“Maybe the main function of economics in general is not, as we usually think, the systematic building of theories and models, or their empirical estimation. Maybe we are intellectual sanitation workers. The world is full of nonsense … Maybe the higher function of economics is to hold out against nonsense, … All those theories and models we invent and teach are just nature’s way of making people who know nonsense when they see it.” — Robert Solow[1]
It takes only a bit of economics to realize how much intellectual garbage there is in the world. Learning economics is depressing in that regard. You see piles of intellectual garbage all around. And you cannot do anything about it. You clean up a bit and it keeps piling up. It’s enough for a body to despair.
People’s minds are so full of garbage that it’s a wonder that the world functions at all. That’s when one realizes, if one understands basic economics, how truly marvelous the Smithian invisible hand is: even though people generally systematically believe in all sorts of garbage, their self-interested actions produce an aggregate outcome that they don’t really intend or even comprehend. The good that arises is accidental, not intentional.
Warning: This is a long read — about 12 minutes.
Part of what I do here is to be an unpaid intellectual sanitation worker. Garbage disposal is not a one-time job; you have to do it regularly since garbage — the same old stuff — keeps being generated all over again.
One major bit of intellectual garbage has to do with wealth. Wealth is important for human flourishing. The crying shame is that the nature of wealth is seriously misunderstood by nearly everybody — I’d estimate 99 out of 100. Even many who have studied economics get it wrong, never mind the untutored. But understanding the concept is not hard at all, provided one is open to reason and has a bit of common sense. It’s not quantum mechanics; very few people have the brain power to understand QM (I don’t). I am no Bob Solow or Friedrich Hayek, but once I thought systematically about wealth, I got it. Can’t be that difficult, can it?
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The world has been getting wealthier with time. Take the world of the year 1800 CE. That’s just approximately 10 generations ago. By today’s standards, everyone was dirt poor. The wealthiest country in the world then, the US, had a per capita income of around $3 a day (in constant 2020 dollars); today the world average is $33 per capita a day, the US is $130, China $20, and India $10. Economic historians like Dierdre McCloskey estimate that the world today is an astounding 30 times richer than it was in 1776, the year that Adam Smith published his monumental work, An Inquiry into the Nature and Causes of the Wealth of Nations. The trend appears unstoppable.
Nearly everyone today is wealthier than their ancestors. The average resident of any industrialized nation is wealthier than, say, Louis XIV (1643 – 1715), the King of France. His residence was the Palace of Versailles. It was huge. “Covered by around a million square feet (10 hectares) of roof, the palace has 2,143 windows, 1,252 chimneys, and 67 staircases.”
Louis XIV no doubt lived like a king — but he was the king of a very poor country by our standards. Imagine this. If a person living in a 2-bedroom luxury apartment in an advanced industrialized economy in 2021 were given the chance to get into a time machine and get transported in time to live his entire life as Louis XIV’s housemate, I doubt he would take it if he had any sense. He’d be absolutely miserably off materially if he took that offer.
I quote myself from a post from May 2019:
Just a 100 years ago, even billionaires could not afford any of the gazillion things we average folks can order from the comfort of our bedrooms and have it delivered the next day. We are immensely richer than even the richest emperors. The Palace of Versailles, the principal royal residence of France from 1682, under Louis XIV, did not have air conditioning or refrigerators. No telephones. No surround sound, no 4K UHD video system. Not even ice cream in summer. I am richer than Louis XIV.
Louis XIV no doubt traveled in comfort by the standards of his time. Perhaps he could cover 50 miles a day in a royal carriage over bumpy dirt roads. But you can do what he couldn’t even imagine. You can, if you are moderately wealthy today, travel to any part of the world within a day, even 10,000 miles away, in first-class comfort in a huge commercial jetliner: big, luxurious bed; food and drinks on demand; bathroom with shower, etc.
Most of us in the developed world are materially better off than the wealthiest people of the past (who were mainly kings and emperors.) In about 100 years, the average person would be materially wealthier than the wealthiest people of the present (who are mainly people who create great wealth.)
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Material wealth gives a person power — over other people and over whatever the contemporary society has to offer in exchange for wealth. If you have the wealth, you can get a heart transplant if you needed one today. No amount of wealth would have allowed Alexander the Great to get that, even though he was the emperor of a great deal of the world. He died young. He probably died of a minor fever or infection that would have been a trivial affair today.
Louis XIV’s palace had hundreds of rooms. But he could have occupied only one room at a time, and slept in only one bed at a time, and I am fairly confident that his bed could not have been more comfortable than a bed I can afford today. Certainly his palace has lots of gold and other glittering stuff but it did not have central heating and cooling, did not have the sort of beautiful lights that I have at home which I control using some app from wherever I am in the world. I have a choice of a few thousand different meals that he could not have imagined even though his kitchen was staffed by hundreds of people.
Louis XIV had power of life and death over anyone in his kingdom. “Off with his head!” and it would be done. Thank you but I don’t have much need for that. What I do have is the power to get antibiotics if I need them, and get painless dental surgery — which L’XIV did not have for all his wealth.
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Two fun facts. One: wealth inequality — which translates into power inequality — has been a fact of life since time immemorial. It’s like weather. It’s a fact of nature. Two: inequality has grown, is growing and will continue to grow exponentially. (I used the word exponentially advisedly.)
I imagine that around 200 years ago, the richest person in the US had a wealth of around $100 million, and the average wealth was around $100. That’s six orders of magnitude inequality. Today the wealthiest in the US have a few hundred billion dollars of wealth, and the average wealth is around $1000. That’s eight orders of magnitude (if I have my arithmetic correct.) Just in raw monetary units, the wealthiest today are 100 times more wealthy than the wealthy of two centuries ago.
Furthermore, in real terms, the super-wealthy of today are incomparably wealthier than the wealthy of the past. Why? Because today’s wealth can get much more than the wealth of the past. Every year livestock are fed millions of tons of antibiotics (which is probably a bad thing) but you could not get antibiotics for any amount of love or money just a few decades ago.
Andrew Carnegie did not have the kind of instant access to information that I have from the comfort of my home (or car or plane.) I can talk to any of the hundreds of people I know around the world instantly. Not just talk, I can do video calls for practically zero marginal cost — something no one on earth could do just a few decades ago.
I don’t envy Carnegie’s wealth because in a (limited) sense I am better off than he was. I do not envy the wealth of today’s billionaires, either. Agreed, it would have been nice if I had billions but I am not so sure that it would buy me more happiness than I have today, or that it would make me a better person than I am.
I think that of all the vices, envy is the worst. And of all the virtues, contentment is the post precious. But I digress.
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Let’s get back to wealth. People do have a hard time understanding the concept. It is a concept at one level. It does have a physical manifestation but it is also importantly subjective. It has to be subjective because it is a human-centric concept. Wealth is subjective since value is subjective, and costs are subjective. It is quite easy to understand that value is subjective. But costs? That’s fairly hard to understand. For now, I’ll pass on that.
Why is wealth so hard to understand? I believe it has something to do with the fact that gold or some other precious metals are considered wealth. Note the word considered implies subjectivity.
Now, we know that there’s only so much gold in the world at any particular time. Which means that if someone has an amount of gold, others have to make do with the remaining. If you take more than your “fair” share of gold, then it necessarily means that that leaves me with less than my share fair. The amount of gold is zero-sum.
Next, gold does not magically spring out of the ground. Getting gold requires effort. If the people who do the work of mining and refining gold don’t get to keep that gold they produce, they are being exploited by those who end up with the gold. Therefore if someone has a huge hoard of gold, that is a wealthy person, and his wealth is a result of the exploitation of workers since he could not have put in the work by himself. The exploitation is morally outrageous. It’s simply wrong.
The conclusion from those three facts — that gold is wealth, that there’s a fixed amount of gold at any time and that it takes effort to get the gold — is that there’s something immoral about wealthy people because they must have stolen the wealth they have from workers. Therefore for the sake of fairness and equity, the wealthy should be dispossessed of their ill-gotten wealth. The government should confiscate and redistribute the wealth. Workers of the world unite. QED.
The trouble with the above argument is that wealth is not like gold or any other precious metal at all. First, gold cannot be created; it exists in nature and therefore finite in a finite world. Wealth, by contrast, does not exist in nature. It has to be created. It is created by transforming naturally occurring stuff on earth. That transformation is effected by combining various nature-given stuff using recipes which we label as “technology.” Although the amount of stuff is, strictly speaking, limited, the amount of stuff is for our purposes unlimited. Moreover, the stuff we have around us can be combined in various different ways to create whatever we value.
There is no limit to how much wealth can be produced. Wealth is not zero-sum.
Let’s consider an analogy. The larder has a bunch of stuff — flour, rice, salt, sugar, butter, beans, spices, vegetables, etc. — all of which are limited in number and quantity. But the number of different dishes you can cook up is a combinatorically large number using various different recipes. The more recipes you have and the better the recipes are, the more number of good dishes you can make. There’s no limit to how many recipes that can be invented and used, and therefore there are no meaningful limits to the variety of what you can make even though the larder has limited quantities of stuff. The finite size of the larder limits the amount of food but not the variety that can be produced.
The production of wealth requires matter. Since there are no meaning limits to the amount of matter around, there are no meaningful limits to wealth that can be produced.
Let’s explore the phrase “no meaningful limits” a bit. We can get energy out of burning wood. There’s a maximum sustainable rate of getting energy out of trees; go beyond that and your land becomes a desert. Therefore there’s a “meaningful limit” to energy we can get out of wood.
Now suppose you figure out how to get energy out of deuterium-tritium through fusion.[2] The reaction is extremely energetic and you get gazillion watthours of energy from a few grams of the stuff. D+T is found in water, and there’s trillions of tons of water on earth, there’s “no meaningful limit” because it is practically unlimited. If you have the technology and you’ll have as much energy as your heart desires.
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Energy is the start and the end of it all. The alpha and the omega. Energy is Shiva, the god of creation and destruction, dancing the universe into existence and out of existence by his dancing the Tandava.[3] The rest of the story is just details of how energy transforms base stuff into wealth through human agency. But I am getting ahead of myself.
The larder of the universe is large. Many trillions of variety of stuff. The various “dishes” you can cook up using those trillions of various kinds of stuff is beyond human imagination. The curious thing is that all those variety of stuff is made up on (as far as we know now) only about hundred elements.
The hundreds of elements are themselves made up of (as far as we know) only of protons, neutrons and electrons. But wait, there’s less. The basic bits (to the best of our knowledge) are just a few even more elementary bits: they are part of the so-called Standard Model of particle physics. Quarks have fanciful names — top, bottom, up, down, charm and strange. The bosons (named after Satyendra Nath Bose) are kind of boring and the leptons are just too simple, having no internal structure.
I will stop here with the physics bit since I am not a particle physicist (though I have friends who are.) The point I want to make is that combinatorial explosion is the name of the game. You start with a few things, and create a larger number of things at a higher level using various combinations of fewer things at the lower level. You iterate on that and soon enough you have a very large number of different things. What we call wealth is what we value of all the different things we create. We create wealth by using our brains. Wealth is not some fixed amount that exists out there in nature.
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The character of wealth and what constituted wealth has changed with time. Once upon a time, land and labor were the only factors of production — mainly food. Labor produced the food that was farmed on the land. Therefore, the greater the amount of land you had under your control, and the greater the labor you had under your control, and the greater the product of the land. The more power you had, the more you could grab of what others produced, and therefore the greater your wealth. Power came prior to becoming wealthy. Conquest of people and their land was the name of the game. The “production function” was simply
Y = f (land, labor(land))
where the variable Y (which is income) was a simple increasing function of land and labor (which itself was a function of land.) More land, more labor, more income, and therefore more the wealth you had. The way to wealth was to capture as much land as you could. In other words, colonization. The British, the Dutch and the Spanish went on expeditions to colonize the world because land (and labor associated with the land) mattered at that stage of human history.
As time went on, income became less reliant on the land-labor variable when capital entered the equation. The production function became
Y = f (capital, land, labor)
Capital is whatever stuff that is used in production but which has to be produced first. The knife you use to make food is capital. It has to be produced first and then used. It’s therefore a “produced means of production.” So the more capital you have, the greater your productive capacity. But that raises the question, “how do we produce capital?” We need to have the knowledge of how to produce the knife.
To produce wealth, we need to have not just land and labor but we need to have capital also. And to have capital, we need the know-how, the recipe — or what we call technology. So now we have to include technology in our production function.
Y = f (technology, capital, land, labor)
Income Y is function of technology, capital (which has to be produced), land (all the stuff that is provided by mother nature), and labor (which is what we humans provide in terms of our physical and mental effort.) Our income aggregated over time net our consumption is our stock of wealth.
We must pause here for a bit to note that all this is not quantum mechanics. Any person of average intelligence can understand all of this. But why don’t people get it? Because they miss one essential trick. They don’t think slow. Thinking slow is the way to comprehension. Read fast but think slow, is my motto. If you want to know what the elephant is really like, take a slow walk around the elephant. If you just touch the elephant in one bit and quickly conclude what it is, you’re going to end up being wrong. Stop doing that.
Bob Solow again. He said that he has to read things three times before he really understands something important. Remember he’s no intellectual slouch. So don’t expect to understand things by just skimming ideas when even Bob with all his awesome brains can’t do that. Think slow, not fast — to put it in Danny Kahneman’s terms.
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Unlike geographers who know the lay of the land, and theoretical physicists who do it with particles, we economists do it with models. Models are stories. We economists tell stories. It is said that we are monkeys who liked stories so much that they lost their tails.
Our economic models are important. They explain what would otherwise be incomprehensible because the world is too complex a phenomenon for us to be able to explain it all in one go. We have to tell simple stories. If you are clever, you use mathematical symbols to tell stories. But the cleverest of the lot tell stories in simple words, then with a simple set of equations, and perhaps with simple diagrams.
Here’s the Solow story of macroeconomic growth in a simple diagram. Note the little upward pointing arrows. It says, “rising output leads to rising savings, which leads to rising investment, which leads to rising capital stock, which leads to rising output, …” It’s a virtuous circle.
Nothing extraordinary, you’d say. And you’d be wrong. Go back and check out the full model. (See footnote 1.) You’d be astounded by Solow’s insights.
That’s not the end of our story. What if there’s a connection between savings, and the creation of technology, and then that technology goes into the production function? What if the production of technology is itself a function of how much wealth there already is in the economy? What if, in other words, technology is endogenous?
Here’s the next iteration of the story, or the model.
Here we posit that technology is produced as a consequence of “R&D investment” which is a function of savings, and that the technology we have leads to output, part of which goes into savings, a part of the savings goes into capital investment, and part of it goes into R&D investment, which then increases output … and so on it goes. Technology is therefore “endogenous” — it is part of the process and not given by some external agency.
(For an accessible account of endogenous growth theory, see Paul Romer’s 1994 piece at the JEP, “The Origins of Endogenous Growth.” Romer was the recipient of the 2018 “Nobel” prize in economics.)
What we have to pay attention to is that there are positive feedback loops in the system — more output, more savings, more investment in capital, more investment in the development of technology, therefore more capital, therefore more technology, therefore more output, which means more wealth, and we keep going round that circle of greater output.
The conclusion is that wealth is endogenous. Which means, that wealth is created by the system from within it through processes that have positive feedback loops. Technology is involved in wealth creation and technology is also endogenous. Since there are no limits to how much technology can be developed, there’s no limit to how much wealth can be produced.
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Wealth has to be created by people since it does not exist in nature. Today, as opposed to any time in the past, there’s more technology. Therefore there’s more wealth today than any time before the present. It also means that there will be more wealth produced in the future than was produced in the past.
In the past, someone could grow extremely wealthy by robbing people of whatever wealth they (the people) had created. But that’s a game that eventually ends because once you have expropriated all the wealth from others, that’s it — you cannot accumulate any more wealth.
But if there’s a process that creates wealth, then as long as the process continues, wealth grows. Furthermore, if you create wealth and take only a part of that wealth yourself, then you are doing good regardless of how wealthy you become.
Here’s a critical distinction. If your wealth is what you acquired through robbing others, then that wealth is condemnable. If the wealth you have is only a part of the wealth you have created, then it is commendable.
Politicians, bureaucrats and judges of third rate nations (such as India) become wealthy not because they have taken a bit of the wealth they themselves have created but because they have captured a part of the wealth that others have created. They are rich through robbery, not industry.
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Wealthy people have existed since the beginning of civilization, but not prior to that. Pre-civilization, in the hunter-gatherer era, everyone was dirt poor and there was no inequality of wealth. No one could hunt and gather significantly more than anyone else, and you could not accumulate much because a nomadic life meant you could not keep more than you could carry, which was pitiably little.
Settled agriculture allowed the accumulation of wealth. That was the start of wealth inequality. But the inequality was limited. The equivalent of today’s billionaires did not exist. It took thousands of years before enough wealth was created for the equivalent of today’s millionaires to exist, and only in the last couple of centuries did it become possible for billionaires to exist.
The number of billionaires per capita varies across both time and space. Longitudinally across time, in any particular location there are more billionaires today than in the past. Cross section across space, there are more billionaires per capita in rich countries than in poor countries.
That last fact should give us a clue about the source of the wealth of the super-wealthy today. Rich countries are by definition rich because they produce more wealth. The creators of wealth — large and small — get to keep a part (often a very small part) of the wealth they create, and the rest of the wealth accrues to the rest of the society. A corollary of this fact is that the more billionaires per capita there are in an economy, the higher the per capita income and wealth of the economy is.
If I were told that I could choose any country to live in but I would not know what my socio-economic standing would be in that country (that is, I would be behind a “veil of ignorance” about my wealth and income), I would choose a country with the highest number of billionaires per capita. The US has a truckload of billionaires (and a handful of super-multi-billionaires); the average US resident is correspondingly rich. Which is one of the reasons I live in the US.
This is worth repeating. The US system has evolved to be such that it allows people to create wealth, then allows them to take a part of the wealth they create, and finally accumulate wealth. If someone has accumulated a couple hundred billion worth of wealth (such as Bezos, Musk), it must be that the total wealth he created was in the order of trillions, which others benefited from.
This means that the higher the number of super-wealthy in an economy, the better the economy is for the average person in that economy. The caveat of course is that the wealth of the super-wealthy was through wealth production and not through wealth redistribution from the poor to the rich.
The envy of and the resentment toward the super rich is understandable but it arises from a basic misunderstanding of the nature and processes of wealth creation. The rich are not rich because they have taken more than their “fair share” from a pile of pre-existing pile of wealth. The rich are rich in a free-market, voluntary exchange economy because they have created additional wealth through entrepreneurship and innovation.
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It is often claimed that no one needs hundreds of billions of personal wealth. That’s true enough because no one can consume that much wealth. The super-wealthy do consume more than the rest of us. But as a percentage of their wealth or income, it is a very small fraction.
An average person person in his lifetime perhaps consumes, say, 75 percent of his lifetime income. A super-billionaire consumes $10 million a year, for a total of $700 million over his lifetime — which may work out to be around 2 percent of his lifetime income.
We should understand that no one has billions of dollars in his checking or savings account. The wealth of the super-wealthy is mainly in terms of shares of large corporations, which they have created and control. Without the control they exercise, the shares of the corporation would be worth very little.
Share prices of corporations reflect the judgement of market participants about the future flow of income that corporations would generate. The success of a corporation depends on the management. Take away Musk from his ventures like Tesla and SpaceX, and the share prices will collapse. Not only will Musk lose his wealth but the economy will lose a lot more.
Musk did not sleep his way to becoming wealthy. He worked (and works) harder than most people are even capable of. To become super-rich in an economy like the US, you have to have super-normal initiative, super-normal intelligence, super-normal diligence, and super-normal luck. Hard work, though necessary, is not sufficient. Luck plays an important role.
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Granted, very wealthy people have the power to game the system in their favor by bribing government officials. To the extent that this is done (done quite frequently in poor countries), it is condemnable but most of the wealth of the super-rich in capitalist economies is not due to crooked deals. To become wealthy, one has to create a great deal more wealth.
Should the government confiscate the wealth of the super-wealthy and distribute it to others? It sounds like an attractive prospect if you feel for the poor. I do feel for the poor. In fact that was the primary reason that motivated me to study economics. I wanted to understand what would be the best way to help the poor.
Now that I have spent several decades studying economics, I know that confiscating lawfully earned wealth from anyone — even the super-rich — would be a super-bad idea. All it would do is to make the poor worse off than they would be if the wealthy could secure in their wealth and their property rights. This is not super-evidently true but it is true if one thinks slowly about it.
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Allow me a personal interlude. I had the good fortune of studying engineering in my undergraduate days. I learned that systems can be engineered. Therefore, I thought, the economic system could also be engineered, like all well-meaning but stupid engineers do who don’t know any economics. Later I learned that economics is about people, not machines. Machines have no will of their own but people do.
Boards don’t hit back. See Central Planners and Wooden Boards, and Understanding Economics is Easy.
Social engineering does not work. Politicians, bureaucrats and social engineers even if their motivations are good (which is not very often), do more harm than good.
The major problem of the do-gooder (many of whom are elevated to the status of demigods) is that they are impatient and they intervene in a system that they don’t understand. We all know what that farmer did to the goose that laid golden eggs was wrong. The goose laid a golden egg every month. The farmer thought that all the eggs that the goose would eventually lay was already in the goose. Why wait, he asked himself. So out of greed and impatience, he slaughtered the goose and found nothing in it.
Killing the goose that lays the golden eggs is stupid. Confiscating wealth will not cure poverty any more than killing the golden goose did.
The super-multi-billionaires’ wealth is not something that they have sitting around in their basement. The wealth does not actually exist here and now. Their wealth lies in the future, and only in time will all that wealth be created. Promise to “kill” them now and you will get nothing. Give them time and promise to not confiscate their wealth, and you will help everyone, rich and poor.
Inequality is hard for us to countenance. Our moral intuitions find it abhorrent and intolerable. There are around a billion people alive today who have to survive on less than $2 a day, while there are dozens of super-ultra-rich who have multi-billions worth of wealth. This cannot be fair.
But it isn’t matter of fairness. The world is not fair. Individuals can be fair or unfair, not collectives. We have to ask if there’s something that can be done to help those who suffer poverty. Note that there’s a distinction between the poor and those who suffer poverty — the former been a relative term, and the latter an absolute term. We all are poor relative to the super-ultra-rich; but none of us reading this is suffering from poverty.
We have to focus on poverty, not the poor. If alleviating poverty requires confiscating property from everyone (including the merely wealthy and the super-ultra-rich), then that’s what we should do; if alleviating poverty requires never confiscating property from anyone, then let’s do that. If it requires central planning, then let’s centrally plan; it is means the separation of the state and the economy, then let’s do that.
Nobody reasonably questions the goal of eliminating poverty; our quarrel is about the appropriate means. If you think slowly about that, you realize that people who have the freedom to create and keep wealth, create the most wealth, and that ends up helping everyone, and reducing poverty.
NOTES:
[1] Robert Solow (b. 1924) is Emeritus Institute Professor of Economics at the Massachusetts Institute of Technology. He was awarded the Nobel Memorial Prize in Economic Sciences in 1987 for his “contribution to the theory of long-term macroeconomic growth.” If you like to see a sketch of the model, I recommend this Fall 2005 U Penn Econ 102 lecture by Prof José-Víctor Ríos-Rull. Caution: not for the mathematically faint-hearted.
Many of Solow’s doctoral students went on to get the “Nobel” prize themselves — Akerloff, Diamond, Nordhous, Stiglitz.
Solow is a very clever fellow. And quite funny too. I should tell you about his complaint about Milton Friedman’s obsession with money supply. He wrote, “Everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of the paper.”
[2] Deuterium–tritium fusion (sometimes abbreviated D+T) is a type of nuclear fusion in which one deuterium nucleus fuses with one tritium nucleus, giving one helium nucleus, one free neutron, and 17.6 MeV of energy. It is the most efficient type of fusion for fusion devices. {Wiki.}
[3] See Tandava — Shiva’s Cosmic Dance.
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