Funny Money: Maybe economics isn't supposed to make sense, after all
November 17, 2011 7:17 PM   Subscribe

How can wealth be considered as anything separate from natural resources?

This article, linked to in an OWS discussion as an example of 'creating wealth' talks about the net worth of Apple as if it is $350 billion that comes from nowhere, except for the genius of Steve Jobs, of course. Thinking of wealth as something that can be created from nothing breaks my brain a little bit. My understanding of money is that it represents purchasing power that entitles you to a 'share' of the available resource-based production. Therefore, if Mr. Warren Buffett gains 1 billion dollars this year, and my wealth remains constant, my ability to purchase material things should go down as I proportionally now have fewer shares of purchasing power.

I started to think about this while watching The One Percent, in which Milton Friedman defends the enormity of change of the average income of the wealthy by saying that also the average income of the poor has gone up. He then promptly shuts down the interview and ejects Jamie Johnson, but that is here nor there. This seemed disingenuous to me; if the wealth ratio of the rich to the poor goes up, doesn't that mean that they are gaining disproportionately more purchasing power and that the poor are actually getting poorer?

Please explain to me how wealth can be created, a la "poof," and how this miracle affects the wealth of others. Forgive me for never having read an economics textbook, but the defenses of the income disparity that I see brought up repeatedly seem wanting in common sense.
posted by StrangerInAStrainedLand to Work & Money (27 answers total) 2 users marked this as a favorite
Wealth is natural resources organized in a useful way. A mountain full of steel is less valuable than a fleet of ships. A house is more valuable than a pile of bricks which is in turn more valuable than the mud they make bricks out of.

Take resources, add work, increase wealth.
posted by tylerkaraszewski at 7:20 PM on November 17, 2011 [2 favorites]

mountain full of *iron ore*.
posted by tylerkaraszewski at 7:21 PM on November 17, 2011

The idea that wealth cannot be created, that the cake is only so big and that if someone is rich that means someone else is poor is one of the simplest of economic fallacies. Think about how you add value to things in your own life by performing a task for service every day. A loaf of bread is worth more than a handful of flour.
posted by joannemullen at 7:32 PM on November 17, 2011 [4 favorites]

You're right that if Mr. Buffet made an additional billion dollars this year while your wealth was unchanged, you have less purchasing power relative to him than you did last year. However, your purchasing power doesn't necessarily have to go down, because "purchasing power" isn't a fixed quantity. New things are created to buy every year, by organizing resources differently as others have described above. Take things that already exist, organize them in a new way that makes people want to give you money (above the costs of the raw materials) for it, and boom! You've added value to the economy.

The poor haven't gotten poorer because the rich have gotten richer; minimum wage not increasing with inflation, overall wages not increasing with inflation, not being able to live decently on minimum wage because there's more that's needed for a decent life now (e.g., healthcare! College! Internet!) Everyone's incomes have gone up, sure- Milty wasn't wrong, but the incomes of the wealthy have gone up at a much faster rate, and that, as I understand it, is the issue.

Apologies in advance to econ people for carelessly conflating wealth and income, and not using purchasing power properly either.

Anyway, I'd suggest getting your hands on a basic intro to economics to understand this stuff better- even if you totally disagree with the discipline on moral grounds or whatever, knowing the terms is helpful for understanding this stuff. My high school econ teacher suggested this one although it's probably outdated at this point.
posted by MadamM at 7:52 PM on November 17, 2011

Everyone else is giving good answers. But this does raise a decent point:

if the wealth ratio of the rich to the poor goes up, doesn't that mean that they are gaining disproportionately more purchasing power and that the poor are actually getting poorer?

In some circumstances, this is true, in the case of limited, unreproducible resources, like, say Manhattan residential real estate: the ability of people from hedge funds to pay large amounts of money for Manhattan co-ops displaced not just the working class but even mid-range professional like lawyers who were making "more" money but not enough to outcompete those with exponentially-increasing salaries on Wall Street.

In cases of things like electronic trinkets, it works in the opposite way: increased wealth creates a market for electronic trinkets, which can be mass produced and can ultimately be sold for relatively nothing, so that even among the poor, purchasing power still increases. The part of the equation you're forgetting is that amount of "stuff" you can purchase with that purchasing power. That's a changing value. If you and Warren Buffet are fighting over the same electronic trinket, then, yes, his $1 billion more dollars makes it harder for you to buy that trinket. But if that trinket factory decides to produce millions of those things, then it means that everyone who wants one can probably buy one.

Stagnating wages have made it hard to buy important things, though. The price of education and health care have been rising faster than inflation and faster than incomes. Even if there are more electronic trinkets being manufactured than we know what to do with, people don't necessarily have jobs to afford them. Etc., etc.
posted by deanc at 7:58 PM on November 17, 2011 [1 favorite]

On one side, Forbes
And agreeing, Russ Roberts.
There's no finite pot of money.
There's no one pie.
posted by Ideefixe at 8:02 PM on November 17, 2011

Wealth can be created, largely by adding value to something (turning wood into a piano, etc).

But a lot of wealth is also imaginary. A house which has increased in "value" from $100,000 to 400,000 is counted as a creation of wealth, because someone thinks that it could sell for $400,000 - BUT that wealth is purely imaginary until
someone actually pays $400k for it.

of course, the idea that actual resources (what we really should care about) are infinite, and people can hoard more and more of the finite resources to themselves without making other people poorer (whether directly or relatively) is one of the simplest of economic and environmental fallacies.
posted by jb at 8:02 PM on November 17, 2011

jb---not to derail or argue but how does anyone hoard electricity? Or nuclear power? I can understand natural resources like water or natural gas or oil, but are there really individuals who hoard these?
posted by Ideefixe at 8:07 PM on November 17, 2011

Of course there is no finite pot of money.

However, food is finite, as is housing and energy - all which are the essential bits of life that we exchange money for. If rich people get more and more money in relation to poor people, they can drive up the prices of housing and food. We see the first at work within first world economies; in the case of the latter, we see it between purchasers in the first world (including speculators) and those in poorer countries.
posted by jb at 8:08 PM on November 17, 2011

Ideefixe: the first world doesn't hoard natural resources; we use them up profligately. But this has the same effect as hoarding - these resources are more expensive, and poorer people are unable to purchase as much as they would have if demand was lower.

We in the first world probably don't think much about energy, as opposed to something like housing, because it is relatively cheap compared to our incomes. But elsewhere in the world, energy is very expensive - if a rich person buys up all the charcoal in a village to heat a big house (since they are able to pay a higher price), their poorer neighbours will be left cold.
posted by jb at 8:14 PM on November 17, 2011

You can buy up fuels, and electricity itself, on exchanges around the world.
posted by blargerz at 8:20 PM on November 17, 2011

Income disparity, by itself, does not adversely impact you. What matters is that wages have not increased as quickly as inflation, which means the average person feels less wealthy. By focusing on the "1%" and wealth disparity, OWS is really missing the point. Shit sucks not because "OMG THE RICH ARE SO RICH", but because the giant credit bubble which was propping up the economy for the past 20 years finally popped. All those jobs which depended on the mammoth river of cash from profligate consumer spending made possible by overeager bank lending are gone. Even if the 1% gave all their money away, it wouldn't come close to reaching the amount of money necessary to return the economy to the way it was before the bubble popped.
posted by blargerz at 9:04 PM on November 17, 2011

StrangerInAStrainedLand: "Please explain to me how wealth can be created, a la "poof," and how this miracle affects the wealth of others."

Wealth isn't necessarily constrained to natural resources. One way is through laws and institutions. If you go into business making widgets, and sell one for a dollar more than you pay in labor, you have a dollar. Maybe you start a company doing this, and secure contracts and promises such that you can project doing the same thing tomorrow, and next year, and so on. If you had the laws and institutions to sell that company to someone else, you could sell it for the future discounted value of those widgets. This applies for lots of things, like say a house you can rent out. So beyond the inventory of widgets, and the equipment to make them, your company has some value as a process that didn't exist in nature.

Rights to a song might be another intangible form of wealth constructed from whole cloth, which society did on the theory that we'd have more songs in the world if we could properly compensate authors. Whether this is a thing worth doing, and if it even works is under debate in today's society.

Also, it's worth pointing out that Warren Buffet didn't make his billions by outbidding the poor for consumer goods. You can find his house on google, and it's not 10000x better than my parent's home, even though his income is. But even if it did, the important thing here is that when people buy up things, the price increases, and supply should rise to lower prices back down by employing more people. So yes, they have a lot of money to buy things with, but we have a lot of untapped labor to soak that up. Arguably, the prescription the US needs is rich people to spend more and save less.
posted by pwnguin at 9:28 PM on November 17, 2011

Let's take a step back and look at the analogy you chose to use to frame this question: "natural resources." Do you think there's even a fixed amount of natural resources? Nope! People have to figure out how to harness them. This takes an enormous amount of hard work and ingenuity. We use oil and water every day, but someone had to discover them, appreciate their potential, create the infrastructure to deliver them to you, etc. These are very arduous, lengthy processes of going from something that's not doing much good to human beings to gradually giving human beings more and more value. So I think it's revealing that even in your attempt to compare wealth to something with a fixed existence and a fixed value, you haven't found that analogue. (The flexibility of "natural resources" is explained better in Thomas Sowell's Economic Facts and Fallacies, in the chapter called "Third World Facts and Fallacies.")

Just as "natural resources" are not a fixed given, wealth is not a fixed given. The fact that wealth isn't a given is plain to see from observing that a country has lots more wealth now (in total or even per capita) than it did, say, a thousand years ago.

And while you might think "but it's not so much more, because of inflation," inflation is a crude measurement that doesn't necessarily present an accurate picture. It's conventional wisdom that a dollar today doesn't go as far as a dollar 100 years ago, but that doesn't take into account that our money now buys things that couldn't possibly be imagined 100 years ago. You're using at least one of them right now.
posted by John Cohen at 9:36 PM on November 17, 2011 [1 favorite]

if the wealth ratio of the rich to the poor goes up, doesn't that mean that they are gaining disproportionately more purchasing power and that the poor are actually getting poorer?

This is an unusually explicit and egregious example of a fallacy that's often implicit in discussions of "inequality" (a term that's almost never given a clear definition). As others have said, you're assuming there's a fixed pie and the only variable is the proportion of each slice. No, the size of the whole pie matters too. Just think about this: what if you had the power to snap your finger and cause the destruction of everyone's wealth above $10,000? Would you do it? Of course not. That would be a disaster. Children who would have been well provided for would go without food and education. Ah, but what about children who were already impoverished in those things? Sorry, they wouldn't be any better off! They would not have gained any wealth. It would give them little comfort to tell them or their parents, "Oh, don't worry, at least everyone else around you is also poor now." There is nothing inherently good about "equality" of income or wealth. It all depends on whether the equality is achieved by people at the bottom/middle getting wealthier, or people at the top/middle getting poorer.

There is, in principle, no limit to how much wealth or poverty a country can have. Although even natural resources are flexible/elastic (as I said in my previous comment), wealth is even more elastic since it's a human fabrication. We represent money with paper or metal, but of course you don't need the paper or metal; that's just a convention. It's good enough to have the information written down somewhere. It's a social construct. People will create more or less of it depending on extremely complex patterns of human activities that I can't begin to describe in my little comment here. The world started out with no money, and we've tended to create more and more money, but there's no guarantee that it won't go away. The zero-sum conception of the economy, expressed in the idea that the rich getting more wealth necessarily means other people get poorer, is a fallacy with potentially disastrous consequences.
posted by John Cohen at 9:55 PM on November 17, 2011

food is finite, as is housing and energy

In an absolute sense, yes. But year-to-year, it's not finite. If rich people start buying up lots and lots of food, then land I use for a golf course I might decide is more profitable to grow wheat in, so I'll produce more food. Rich people buy up all the houses in one neighborhood might inspire me to buy up a local apple orchard and build condos on top of it. Fuel I can decide either to leave in the ground or to dig into the ground and burn for energy or maybe process that petroleum into plastic widgets.

At the edges, there are limits, of course-- we can run out of oil, the planet can only feed so many people, there's only so much space in Manhattan, etc. But it's illogical to think that all of the "stuff" we can buy is a fixed pie that we're fighting with our neighbors over.
posted by deanc at 10:14 PM on November 17, 2011 [1 favorite]

And I might add that it's the edge cases that are interesting and it's their existence that is causing a lot of public and social and economic disruption that is driving a lot of OWS and the civil unrest around the world right now.
posted by deanc at 10:19 PM on November 17, 2011 [1 favorite]

Thinking of wealth as something that can be created from nothing breaks my brain a little bit.

Let me break it a little more.

Let's imagine an island economy where the local currency is cowrie shells, and further imagine that the island population has grown to the extent that all available cowrie shells have been glommed up and nobody can find any more, so the only shells in circulation are those that have already been in circulation for some time.

Let's further imagine that you've been working for a year and you now have 20,000 cowrie shells under your mattress. You're concerned about cowrie shell thieves, and you'd rather keep them somewhere safer. So when the Cowrie Bank opens up down the road from you, and you see the impressive strength of their vault and they tell you that if you let them look after your 20,000 cowrie shells for you, then not only can you pop down and get as many of them as you want at any time but that they will add an extra 500 cowrie shells to your pile at the end of the year: you decide that this is a good deal, and you hand over all your shells.

Every time you get paid, you take what you made down to the Cowrie Bank to add to your pile; every time you need to buy stuff, you go to the Cowrie Bank and get some shells to do that with. They don't charge you any fees for doing any of this, the people behind the counter are polite and friendly and all in all it really is a good deal for you. You have ready access to your shells and you have not had to worry about somebody thieving them for a couple of years now.

It's a bit weird to see everybody's shells all mixed up higgledy-piggledy in the same massive pile in the vault, but you've seen the books where they keep track of how many shells everybody has put in and they look fine. You're not fussed about which shells you get back - for buying purposes, any cowrie shell is as good as any other - and you can clearly see that the bank has the correct number of shells logged against your name in their account book. All is well.

Mr. Fisher, who lives a few blocks from you, needs a new fishing net. He can't afford to buy one, but he knows that if he had one it would only take a couple of weeks of using it to be able to sell enough fish to pay for it. So he goes and sees the manager of the Cowrie Bank to talk about a loan.

The manager decides that the business proposition makes good sense, hands over 200 shells from the pile in the vault, and makes a book entry saying that 210 shells are expected to come back this time next month. And in fact the fishing is good, and Mr. Fisher makes 400 shells selling fish and brings them all to the bank. 200 of those replace the ones originally borrowed, 10 go in the Cowrie Bank's own account as an interest payment, and the remaining 190 go to Mr. Fisher's deposit account. Everybody wins!

There are lots of people like Mr. Fisher, and the bank lends them lots of shells. This is good for the bank, because it's becoming very popular and if they didn't lend those shells out they'd need a much bigger vault. It's good for the shell borrowers, because they become able to fund enterprises they would otherwise be unable to afford to run. And it's good for all the original shell depositors like you, because some of what the bank makes in interest charges funds stuff like secure vaults and friendly staff and the yearly interest the bank pays you. Business on the island has certainly improved since the Cowrie Bank started up, and nobody is feeling panicky any more about the island having run out of shells.

Fifty years after the Cowrie Bank started, somebody notices that the guy who runs it now has more shells in his account than anybody else on the island, and that he now lives in a very nice treehouse and employs hot and cold running servants. But careful auditing shows that the bank's books all balance; it has done nothing undisclosed for as long as it's been in operation and there is still no shortage of shells in circulation. They're all getting a bit worn and chipped, but business is still much better than it was before the bank got started.

So the brain-breaking question for you is: who created the Cowrie Banker's wealth, and how, and by the use of which natural resources?
posted by flabdablet at 10:22 PM on November 17, 2011 [5 favorites]

The zero-sum conception of the economy, expressed in the idea that the rich getting more wealth necessarily means other people get poorer, is a fallacy with potentially disastrous consequences.

The idea that making things better for everybody requires skewing public policy toward further enrichment of the already rich is also a fallacy with potentially disastrous consequences.

Good public policy needs to strike a balance between wealth creation and wealth redistribution where those two things are opposed. Good analysis of public policy needs to recognize that more often than not they actually go hand in hand.
posted by flabdablet at 10:34 PM on November 17, 2011 [1 favorite]

it's illogical to think that all of the "stuff" we can buy is a fixed pie that we're fighting with our neighbors over

It's also illogical to ignore the fact that some of life's necessities (such as clean fresh water, topsoil, and biodiversity sufficient to reprocess humanity's wastes) are in fact a fixed or even shrinking pie to a good first approximation. In a world with seven billion neighbors, paying at least some attention to these things will do more good than harm.
posted by flabdablet at 10:43 PM on November 17, 2011 [2 favorites]

I think the OP would find part 2 of the most recent quarterly letter from Jeremy Grantham, co-founder of one of the world's biggest asset management funds, interesting.

Several of the replies here are dismissive of the idea that resource finiteness could be a constraint on economic growth. I used to be dismissive of that too, because that's what we learn in Macroeconomics 101 -- misguided mercentilism, blah blah.

But when you look at the role of energy, and particularly fossil fuels - which are basically highly concentrated solar energy - in the world's economic growth in the past couple of centuries, our Econ 101 learnings don't look so hot (not for the first time). And certainly there are a lot of people much smarter and more learned than me who argue that resource finiteness is a constraint.

You can't beat the laws of thermo-dynamics, after all.
posted by 8k at 12:33 AM on November 18, 2011 [1 favorite]

Flabdablet at the end of your thought experiment there are more shells belonging to people who have deposited them in the bank than there are shells in the bank, so the bank itself created them by simply saying that there are more than there actually are. Poof money out of thin air and it gets shared with the bank and people who have deposited them into the bank. Now better would be when that bank gets really big and has nearly every shell on the island it then begins to get too big. Now other people are fed of with the banker getting more and more fake shells by only sharing other peoples shells with people who need them instead of actually doing work. People begin to revert to their own hoarding of shells and then they discover that there isn't enough shells for everyone to get their shells back out, and certainly not enough to cover the shells owed to the banker. The banker then pays itself with the shells left in the bank and runs off to another more tropical island to be a king and the rest of the people are left wondering what the hell happened, they just wanted a safe place to store their shells.
posted by koolkat at 1:46 AM on November 18, 2011

Income disparity, by itself, does not adversely impact you.

Except that, apparently, it does.
posted by jb at 8:16 AM on November 18, 2011

But even if it did, the important thing here is that when people buy up things, the price increases, and supply should rise to lower prices back down by employing more people.

So the very high demand on housing in the Vancouver market - which is largely driven by investors buying up properties - has led to an increase in housing and prices have started falling? Nice to live in your world - in mine, prices for things like housing and (in the developing world) food stay beyond the means of a great many people, because there is no profit in increasing the supply to the point where the price lowers.
posted by jb at 8:18 AM on November 18, 2011 [1 favorite]

So the very high demand on housing in the Vancouver market - which is largely driven by investors buying up properties - has led to an increase in housing and prices have started falling?

Thats the general trend in the US, yes. Prices rose, developers converted farmland into houses and irrational investors bought houses to flip to someone else at higher price. Prices spiraled up, then the whole thing fell apart and prices are falling nationwide as a result of overbuilding -- more homes than the population growth merits.

You can find spots where this isn't the case, and its usually the places where new building is heavily regulated. I figure the difference between a place like Boulder CO and Miami FL is regulatory. When I read articles like this, I suspect that a lot of it is a consequence of policy, and this Yahoo! answer confirms it. But we're a long ways from the question of the origins of wealth now.
posted by pwnguin at 2:52 PM on November 18, 2011

How to make wealth by Paul Graham
posted by leigh1 at 6:37 AM on November 19, 2011

The real point of my little fable is that personal wealth has very little to do with the amount of cowrie shells you can lay your hands on at any given moment, necessary though those may be for the day-to-day conduct of business. Entries in a trusted accounts book will do just as well.

The bank did not create Mr. Fisher's wealth "out of thin air", as koolkat puts it. Mr Fisher created his own wealth by catching fish with a net. All the bank did was extend Mr. Fisher a loan, which he might well have been able to get from somebody else on the same terms even if no bank existed. The bank functions as a trusted middleman and skilled risk evaluator between people who wish to lend money at interest, and people who wish to borrow money for interest.

So if money can be as ephemeral as records in an account book and still function as a measure of wealth, what is wealth?

In my view, individual wealth is essentially the degree to which society has given a person a right to do as they please. It's a social arrangement, and as such has got almost nothing to do with natural resources except to the extent that access to rare ones is generally easier for the wealthy.

Collective wealth is somewhat similar in that wealthy countries get first crack at almost everything, except that there is generally less consensus and more coercion involved. Natural resources contribute more toward collective than individual wealth (the sheer size of the US economy is in large part a reflection of the extent to which European colonizers were inclined and able to make use of the vast natural resources available to them on the North American continent) but once a certain degree of collective wealth has been achieved it tends to be maintained more by force of arms than anything else. This is the point of building empires.

It must be noted that people who care enough about building empires to actually get that job done do tend to be quite wealthy individuals who spend most of their time interacting with other quite wealthy individuals. It must also be noted that accumulation of wealth tends toward positive feedback, and that sometimes we give people the right to do as they please not because we think they earned that right but because we are simply shit-scared of them; bullies quite often do very well for themselves.
posted by flabdablet at 3:12 AM on November 21, 2011

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