July 31, 2010

First Principles: What is wealth?

As complex as things are in the financial world, it helps to return to first principles from time to time.  The key principle in economics is the notion of wealth.   That $20 in your pocket (or 62 cents and a broken rubber band for most morons) is a representation of wealth in an economy that's complex enough to require a medium of exchange, but it's not wealth in and of itself.  It's a piece of very fancy paper.  So, what is wealth and where does it come from?

All wealth originates from the exploitation of natural resources.  Without food, clothing, shelter, and energy, your new iGadget isn't going to do you much good.  From there, almost all remaining wealth is created from two areas: Increases in productivity, and services provided to improve living standards.  Lastly, there is the preservation of wealth, as there isn't much point in gaining wealth if someone bigger and meaner than you can come along and just take your wealth away, or if your wealth-gaining efforts despoil the natural resources to an extent that future wealth can no longer be created.

It helps to imagine a small farming community, where everyone does everything for themselves.  Pa Kettle grows food, Junior Kettle hunts game and Ma Kettle sews clothes from the pelts of animals Junior brings home to the house they built themselves.  Suddenly Pa gets an amazing idea -- he'll use his mule to increase the amount of food he can grow and harvest.  Now Pa can grow enough food to feed 5 families.  This lets one of his neighbors grow cotton instead of food and supply better clothes to the Kettles in exchange for food.  Meanwhile, the lousy, but very imaginative, farmer down the way can stop subsisting on his own farming and instead tell everyone else entertaining stories in exchange for food and clothing.  Finally, the other two farmers beat their plowshares into swords to protect this small community from the hippie commune over the next hill.  Thus a basic barter economy is born.

Fast forward to today and ask yourself:  Why are we, as a society, wealthy?  Who provides this wealth?  If we do A instead of B will this wealth increase or decrease?  The 'science' of economics is supposed to provide answers to these key questions within the context of a complex economy.  Unfortunately, most of modern economics is consumed with esoterica that does nothing to address these very basic concepts.

For example, how should one view the Government within this basic economic framework?  The standard libertarian answer is that the sole function of Government is to preserve wealth, thus Government should be limited to self-defense, dispute adjudication, and a few other very basic functions.  A libertarian believes that, due to the selfish nature of mankind, the Government can only be a rent-seeker (a person or entity that derives its existence from a continuing claim on the wealth of others), thus Government should be as small as possible.  Those who advocate socialism would claim (whether or not they realize it) that the Government can somehow be a primary provider of societal wealth (good luck trying to demonstrate that).  A 'conservative libertarian' such as myself is willing to admit that, in a large enough society, the Government can actually contribute to wealth in a limited form (productivity increases from the interstate highway system being my favorite example), and would allow for a few additional Government functions.

The point of this piece is not to try to analyze the true state of current economic conditions through first principles -- that would take several books, not a blog post from a moron.  The point is to get the reader (all zero of you) to think about economics from a more basic perspective, so that it is much harder for someone to 'baffle you with bullshit'.  Also, in the event of partial societal collapse (not impossible given the current state of the world) to consider how one might provide wealth in a more basic economy, thus ensuring personal survival.

The next time you're faced with trying to evaluate a complex economic question, simply ask yourself 'Does this idea create or preserve wealth?'  It's amazing how easy it can be to cut through huge swaths of bullshit with this very basic question.

Posted by: Hermit Dave at 02:51 PM | No Comments | Add Comment
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