to fully capture all the “consumer surplus” that was created. But that’s nearly impossible to do; the consumers get some, often quite significant, consumer surplus.

Here’s roughly what is meant by that. If I paid $200 for my phone, and I get around $500 worth of utility from its use, then my consumer surplus is $300. If I had paid $450 for the phone, then my CS would be only $50. In the latter case, the producer would have been able to extract more of the CS.

Now suppose the phone was produced at a cost of $150. Then when I paid $200 for it, the producer’s profit was $50. As above, if my total utility was $500, then the total surplus the phone created was $350 ($500 minus $150 the cost of production.) Thus $350 is the total increase of wealth. Therefore the producer was able to capture only $50 of that total surplus as profits.

The producer makes a profit but that’s not the whole story. The profit is the tip of the iceberg; the larger bit of the iceberg — the welfare gain to consumers — is invisible. The fabulously rich are rich because they created fabulous amounts of wealth.

In the past, the fabulously wealthy became wealthy by looting and plundering others. The poor had little wealth but the combined wealth of tens of millions did amount to a decent sum.

In the modern world, invasion and plunder is not fashionable (although there are exceptions.) These days, the primary method of acquiring great wealth is through production. Note however, that it’s not the only way. The other ways are important and we must note them later. But generally speaking, there is only one way to acquire fabulous wealth. Which is, first create a great deal of wealth, and then capture a fraction of that wealth you create.

Modern wealth is not just different in its genesis but also in its quantity and quality. The richest emperors of the past did not have the wealth that today’s wealthiest have. If the world was abjectly poor, it wasn’t possible to be very wealthy.

Furthermore, modern wealth is different in quality. They in the past may have had heaps of gold and diamonds — but they did not have antibiotics and flush toilets and dentistry and luxury private jets and 400-foot yachts or air conditioning, etc.

In fact, the average resident of a modern rich nation is arguably richer than the richest people of the past. Speaking for myself, I’d rather be the upper middle-class Mr. Nobody in the US today than be the emperor of China any time in the past.

Now let’s get back to the matter of the fabulously wealthy. Generally these are people who created very valuable companies. Microsoft, Apple, Google — that sort.

Bill Gates is reportedly worth around $107 billion. The details of how he became so wealthy doesn’t matter. What matters is that he probably was instrumental in producing hundreds of billions of wealth across the world over the decades — and was able to take home a very small fraction of the wealth he created.

I am going to make an educated guess here. A generous estimate is that Gates probably captured around 5 percent of the total wealth he helped create. Bill is rich but thanks to him, all of us are a little bit richer. Sure he doesn’t need billions of dollars. Nobody needs billions. But the point is that he is not consuming billions of dollars of wealth either. The billions he has are working on generating additional wealth, the majority of which is again as before going to benefit the world at large.

The same is true of all the other extremely wealthy people in the US (and in other developed countries around the world.) They will not ever consume the wealth they have acquired. The wealth that they acquired is a tiny fraction of the wealth that they created.

Therefore the larger the number of extremely wealthy individuals signals that great wealth is being created that is benefiting every one of us, including people who live in the poorer parts of the world.

We should note that every entrepreneur and producer — not just those who end up with billions — captures only a small share of the wealth that he or she creates. My focus on the super wealthy is merely because politicians love to throw shit at them instead of celebrating their achievements.

Does it bother me that Bill Gates’ wealth is four magnitudes greater than mine? Not in the least. I wish I had more money than I do but really who doesn’t? What I care about is whether what I have meets my needs. (It does.)

What I care about is whether the poor are doing OK. Well, as it happens, the number of people (absolute and relative) living in extreme poverty is lower than before and falling. In about 10 years, the world will be entirely free of extreme poverty. And what’s more, in some countries, the middle-class is also shrinking because more people are moving up to the affluent class.

Income and wealth inequality does not matter as long as those at the bottom of the scale are better off than before. The poor in the rich countries are actually much better off today than the rich anywhere just a couple of centuries ago.

The world is getting richer — and it is getting richer faster. That’s happening because more people are producing goods and services that are better. The greater production of wealth is making them wealthier but the greater part of the additional wealth redounds to the world at large, not just to the wealthy.

So what’s the NY Times bitching about? What’s the story with Elizabeth Warren who wants to tax the rich and confiscate their wealth? Why do politicians love to hate the creators of wealth?

In the next part in this series, I will address those points, and later do a take down of the opinion piece in the NY Times.

{Continue on to part 3 of this series.}

{The image at the top of the post is from last week when I was at Costco. I didn’t buy that whisky.}