Creating Wealth

There is a widespread notion that there’s only a fixed amount of wealth in the world — that one can only gain wealth at the expense of others. This belief goes hand in hand with a variety of common viewpoints: the conviction that one man’s fortune is unfair to the rest of us; the guilt many Americans feel on account of our relative wealth in the world; and the fear that immigrants who send money back home have reduced our overall wealth. But what exactly is wealth? And if the fixed-wealth view is wrong, how is wealth created?

Wealth is anything that helps a person or group meet their needs and desires. People use wealth to meet needs on their own (e.g., a house is a form of wealth that provides shelter) and by interacting with others who are in a position to help (e.g., money is wealth that can be used to buy food from a vendor). To better understand the nature of wealth, let’s consider whether a simple transaction between two people adds wealth to their community, and whether wealth has been taken from others in the process.

Let’s say that Grace needs a jacket and pays James $50 to make one for her. For simplicity we’ll assume that James already has the materials and machinery necessary for the job.

After the exchange, the community has gained one jacket at the expense of the materials required to make it. Since the jacket is able to meet needs such as warmth and comfort that the raw materials alone could not, wealth has been added to the community.

In addition, James has likely learned something by making the jacket. Perhaps he’s discovered a way to speed up the process or to improve the quality of his product. James is now better able to meet the needs of others; his newfound knowledge is a form of wealth added to the community.

The 50 dollars themselves still exist, but are they worth as much as they were before? Do transactions like this reduce the value of currency or raise it? Well an increase in the supply of a product tends to reduce its price because the additional competition among suppliers forces them to slash prices to compete for customers. And lower prices mean more bang for the buck. So this transaction is representative of the type of production that increases the value of currency, which adds wealth to communities throughout the world.

On the other hand, the machinery used to make the jacket has undergone wear and tear that will eventually take it out of service, leaving it unable to meet needs any longer. Over time, different forms of wealth are inevitably lost: products age and lose their value, and people leave the work force taking their expertise with them. But if beneficial transactions happen efficiently and often enough, overall wealth creation will outpace these natural losses.

In the end, Grace and James have added wealth to their community without taking it from anyone! Wealth has been created.

Sadly, the fixed-wealth misconception is self-fulfilling: antipathy toward achievers leads to tax-raising schemes that stifle people’s ability and incentive to create wealth. In this time of need, we should allow and encourage talented and motivated people to do what they do best.

Economics vs. Politics

In Applied Economics: Thinking Beyond Stage One, Thomas Sowell illustrates the major difference between economic and political mindsets:

"Politics offers attractive solutions, but economics can offer only tradeoffs. For example, when laws are proposed to restrict the height of apartment buildings in a community, politics presents the issue in terms of whether we prefer tall buildings or buildings of more modest height in our town; economics asks what you are prepared to trade off in order to keep the height of buildings below some specified level. In places where land costs can equal or exceed the cost of the apartment buildings themselves, the difference between allowing ten-story buildings to be built and allowing a maximum of five stories may be that rents will be much higher in the shorter buildings, because land costs are now twice as high per apartment.

"Nor are money costs the only costs. With twice as many shorter buildings now required to house the same number of people, the community must spread outward since it cannot spread upward, and that means more commuting and more highway fatalities. The question then is not simply whether you prefer shorter buildings, but how much do you prefer shorter buildings, and what price are you prepared to pay to mandate height restrictions in your community. A doubling of rents and three additional highway fatalities per year? A tripling of rents and ten additional highway fatalities per year? Economics cannot answer such questions — it can only make you aware of a need to ask them.

"Economics was christened 'the dismal science' because it dealt with inescapable constraints and painful tradeoffs instead of more pleasant, unbounded visions and their accompanying inspiring rhetoric, which many find so attractive in politics and in the media. Moreover, economics follows the unfolding consequences of decisions over time, not just what happens in stage one, which may indeed seem to fulfill the hopes that inspired these decisions. Nowhere are the consequences more long-lasting than in housing, where a community can have an aging and shrinking supply of apartment buildings with accompanying housing shortages for decades, or even generations, after passing rent control laws which have a track record of leading to such consequences in countries around the world.

"The passage of time insulates many political decisions from public awareness of their real consequences. Only a small fraction of New Yorkers today are old enough to remember what the housing situation was there before rent control laws were introduced during World War II. Only a dwindling number of Californians are old enough to remember when that state's housing prices were very much like housing prices in the rest of the country, instead of being some multiple of what people pay elsewhere for a home or an apartment. These and other consequences of particular political decisions in the past are today just facts of life that new generations have grown up with as something as natural as the weather or other circumstances of their existence which are beyond their control.

"The vast numbers of frustrated California motorists who endure long commutes to and from work on congested highways are unlikely to see any connection between their daily frustrations and attractive-sounding policies about 'open space' or 'farmland preservation.' Nor are economists who point out that connection likely to be as popular with them as politicians, who are ready to offer solutions to rescue these motorists from their current problems using the same kind of one-stage thinking that created those problems in the first place."¹

1. Thomas Sowell. Applied Economics: Thinking Beyond Stage One.

Heeding Hazlitt

David Axelrod, Senior Advisor to President Obama, recently advocated the Stimulus Bill (the American Recovery and Reinvestment Act of 2009):

"This summer will be the most active Recovery Act season yet, with thousands of highly-visible road, bridge, water and other infrastructure projects breaking ground across the country, giving the American people a first-hand look at the Recovery Act in their own backyards and making it crystal clear what the cost would have been of doing nothing...The Recovery Act is putting millions of Americans to work and helping the economy grow again."

Axelrod is correct in saying that the bill's spending provides employment and improves infrastructure. However, further analysis calls into question whether such spending actually helps the economy grow.

Distinguished economist Henry Hazlitt provides such analysis in his compelling book, Economics in One Lesson:¹

"A certain amount of public spending is necessary to perform essential government functions. A certain amount of public works—of streets and roads and bridges and tunnels, of armories and navy yards, of buildings to house legislatures, police and fire departments—is necessary to supply essential public services. With such public works, necessary for their own sake, and defended on that ground alone, I am not here concerned. I am here concerned with public works considered as a means of 'providing employment' or of adding wealth to the community that it would not otherwise have had.

"A bridge is built. If it is built to meet an insistent public demand, if it solves a traffic problem or a transportation problem otherwise insoluble, if, in short, it is even more necessary than the things for which the taxpayers would have spent their money if it had not been taxed away from them, there can be no objection. But a bridge built primarily 'to provide employment' is a different kind of bridge. When providing employment becomes the end, need becomes a subordinate consideration. 'Projects' have to be invented. Instead of thinking only where bridges must be built, the government spenders begin to ask themselves where bridges can be built. Can they think of plausible reasons why an additional bridge should connect Easton and Weston? It soon becomes absolutely essential. Those who doubt the necessity are dismissed as obstructionists and reactionaries.

"Two arguments are put forward for the bridge, one of which is mainly heard before it is built, the other of which is mainly heard after it has been completed. The first argument is that it will provide employment. It will provide, say, 500 jobs for a year. The implication is that these are jobs that would not otherwise have come into existence.

"This is what is immediately seen. But if we have trained ourselves to look beyond immediate to secondary consequences, and beyond those who are directly benefited by a government project to others who are indirectly affected, a different picture presents itself. It is true that a particular group of bridgeworkers may receive more employment than otherwise. But the bridge has to be paid for out of taxes. For every dollar that is spent on the bridge a dollar will be taken away from taxpayers. If the bridge costs $1,000,000 the taxpayers will lose $1,000,000. They will have that much taken away from them which they would otherwise have spent on the things they needed most.

"Therefore for every public job created by the bridge project a private job has been destroyed somewhere else. We can see the men employed on the bridge. We can watch them at work. The employment argument of the government spenders becomes vivid, and probably for most people convincing. But there are other things that we do not see, because, alas, they have never been permitted to come into existence. They are the jobs destroyed by the $1,000,000 taken from the taxpayers. All that has happened, at best, is that there has been a diversion of jobs because of the project. More bridge builders; fewer automobile workers, radio technicians, clothing workers, farmers.

"But then we come to the second argument. The bridge exists. It is, let us suppose, a beautiful and not an ugly bridge. It has come into being through the magic of government spending. Where would it have been if the obstructionists and the reactionaries had had their way? There would have been no bridge. The country would have been just that much poorer.

"Here again the government spenders have the better of the argument with all those who cannot see beyond the immediate range of their physical eyes. They can see the bridge. But if they have taught themselves to look for indirect as well as direct consequences they can once more see in the eye of imagination the possibilities that have never been allowed to come into existence. They can see the unbuilt homes, the unmade cars and radios, the unmade dresses and coats, perhaps the unsold and ungrown foodstuffs. To see these uncreated things requires a kind of imagination that not many people have. We can think of these non-existent objects once, perhaps, but we cannot keep them before our minds as we can the bridge that we pass every working day. What has happened is merely that one thing has been created instead of others."²

1. It's amazing that a book written 60 years ago directly addresses what Axelrod said just last week.
2. Henry Hazlitt. Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics, pg. 19-21.

Freedom and Happiness

I had a great day at work the other day. After hours of trying to figure out why the software I'd written wasn't working, I finally found the error in my code that was causing the problem. As a software engineer, one of the most rewarding parts of my job is successfully debugging code — finding and fixing my own mistakes. It's strange that part of my happiness requires that I make mistakes, because those same mistakes can cause frustration and delay! It's sometimes hard to understand what makes us happy.

This got me thinking about a friend of mine who moved from beautiful Palo Alto, California to blustery Chicago. I remember asking him why he'd want to leave such a great climate for cold and windy weather, and he told me that he'd become bored of the perfect weather and that he missed the rain and the cold. It struck me as odd that even though my friend would probably prefer nice weather on any given day, he was happiest when he experienced subpar weather some of the time.

The recipe for happiness can be puzzling, and it changes from person to person and from time to time. The inconsistent and unpredictable nature of happiness underscores the importance of giving individuals the freedom to find and bring about their own happiness, and makes me wary of any mandatory government program that is claimed to make life better for all people.

Take Social Security, the social insurance program that is funded by mandatory payroll taxes. Before Social Security was signed into law, President Franklin D. Roosevelt said, "There is no reason why everyone in the United States should not be covered. I see no reason why every child, from the day he is born, shouldn't be a member of the social security system." So FDR couldn't see any reason why people shouldn't have Social Security? Well what about if they don't want to? What if they want to spend their hard-earned money on something else? And who is anyone to say what should or shouldn't be a part of everyone else's life?

I think it's arrogant for anyone, even the President, to presume that any one thing will make life better for everybody. And while financial security can greatly improve a person's quality of life, government-imposed financial security undermines our freedom. As Benjamin Franklin put it, "They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety."

High Prices and Fairness

High prices are often associated with greed and a lack of compassion. Companies that charge high prices are considered to be taking advantage of their customers, and unfair to those who don't get the company's service. Yet most people don't think twice about charging a high price when it comes to looking for a job.

Your salary is the price a company must pay for your time and effort, so seeking the best salary is essentially charging the highest possible price for your work. Are you greedy and uncompassionate for doing this? Are you taking advantage of your new company? Not at all — you're just taking part in the fair and widely beneficial system of competitive pricing.

High prices are considered unfair for a couple reasons:

"People who pay high prices are being exploited."

If this were true, then people who receive high salaries would be exploiting their companies. On the contrary, companies choose to pay high salaries to valuable workers just like people choose to pay high prices for valuable services. In free market competition, the price system requires a mutual agreement between buyer and seller — it doesn't get any fairer than that.

"Some people can't afford pricey services."

A service's high price shows how highly valued it is among the population. There are many people who can afford a pricey service but do not value it highly enough to purchase it, which means that the scarce service is left for those who value it the most. Along these lines, your job search matches you with the company that values you the highest among all companies that could have afforded to pay your new salary.

But what about the people who legitimately cannot afford a needed service? For one, these people are greatly benefited by private charity.¹ In addition, the price system will help them in two ways. First, a service's high price signals other businesses to start providing that service in order to profit from its high price. The increased supply will drive down the price so that more people can afford the service. Second, the high price encourages hard work and saving, enough of which will allow anyone to eventually get the service.

With ample competition, the price system is fair because both sides have to agree, and helpful in sending resources where they are most valued.

1. The United States is the most charitable nation in the world.

The Trillion-Dollar Bill, Part II

People who have dug themselves out of serious debt have done so by drastically changing their spending habits, making difficult decisions about which beneficial goods and services to sacrifice for the sake of financial freedom. Similarly, paying off our $12.8 trillion national debt will require a significant reduction in government spending. The only alternative is for the government to pay down the debt with increased tax revenue, but this approach is unreliable.

The government cannot guarantee consistently higher tax revenue — they can only control the tax rates. This is because tax revenue is the tax rate multiplied by the pool of taxable money, and that pool shrinks when the tax rate increases. For example, if the government were to raise everyone's income tax rate to 100%, nearly everyone would stop working, which would leave the government with barely any income tax revenue. In a free society where people act to avoid taxation, raising tax rates even slightly can lower tax revenue; however, lowering tax rates can also lower tax revenue if there isn't enough additional taxable activity. A complex society of millions of individuals acting in their own changing self-interests makes it very difficult to predict how tax revenue will change as a result of tax rate adjustments. As a result, relying on significantly increased tax revenue to pay down the debt isn't a very sound approach.

Even if the government were able to generate consistently higher tax revenue, politicians would be inclined to spend the additional money on popular, vote-getting services rather than using it to pay down the debt. If you were a politician looking to get reelected, and you had a pile of new money to play with, would you use it to make a dent in the debt problem that seems abstract to the voters? Or would you rather stage a press conference announcing a brand-new benefit that you are giving to the electorate? The natural incentives of politicians make it highly unlikely that increased tax revenue would be consistently used to tackle the debt.

Instead of seeking increased tax revenue, our government should find ways to significantly reduce spending without pulling the rug out from under the people who rely on that spending. Congressman Paul Ryan's Roadmap for America's Future is a plan to do just that — gradually reforming unsustainable government programs while adding simple new measures to force these programs to control their spending.

One aspect of Congressman Ryan's plan is to reform Medicare and Medicaid, which together account for 22% of the federal budget (more than national defense) and are the main contributors to projected deficits in the years ahead.¹ A major problem with these programs today is that doctors are reimbursed by the government for any medical care given to Medicare/Medicaid recipients, and the government's poor track record of properly reimbursing doctors has resulted in over half of doctors choosing not to see Medicare/Medicaid patients. The lack of available doctors has forced many recipients to go to the emergency room even for basic care, resulting in heavily inflated costs to the federal government. Congressman Ryan's plan would replace the government reimbursement system by giving recipients health-related expense accounts to cover the costs of medical care. Doctors would no longer avoid Medicare/Medicaid patients, and more available doctors would mean lower emergency room costs. In addition, ownership of the financing would force recipients to economize their health-related expenses instead of having recipients ignore medical costs altogether.

With our national debt projected to double over the next decade,² we need leaders with the foresight and fortitude to reign in runaway spending.

1. The Budget Committee Republicans. A Roadmap for America's Future.
2. The Congressional Budget Office's analysis of President Obama's 2011 budget indicates that our national debt will increase by $12.8 trillion over the next ten years.

The Trillion-Dollar Bill, Part I

Our national debt is $12.8 trillion. It's hard to comprehend how much money this is, and we rarely consider how this massive debt impacts our personal lives.

The following comparisons help to reveal the magnitude of our debt:

Trillions are way more than millions. Consider that a million seconds is under 12 days, but a trillion seconds is over 30,000 years.

Imagine the combined annual salary of all professional athletes. It would take 1200 years' worth of that salary to pay off our national debt.¹

The government will add $1.5 trillion to our national debt this year, which translates to adding $3 million of debt every minute...

National debt grows when the federal government borrows money. Government money comes either from borrowing, printing, or taxing, so any borrowed money must be returned by printing or taxing. Printing money is perhaps the worst possible form of taxation,² so the best method for returning borrowed money is direct taxation. This means that our national debt is really the amount of money that taxpayers owe.

The taxpayers who pay back the money our government has borrowed are unlikely to even benefit from that borrowed money. To see this, consider that the larger our national debt becomes, the longer it will take to pay it off. A longer period of time between borrowing and taxpayer repayment makes it less likely that the borrowed money was spent in a way that will help the eventual taxpayer. As a result, our gigantic national debt leaves us with a heavy tax burden without giving us much in return.

Our $12.8 trillion debt also means that our government is now spending $400 billion every year on interest. Interest is the cost of borrowing money, so $400 billion is the yearly cost of having such a large debt. Without this debt, those billions of dollars could be used to pay for our current needs! For instance, $400 billion a year is enough to provide private health insurance for all uninsured Americans.³

The costly consequences of our national debt are often unseen, but that doesn't make the debt any less detrimental to us and future generations. My next post will discuss the important process of digging out of debt.

1. This year's combined payroll for all professional football, basketball, baseball, and hockey teams is $9.8 billion.
2. Henry Hazlitt. Economics In One Lesson, pg. 161: "Inflation itself is a form of taxation. It is perhaps the worst possible form, which usually bears hardest on those least able to pay."
3. The average cost of individual health insurance is $4824 a year. Assuming that there are 46 million uninsured Americans, it would cost $222 billion a year to provide insurance for all uninsured Americans.