How is Wealth Created?

This is a hypothetical short story my Dad wrote a while back for my other blog to demonstrate what wealth really is. It is an interesting discussion of quality of life, and what it means to really create wealth.

Most would agree that America is a wealthy country, but what is wealth and how does it come into being?

It is tempting to think of wealth as piles and piles of money; however, history is replete with examples of worthless currency – Confederate notes at the end of the American Civil War, for example.

What about gold and diamonds? Precious metals and stones are widely accepted as having value, so this is closer to the mark; still, you can’t eat them. To live, humans need air, water, food, and some protection from their environment. We can probably agree that someone who must spend all of his time just to provide the bare essentials to ensure survival is not wealthy. So does free time equate to wealth? In a way, yes, but running around half naked and living in a grass hut does not meet the western vision of wealth, even if you do have only a five hour work week.

In the developed world, we tend to use our extra time, time left over after we meet our need for food and shelter, to increase our standard of living. We strive to obtain better food and more of it, more comfortable shelter, labor saving devices, various forms of entertainment and possessions that increase our sense of well-being. We also take steps to feel good about ourselves such as working for charities or running marathons. This is the essence of wealth: a high standard of living. The higher your standard of living, the wealthier you are. Even those who spend all their time acquiring this high standard of living are considered wealthy.

One could, and some do, argue that this is also the definition of the rat race, that we are not actually better off than our ancestors for all our accumulated wealth. The fact remains, however, that even the marginally wealthy can expect to live a long and healthful life without the threat of epidemic, starvation, being eaten by an animal, freezing to death, or being overrun by a barbarian horde. Thus our working definition of wealth will be a high standard of living.

So where does wealth come from?

Suppose you are stranded on a deserted tropical island with one other person, Alex. You both hunt and gather all day, every day, in order to stay alive.

But Alex is a better hunter than you, and you are a better gatherer. You get an idea; you offer to gather for Alex if Alex will hunt for you. Now, since you are both doing a job you do more efficiently, you have a little free time every day. With that time you develop tools for hunting and gathering, giving you even more free time. Your next innovation is to create fishing gear which you use to improve your diet, and since fish are plentiful, free up more time. With that time you make chairs, hammocks, shelters, and other comforts.

Specialization, cooperation, innovation and motivation have increased your standard of living. You created wealth. All the resources were already present on the island, but this did not raise your standard of living. It was your labor, both physical and mental, that transformed these resources into a higher standard of living.

Next, since life is now easier, you decide to build a musical instrument. It takes a long time. You work hard creating many prototypes that sound terrible. Finally you succeed! You now have music, another boost to your standard of living.

Your island mate would like an instrument too. You teach your friend everything you learned about making this instrument, but to no avail. Alex just does not have the talent required to make one. You are now wealthier than Alex. Your buddy knows how hard you worked to make your instrument and therefore does not ask you to make another. However, Alex is also better off now that there is music on the island. Your wealth benefits both of you.

One day you are walking the beach when you come across two more people who have washed ashore. Their names are Chris and Taylor. You and your island mate introduce Chris and Taylor to island life and get them fed and settled. You assume that, like you and Alex, Chris and Taylor will hunt, gather, fish, and build things. It soon becomes apparent, however, that Chris and Taylor are not very good at fending for themselves.

You and Alex now have a problem; you are spending part of your time to make up the difference between what Chris and Taylor consume and what they produce. Some of your wealth is being transferred to Chris and Taylor. But what can you do? You don’t think it is right to let them starve, so you keep helping them. Time goes by. Chris is still working hard and falling short, but Taylor is only making a half-hearted effort. Taylor’s attitude is “I eat whether I work or not, so why kill myself?”

Alex has had enough and refuses to help Taylor any more. That leaves just you to support Taylor. You are back to square one: working all day every day so that you, Chris and Taylor can survive. The wealth of the island is declining. You are the most productive but your excess goes to Chris and Taylor. Alex helps Chris, but not Taylor, so Alex still has time to create wealth. Your tools and comforts start to wear out and you don’t have time to maintain them. Alex is now the wealthiest, but the island as a whole is poorer. Then you get sick.

Chris and Alex take care of you. Without your support Taylor does not have enough to eat. Taylor has some cash and tries to buy food from Alex, but cash is useless to Alex on the island. The same goes for jewelry and other “valuables”; without an advanced society to create a demand for these items they are worthless. Taylor slinks off to the other side of the island. In time you regain your health.

But Taylor has a serious problem: no shelter, no tools, no companions and not enough to eat. Taylor needs to think of something quickly. Taylor was an accountant before being stranded. This is a valuable skill in an advanced society, but not on the island. Before being stranded Taylor liked to read books about sailing, ship building, and navigation. Taylor sets to work to identify sources on the island for the materials needed to build a sailing vessel.

Taylor returns with a proposal: “In exchange for food I will design a sailing vessel and direct its construction.” Now Taylor has something to trade: knowledge. Taylor knows the important aspects of ship design. Taylor can identify suitable materials. Taylor can navigate by the stars. You, Alex and Chris agree.

With Taylor’s leadership you build a boat and sail it to Hawaii. You have rescued yourselves. With the proceeds from a movie deal you each dramatically increase your standard of living.

You have learned some lessons:

Resources alone are not wealth. Resources must be converted to wealth with labor. The game must be hunted, the berries must be gathered, the fish must be caught, the wood must be cut and worked.

Skill is an important resource. All the other resources in the world are useless if the skill to convert them is not available.

Knowledge is a very important resource. The ability to stuff your head full of things you didn’t know before, recall them, and apply them to the situation at hand is valuable. It is important to note that you need not develop this knowledge yourself. You don’t have to reinvent the wheel. A written language confers a huge advantage. Knowledge can then be saved for posterity.

Specialization leads to efficiency. When people do what they do best, work gets done in less time. The remaining time can be enjoyed or used to increase the standard of living.

The ability to organize is valuable. People who organize often don’t appear to do much. Stuff can still get done without them. But just muddling through is often not enough. What would a car cost if a whole gaggle of organizers didn’t plan for every nut, bolt, wire and hose to be where it needed to be, when it needed to be there, at the lowest possible price? The answer: too much. This was the situation before Henry Ford applied the assembly line to auto production. Henry Ford did not build cars, he organized the building of cars. In our story Taylor did not build a boat. Taylor provided the knowledge and organization to build a boat. In the beginning Taylor was a drain, but in the end Taylor was the MVP.

There can be no consumption without production. This is obvious. In our story, on day one, no one can eat, or sleep under cover, or play music because none of this has been produced yet. Later, Taylor consumes what you and Alex have produced. In the end you invest some of your wealth (you feed Taylor) in Taylor’s boat project in the hope that you can get off the island. It was a risk; maybe Taylor didn’t really know how to build a boat. You were willing to take that risk and in this case it paid off.

Just as obvious is the fact that shuffling existing wealth around the island will not increase the wealth of the island. If Alex gets your musical instrument and you get Chris’s hammock and Chris gets Taylor’s chair and Taylor gets Alex’s spear, what has changed? There is still the same amount of wealth on the island, it is just in different hands. Maybe the new owners will make better use of these things, but probably not, otherwise the islanders would have traded amongst themselves or produced more of these things. Yet governments routinely take wealth from one group, give it to another group and expect that somehow the country will be better off.

To participate in commerce you must produce something that somebody else wants. On the island Taylor was not very good at manual labor. With just four people there was no need for an accountant. It was knowledge and organizational skills that Taylor was finally able to trade for food.

A rising tide lifts all ships. As the wealth of an area increases everyone benefits. When you made a musical instrument, but Alex couldn’t, Alex still got to hear the music you played. When your productivity exceeds your basic needs you seek out products and services that increase your standard of living. This gives others the chance to produce and fosters competition to supply these items. Competition leads to lower prices and more choices. Think of the things that at one time only the well off could afford. Cars, radios, TVs, stereos, cell phones, computers, travel… The list goes on and on. Now even the poor (in America) have all these things.

So where does the wealth come from? It comes from individuals who produce more than they need to survive and consume no more than they produce. In a perfect world, this would be everybody. On the island it was you and Alex. On the island Chris tried hard but fell short. Maybe in an advanced society Chris could do alright. Maybe Chris could be a doctor or an entertainer. We don’t know enough about Chris. On the island, Taylor was content to live off the efforts of you and Alex. When Alex balked and you got sick, Taylor was forced to find a way to contribute.

And what is the role of government? Government exists to protect the society as a whole from a common threat, and you as an individual from having force used against you. If you decide to buy insurance in order to share the risk of some catastrophe with others in the insurance pool, that is commerce. If Big Al sends the boys around to “convince” you to pay for “protection,” that is force. For society to get the maximum benefit each individual must be free to decide what to produce and what to consume. That individual must also live with the consequences of that decision.