An Essay into the Nature and Causes of Poverty — Part 2

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Value and Wealth

Since this is an essay on poverty (part 1 here), it is useful to consider its polar opposite, namely wealth. Defining wealth precisely is therefore the first order of business. Wealth is anything that is of some value to some person. Value is hard to pin down because it varies according to the person doing the evaluating. Just as beauty lies in the eye of the beholder, value lies in the mind of the evaluating person. 

Exchange

One man’s garbage is another man’s treasure, as the adage states quite correctly. Therefore two people may value the same thing quite differently. That difference is the only reason that people exchange stuff. For example, when Jim buys a sandwich for $5 from Joe, clearly Jim values the sandwich more than he values $5, and conversely Joe values $5 more than he values the sandwich. Also worth noting that exchange involves distinctly dissimilar things.

Exchange is one of the very few behaviors that distinguishes humans from other animals. You’ll never see a dog exchanging anything with another dog. But humans constantly exchange things with other humans. Strictly speaking, without exchange behavior, there would be no wealth, no economy to speak of, and therefore no reason for the discipline of economics. We will have a lot more to say about exchange because exchange is the central concern of economics. 

A Story

I have to tell you a story, probably just an urban legend, which is about a guy who starting with a paperclip, through a series of exchanges, got himself a house. First he got a pencil in exchange from someone who needed a paperclip. The pencil he exchanged for a lighter; then got a paperback novel; then a framed painting; then a table lamp; then a chair; then a set of speakers; … and … then a plot of land; then a house in exchange for the plot of land. 

The story illustrates what’s central to exchange: both parties to an exchange benefit from it. The man got himself a house through a series of exchanges. He did improve his situation but along the way, every exchange he did left his trading partner better off. He didn’t rip off anybody.

This cannot be stressed often enough: all of us are better off because people figure out more and better ways of exchanging stuff. 

(Vocabulary note: The study of human action is called praxeology. That part of praxeology which studies exchange is called catallactics. The word “economics” suggests economizing behavior, whereas catallactics stresses the more fundamental feature of exchange. We will go into the details later.)

Wealth and Knowledge

Back to the claim that wealth is anything that someone values. People differ one from another in various ways such as in their talents, skills, interests, preferences, endowments, knowledge and so on. 

Take knowledge, for instance. If you find what looks like some worthless rock, you won’t bother with it. But if you had the knowledge to recognize that it was a fossil, it could be very valuable to a biologist. Or a book on quantum physics may be worthless to someone who lacks the proper training in the subject.

What is wealth changes with time. With the changing state of knowledge, something which used to be worthless becomes valuable, and conversely something valuable could become worthless. If you had a mountain of rich uranium ore one hundred years ago, it would not have been wealth. Now we know how to produce energy (and bombs) with that stuff, and so it’s valuable. Aluminum used to be more valuable than gold at one time. Now that we have the technology, aluminum is so cheap that we simply throw it away after use. (BTW, a good deal of that trash is economically recycled.)

Material Wealth

Wealth does not exist in nature. Nature provides the raw materials but wealth has to be created. Air, water, land, minerals, flora and fauna are all nature-made and have been around for millions or even billions of years. But for wealth to exist in the world, nature had to first make anatomically modern humans. Wealth is artificial, not natural. It has to be created. It does not fall from the skies like rain.

Wealth can be destroyed. A fine crystal bowl turns in a heap of broken shards of glass on being dropped. A fire reduces a house to a heap of ashes. Wars involve humans destroying wealth. Natural disasters destroy wealth. The fact that destroying wealth is easier than creating wealth follows from the laws of thermodynamics. That mysterious thing called entropy which always rises in a closed system. 

Wealth can be stored and saved. It can be lent, borrowed, traded, gifted, and inherited. Wealth can be acquired honorably or stolen, obtained legally or illegally. All that is clear enough. 

Wealth is material — houses, cars, gold, clothes. But we value things that are not material — friendship, love, self-improvement, knowledge, philosophical contemplation, etc. We aspire for more than just material stuff and animal comforts. Those are valuable no doubt. However here I am restricting myself to material poverty, and therefore my focus is on material wealth, and not the other kinds of wealth.

Wealth and Private Property

Wealth can be owned privately or collectively. Under communism, all wealth is collectively owned, and no individual owns any property. Under socialism, wealth in the form of productive assets (factories and farms) are collectively owned but individuals are allowed to own all other forms of wealth. In capitalistic societies, nearly all wealth is held by private parties (individuals and corporations.)

Money and Wealth

Finally, wealth is distinct from money. Money buys you wealth but money itself is not wealth. Money is what people are willing to accept in exchange for wealth because they trust that others will accept that money in exchange for wealth.

It’s useful to remember this distinction between money and wealth when we talk of billionaires or even the modestly rich. Their net worth is counted in money but they don’t have money stored in huge rooms in their mansions. All their billions are in some form of material wealth — in real estate, factories and shares of corporations.  

Very little of wealth is actually held in money. As an aside, the idea of Modi’s demonetization disastrously failed because only a very small fraction of ill-gotten wealth is kept in the form of money. All that demonetization did was impose a heavy burden on the poor, and threw a spanner the economic engine. The rich own real estate and shares of corporations.

Wealth Creation

The recipe or algorithm for wealth creation is the soul of simplicity itself.

        • Step 1: Start with some wealth, W1.
        • Step 2: Using some idea, transform wealth W1 to generate wealth W2 such that W2 > W1.
        • Step 3: Go to step 1.

The thing is that you need to have some wealth to create additional wealth. If you don’t have access to some wealth, you cannot get started. That is, you need seed corn to grow corn.

Poverty Defined

So now we are ready to define what are necessary and sufficient conditions that separate the poor from the non-poor. Having wealth is a sufficient condition for being non-poor. How much wealth makes you rich? That’s a matter of context and definition. If  we define rich to mean having an amount of wealth above the median wealth, then the same amount of wealth that puts you in the ranks of the rich in a poor country will put you in the ranks of the poor in a rich country. 

What makes a person poor? Here’s the important bit. The sufficient condition for being poor is not having the ability to borrow. That is, even if you don’t have any wealth, as long as you can borrow, you are actually not poor.

Remember this. People sometimes have below zero net worth but they still aren’t poor because they have the ability to borrow. If you cannot borrow, you are credit-constrained. And if you are credit-constrained, you are really, truly, genuinely, definitely, sadly poor.

The Lesson

In summary, the way to help a person become non-poor is to release the credit-constraint that blocks the way. In the next bit, using this basic principle show how poverty can be eliminated in India.

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Read the next part: Part 3. Previous: Part 1

{Image at the top of the post. A big-ass tractor in a lot in the town of Intercourse, Lancaster Country, PA. I had taken Akshar and Tanvi, my friends who were visiting me from the Silicon Valley last December, to see the Amish country. Too bad it was a Sunday and the town was closed.}

Author: Atanu Dey

Economist.

9 thoughts on “An Essay into the Nature and Causes of Poverty — Part 2”


  1. In summary, the way to help a person become non-poor is to release the credit-constraint that blocks the way. In the next bit, using this basic principle show how poverty can be eliminated in India.

    On reading your last line, I cannot help being reminded of micro-finance and Muhammad Yunus, and of course the disaster that it turned out to be. Something tells me that you are NOT going to propose something similar, but in any case please read this illuminating paper:

    The Microfinance Illusion
    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2385174

    Like

    1. I had been a critic of microfinance even before the whole business collapsed. My objections were many. First was that entrepreneurship is more difficult than doing a job. Then the really poor don’t need loans. They need transfers and grants so that they can feed themselves. Otherwise microfinance was going to be used for consumption, or at best income smoothing.

      The idea of credit-constraint is broader than microfinance. Thanks for the link but I have a lot more to get done than read about that failed project.

      Like

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