Wealth, Income, Consumption & Utility – Part 1

Thomas Hobbes (born 1588 CE) had a dismal view of humans living “in a state of nature.” In his famous book Leviathan (published 1651 CE) he characterized human life as “solitary, poor, nasty, brutish and short.” From all the evidence we have it appears that he was, to a first approximation, absolutely correct about the human condition.

Human beings — species homo sapience — have been around for approximately 300,000 years. Taking a generation to be 25 years, we have had 12,000 generations of human beings prior to our own. An estimated 100 billion of us have ever lived, including the present 8 billion.

The industrial revolution began around 1750 CE. Before that, all humans lived a Hobbesian existence; after that, humans started escaping that horrible fate, slowly at first and gradually gaining speed. Therefore in fewer than 20 generations of the 12,000 generations of humans have people had a chance to live somewhat comfortable lives. That means 98.3% of generations of human beings lived in abject poverty. That means that to “a first approximation” 100% of all people have lived in misery. Consider yourself awesomely lucky.

But, if instead of generations, you consider the number of human beings who have escaped dire poverty, the number looks somewhat better. My rough estimate is that only around 10 billion people out of 100 billion ever have not lived in dire poverty. That means of all humans ever born, 90% have lived lives we would reject as not worth living.

Today the world is astonishingly wealthy compared to any time in the past. Around three billion of us are very well off; another four billion are moderately well off; and only around 800 million are living at or below the poverty line.

Certainly 10% of the world population living in poverty is not a happy figure but that is a small number compared to the 90% who lived below the poverty line just 200 years ago. It represents a huge improvement in the human condition.

Just to make this personal to bring my point home, all of my ancestors, with the exception of only the most recent three generations, have lived lives that I would consider to be abject material poverty. My grandparents moved up from dire poverty to simple poverty; my parents were comfortable; and the people of my generation are quite well off. They have cars and travel internationally on holidays.

The wealth that my generation enjoys — and no doubt your generation too, dear reader — would have been inconceivable to all of my ancestors, including my parents and grandparents. Nothing that we take for granted today could have even been imagined by people living just 100 years ago. That’s true for me, and undoubtedly true for all your ancestors as well. Ponder that fact.

Things have changed at a pace and direction that is simply beyond human imagination, although every advance was the result of human creativity and imagination. The wealth that we humans have today is impossibly large compared to the wealth humanity had just a 100 years ago. And what’s more, the wealth that humanity will have in the next 100 years is beyond our capacity to imagine.

Just as abject poverty was the normal condition of humanity in the past, incredible wealth will be the normal condition of humanity in the future.

In this piece, I would like to explore three concepts related to wealth: income, consumption, and utility.

Material wealth arises from human action. Most of the wealth we enjoy is what we have created. Wealth is not natural. It’s entirely artificial. Society collectively has wealth which is the sum of the wealth created and owned by individuals. If in a society the individuals do not create wealth, that society is poor.

Wealth is a stock, and that stock changes over time. Wealth is a function of income. What we earn in a specific period is income. Income is a flow. Over time our wealth grows if our consumption is lower than our income. If we save part of what we earn, our wealth grows; else it shrinks.

Consumption is what we spend in a specific period. If we consume less than we earn, our stock of wealth grows, and vice versa.

Finally, we derive utility (or satisfaction) from our consumption. The utility we derive from whatever we consume is entirely subjective. Meaning, the same thing consumed by someone else would afford different utility for different people.

The subjective utility depends on one’s preferences. A ham sandwich to a vegetarian has zero (or even negative) utility; to a meat eater, it would be positive.

Also, the additional utility from consuming a particular item decreases. The first ham sandwich has a great deal of utility when one is hungry; the second one provides some additional utility but because one is less hungry, the additional utility decreases even though the total utility increases. This effect has a technical term associated with it: diminishing marginal utility.

Therefore the total utility derived from the consumption of a particular item is bounded. When you are fully satiated (or satisfied), your utility does not increase any more, and indeed will start decreasing. If a person is forced to drink too many glasses of water, he gets lower total satisfaction than when he decides that he’s had enough.

Because of the fact of diminishing marginal utility of a particular item, and because one reaches a point of satiety, the total utility for that particular item is bounded. But the aggregate utility from a variety of consumption goods can grow with the number of items available for consumption.

If I have a variety of foods, each individual item has a utility upper bound but the total utility will increase until the point that I am fully satiated with food and that’s when I will have to stop.

This brings me to the point of this piece.

Wealth is unbounded. An individual can have millions or even billions of dollars of wealth. There’s no conceivable upper bound on the wealth one can own. In the end, wealth is just a number in come accounting system. Income, likewise, is unbounded. However, consumption is less unbounded. And utility is bounded even more than consumption.

How about the lower limits of wealth, income, consumption and utility?

In the world of the past, the total wealth of the world was very low. There were of course fewer people in the world but everyone was abjectly poor and the total wealth was nothing to write home about.

Another way of thinking about income is that it is the amount of wealth that is created in a specific time. If the collective produced only a little amount of wealth in a specific time, the average income was low; and vice versa. A nation is considered rich if the people have high income — which means that the people produce more wealth in the specified period.

So therefore in the past, people produced little wealth, therefore had low income, therefore they had low consumption — therefore the world was poor in the past. And finally, given the low levels of consumption, utility was also severely limited.

One could easily catalog the number of distinct goods produced in the world of the past. Each region of the world produced mostly some food (agricultural and farm animals), some tools and some shelter, some clothing and that was that.

People lived hand to mouth. Literally. Nothing was in such abundant supply that everyone would have been satiated; scarcity was the defining feature of the world.

Today the world has an unimaginably large amount of production. Tens of millions of distinct items are produced by the collective. Billions of people have access to them. These billions are not just the consumers of these items; they have to be the producers too. It isn’t as if the goods we consume are produced by aliens. We consume only what we are able to produce. Production is upstream of consumption, as we economists say.

One interesting consequence of the incredible increase in the wealth of the world is inequality. The world of the past was equal in terms of wealth, income, consumption and utility. Equality was the norm and what inequality there was was not that remarkable.

The difference between the people at the top of the heap and the bottom of the heap was limited. Sure the emperors and kings of the past had a lot of “wealth” measured in their stock of gold and other precious metals. But their consumption was severely limited compared to what we consume and derive utility from today.

There was what we recognize as inequality but the difference between the rich and the poor was inconsequential in terms we recognize today. From our vantage point, the most wealthy of the past were pathetically poor relative to the people of today.

I will explore the notion of inequality over time. The summary is that inequality in most dimensions will increase monotonically with time. Is that something we should decry or we should celebrate? That’s something to think about. Let’s continue to think about next time.

Be well, do good work and keep in touch.

{Continue on to read Part 2}

[Image at the top of the post: a seat on an intercontinental flight in comfort that the richest emperor just two generations ago could not have enjoyed. But millions of moderately rich people today have that.]