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What does the term "wealth creation" mean?

Consider twenty college students living in a large house. We'll make this easy: they have unlimited free electricity, can order free pizza to eat and free beer to drink, and their toilets work and cost nothing. However, they have no other contact whatsoever with the outside world, and cannot leave the house. Ever.

Can anyone explain to me how these 20 students could "create wealth"?

They are welcome to dismantle and rearrange parts of the house at will, but they cannot leave its boundaries. They can also increase their population at will by having other college students (the pizza deliver guys) join them, but the newcomers bring nothing with them but the clothes they are wearing.

The analogy to our world economy is crude, but contains the same essential features. We have the free electricity (solar influx). We don't have the beer, pizza, or working plumbing, though we have a large water-treatment plant (the hydrologic cycle), a composting toilet, and a greenhouse.

Can anyone explain to me what it really means to "create wealth"?

It seems to me that wealth creation is impossible. What happens is actually wealth redistribution. We draw semantic lines that say "mine" or "ours", and when we put stuff inside that line, we say that we "created" wealth. But we didn't. It's a zero-sum game, and for us to increase "our" wealth, something or someone else has to lose it.

If this is essentially true, then isn't the entire concept of "wealth creation" through investment essentially a pyramid or Ponzi scam?

I'm looking to gain a basic understanding of what economists are talking about in the context of the real world. Because it makes no sense to me at all.

  • May 12 2011: Another side note, if you don't mind:

    Wealth is nothing more than the valuation of resources. If people suddenly stopped liking the iPad Apple would lose billions in wealth because all wealth is is a measure of how much people are willing to give for it. Given that view can you see how you could generate wealth in ANY system, closed or not? And don't forget the law of deflation! More wealth with equal money = less money needed to buy the same amount of wealth. It always balances out!

    To use your example: if 10 people had 10 chore points and there were ten radios worth 10 points each a delivery of 10 new radios also worth ten points each would force the value of ALL radios down to 5 points. Conversely if the existing radios were improved so that they were now worth twenty points it would also push the value back down to 10 points! Weird eh?
    • May 12 2011: So if wealth is valuation of resources, then you cannot increase wealth without increasing resources. Is that correct?

      So let's make the simple model a bit more interesting. Let's add a basement. No one lives down there (it's cold and damp), but there's all kinds of "stuff" stockpiled. Old phonograph records. Vintage dresses. A bag of pirate gold. Galileo's telescope.

      One of the enterprising students figures out how to wrap pizza around the end of a stick and burn it, and uses this makeshift torch to go down in the basement and bring up vintage dresses. He cuts them up and makes -- curtains! A novelty for which the other students will pay a premium in chore points. But his first load only made one set of curtains. So he goes back to the basement, brings up more dresses, and makes more curtains.

      Resources are increasing every time he brings up a load of dresses, so wealth would increase.

      I've seen this way of describing wealth creation, and we use it a lot. Clear-cutting a forest, topping a mountain for coal, drilling and then fracking for oil. But this illustrates the problem with this model: the basement has a limited number of dresses, the earth has limited resources.

      Now we can make this a really BIG basement, maybe even bigger than the house, but it isn't infinite. We've worked under an economic model of "resource development" that has relied upon the sheer vastness of earth's natural resources, but we've become so efficient and rapacious as a species that we are actually managing to empty the basement. To drink the entire ocean, as in many old tales.

      Which illustrates that in this case, at least, we are simply doing faulty accounting with a zero-sum game. We have a set of markers in the game that we don't count -- those are our undeveloped resources. When we put them into play, we pretend we "created" them. We didn't. We moved them around.
      • May 13 2011: You are correct. Given that view of wealth it's not really ever created. But I think you're thinking of wealth as a direct correspondence to resources, not a fluid human valuation of those resources. An iron bar is worth more than a truck full of iron ore. We created wealth through the simple act of refining the ore because people will pay for not having to go through the nuisance of refining it. No, we haven't created ANYTHING by refining it, but we've still created wealth because we've increased the value that other human beings ascribe to what we have. Lots of companies do this in even bolder ways. Nike, for example, generates wealth every time they add a Nike swoosh to a shirt because even though they've merely stitched some thread into a plain white shirt suddenly 20-something jocks will pay $50 for it. In this case Nike has generated wealth without doing anything with the Earth's resources (well, other than a bit of thread).

        Yes, eventually all the ore will be gone. That's a whole different problem and underscores a problem with our current economic model. It's currently most profitable to generate wealth by spending the least amount of wealth on it yourself. If you have a choice between renewable resources (say, bio-synthetic plastics or something) and pillaging more finite resources from the earth you're going to choose the method that's cheaper regardless of which choice is right. Unfortunately usually this is the pillaging option, and that's why we need regulation and taxation to make the right choice the cheap one.

        As resources become scarcer things will turn around but it might tip past a point where much harm and suffering comes about because of our short-sightedness. This doesn't mean we're a terrible species- every other species on earth does the same thing, though usually on a smaller scale. The difference is we have the intelligence, and therefore the responsibility, to decide NOT to frack for oil and poison the water supply. But you knew that ;).
        • May 22 2011: That's fair, but it begs the question: what do people who "value" a resource more highly use to PAY for their inflated valuation of the resource?

          This gets lost in the shell game of largeness. It's hard enough to follow three cups, much less seven billion cups.

          I use the red pen/blue pen example. Let's say student A has red pens, but likes blue pens, and student B has blue pens, but likes red pens. There's an obvious win-win scenario here (meaning a non-zero-sum game, or "creation of wealth") if the two students simply exchange pens. But if they both like blue pens, the student with the red pens has nothing to trade with. So how does he "pay" for the blue pens the other persons has? Obviously in something that he has, that the other person values more highly than he does.

          The end result is a creation of "satisfaction wealth" by redistribution of resources. This economy will never end because people's tastes and desires change all the time, so it will be like the fixed set of Christmas gifts that change hands every year as people give away the gift they got last year. But I don't see the traditional economic wealth creation in this.

          To use your Nike example: what do the Nike employees DO with the money they get for their swoosh? They buy a TV so they can watch the 20-something jocks play soccer. Is this what we mean by "creation of wealth?"
  • May 12 2011: Side note: The way salaries work hides the true structure and mechanism of wealth generation, which makes these discussions frequent and difficult to explain.

    In this day and age you're not actually paid for producing anything, you're paid a flat rate based on what wealth your company THINKS you'll make them, averaged out over the year and minus whatever profit they'd like to see or think they can get. This isn't bad per se- you're free to start your own company if you like, create your wealth that way, and pocket the profit they were taking from you, but since it's a lot more secure to work for a company, you pay for that security.
    Ironically security itself is a form of wealth: If the company you work for goes under you're out a job, not your life savings. You pay for that security by allowing the company to profit off of your wealth generation.
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      May 12 2011: OK Addison, your thoughts are very mainstream and accurate in that way of viewing things but I think that Joseph (please correct me if I am wrong here Joseph) is pointing us to the factual flaws in the factual system and the reasoning that supports it that everyone ignores like the elephant in the room. The economy MUST be ever expanding- into new markets and new countries or the system cannot sustain its own weight. This is precisely why the world is ticked with China for not buying more and doing it more quickly. China has a huge untapped market that could provide the stability through expansion that this economic machinery needs. While getting my own MBA I was amazed to discover how fragile this system really is.
      • May 12 2011: I suspect I may be pointing out an elephant in the room.

        But I'm posing this as a question, because if this isn't an elephant in the room -- if it really IS possible to create wealth -- I'd really like someone to explain it to me in terms that I can understand.
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          May 12 2011: Joseph did you see this video on this topic by RSA? I think it informs and addresses the issues of systemic risk.

          http://youtu.be/qOP2V_np2c0
        • May 12 2011: I am humbled by your honest inquisition and can only hope to have helped you in some small way.

          Economics is very complex and I encourage you to research it further on your own. Be careful though. Economics is the kind of thing that is very complex, and so difficult that no one really understands it, yet everyone has an opinion! It's like ADHD- a doctor's opinion is worth a heck of a lot more than a teacher despite how sure of themselves they may act.

          The dirty secret of economics is it while it might make no sense to you it makes no sense to economists either! They just have a better sense of the mechanisms and how to get it to do what you want. Economics, intelligence, consciousness, and social insect behavior (think ant hills) are all the same- they require randomness, complexity, time, and simple, clear rules to operate and produce amazing outputs. Humanity has yet to solve this sort of "chaos theory", despite what people might like to tell you.

          Economics is a science of tenuous experimentation with no concrete rules.
      • May 12 2011: The way the system works does not necessitate growth, it just encourages it. With no growth interest rates would fall to 0%. . . which is exactly what happened in 2008 when many economies reached 0% growth. Things stabilized at 0% and proceeded to grow again but only because there are still tangible assets to generate wealth with, not because the system requires it. The problem is bare-faced capitalism. Capitalism's unspoken rule of "every man for himself, may the best pillager of natural resources win" is the issue and can be counteracted by taxation, regulation, and reapropriation. all dirty words to many advocates of capitalism, and for good reason.
      • May 12 2011: Deborah, that video is hilarious! And I think spot-on.
  • May 12 2011: That is an incorrect view of wealth and wealth generation. Economic policy thankfully does not work along those lines. One of the two major reasons interest rates exist is because wealth generation exists. You have to increase the money supply as you increase the wealth available to purchase with the money or you encounter 'deflation', which means that a dollar is worth more and more over time. In this scenario it's a lot better to hoard all the money for yourself because the amount of wealth you can acquire with it will always go up. This is why countries try to stabilize at about 2% inflation. Interest rates do the opposite- as long as they are a bit more than inflation it's actually better to give all your money away to other people (who will then use it to generate wealth and increase their own money supply, allowing them to pay the interest) than to keep it for yourself. This is why companies can build factories and why you can buy a house before you're 45. It's an amazing system, though it requires heavy regulation (I'm looking at you America).

    Yet I still haven't explained how wealth can be generated.

    I'm afraid your example removes too much existing structure and I'd have to explain how all that structure would arise again in order to explain how the students could generate wealth, so instead I'll use my own example.

    Suppose you bought an old beat-up antique car for $1000. You work hard to restore it and at the end of it you've got a shiny little car and have spent an additional $4000 on parts. However, you don't sell it for $5000, you sell it for $10,000. In this case you've generated $5000 of wealth in the economy in which you and the buyer operate. You did not take that $5000 from anyone. It was given to you freely in exchange for something of real, tangible value. Even the money that was used to buy your car was, of course, generated by producing wealth.

    The students can do the same but they'd need to build their own economy first.
    • May 12 2011: Okay, what I hear you saying is that "wealth" is an artifact of an "economy." If you don't have an "economy", you cannot generate "wealth". Is this correct?

      The reason I chose the 20 students model is to make the closed nature of the system apparent. We can make your same example in the model system.

      Student A has an old stereo system that is broken. Student B "buys" it from A for 1 "chore-point." He buys working parts from other students for chore points, and spends a total of 5 chore points getting it working. He sells the stereo to student E for 10 chore points. He now owns five chore points free and clear, and can sit in his room and write poetry while everyone else is scrubbing toilets.

      Where did those five extra chore points come from? How did student E end up with 10 chore-points?

      Well, he must have fixed TWO stereos (or performed some equally life-enhancing act for someone else). But this means that somewhere in the system there were 10 chore points floating around for him to accumulate by selling his goods or services. Where did those 10 chore points come from?

      I think calling them "chore points" is a good model, because under our federal reserve banking system, dollars represent debt -- they would be chore points that don't exist yet. Ultimately they come from the five pizza delivery guys who haven't been drafted into the house population yet (unborn generations in the real economy).

      This means that wealth creation is roughly equivalent to population growth, which is fair enough, except for two problems. First, the house gets awfully crowded if every guy who delivers pizza stays for the party and never goes home (overpopulation), and "economic growth" requires this. Second, the new guy gets shafted, because he walks into the house with nothing, while everyone else has a stash of chore points. When it comes time to scrub toilets, guess who gets stuck with the job?

      End result? The "pizza guy revolt." Bloodshed and rapid population reduction.
      • May 12 2011: As your students fix more stereos the chore points required to buy them lessen because there are more stereos to buy with the same amount of chore points- deflation. On this small of a scale it's hard to see exactly how this works, but ultimately it does, barring that someone with enough power doesn't walk in and screw with it- this is where regulation come into play. *cough*banking industry

        If the system was changed so that there was a central "bank" of chore points that slowly leaked them out at a similar rate as stereos were fixed then you would have a stable economy where the magically produced chore points released from said bank were gathered up by those that fixed stereos by way of acquiring the wealth over time by providing a product worth those points. Those that don't are stuck with the points they have until they do something to convince someone to give them theirs. It is important to note that this magically produced chore point could be as interest, with the point loaned out to the "pizza guy", who has none.

        Every country in the western world operates on this model. While this is almost criminally simplistic essentially its designed so that those who generate the wealth are the benefactors of the "magic" money produced by interest rates.

        No, wealth has nothing to do with population. India has a large, stable economy, but makes many times less per person than most European countries. Wealth is generated by convincing someone to give you THEIR wealth in exchange, and to give you more than you paid for that same wealth originally (but likely have since changed in the process- by refining, sorting, building, etc.). It's important to divorce money from this equation because it just a placeholder. Ironically, those advocating "resource-based" economies are unaware that we already have one of those, and money is just a useful placeholder for resources, with "resources" being a word for "something tangible that people will give something in exchange for".
        • May 12 2011: First, thank you for engaging in this topic.

          I think I understand inflation and deflation, and it's a direct result of the zero-sum nature of resource wealth in this system. The value of all chore points will (overall) exactly equal the value of all resources. If you put twice as many chore points in circulation, they become half as valuable (inflation). If someone hoards points, the remaining points in circulation become more valuable (deflation). At some point during deflation, everyone starts hoarding their chore points, and you end up with a "liquidity crisis." So your central bank issues more chore points, devaluing the stockpile of the principle hoarder (which pisses him off) and relieving the liquidity crisis. They call this "quantitative easing."

          I also understand that all the chore points will redistribute themselves according to supply and demand. Stereos are popular today, tomorrow it will be bongs, the next day beer steins. Chore points and goods will flow around all over the place.

          This still doesn't answer (for me) the question of how wealth can be created. I still see a zero-sum game.

          There are only so many working stereo parts in the house, so many bongs, so many beer steins. You can convert beer steins to bongs, but not to stereos. You can convert bongs back to beer steins, but it doesn't work so well, and you need to use stereo parts to fill the holes you drilled. Working stereos become scarce, so the price goes up until it becomes too expensive for anyone, and they stop fixing stereos.

          All zero-sum. Where is wealth created?
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    May 12 2011: Wow! A powerful and potent argument Joseph.
    You have the makings of someone who could really tick off the 'establishment'.
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    May 11 2011: I wouldn't be bound to stay anywhere I don't want to stay. I'd try and get the world to know some awesome stuff that'll create peace.
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    May 11 2011: It's made that way not to make sense but to bring power to those who put this system in the 1st place and though those who will benefit from it the most because they settled it up themselves.

    But i will answer your question how these students could create wealth, they can give a virtual amount of wealth to anyone who increases somebody else's quality of life, and take away the virtual amount of wealth from someone who decreases somebody else's quality of life to someone who can reverse the situation.

    These amount of wealth would then be used to do anything they wish and which would increase their quality of life.

    But in that scenario, every possible interaction of something good or bad from someone to someone else must be recorded and managed artificially by an objective AI.
    • May 12 2011: Plus, what you describe is what's called a zero-sum game, or a win-lose scenario. Any time someone gains this virtual wealth, someone else has to lose it.

      So that would mean wealth isn't created, it's just moved around.
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        • May 12 2011: Remember, the premise is that they have no contact with the outside world. They could make videos for each other, and buy and sell them from/to each other, but there is no "outside world" to interact with (other than the pizza guys, and I added them only to avoid the complications inherent in making this a Biosphere III sustainability project). Until we have trade with space aliens to whom we can sell internet videos, our global economy is stuck with the "twenty students" (plus the population growth through pizza guys).
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        May 12 2011: Well i didn't know they couldn't interact with each other physically, so in that case what i was writing couldn't work, but i disagree that it is a zero-sum game. Because from my own point of view, this new system of creating wealth from benevolent actions is the only true solution for the future of humanity.

        I thought you were simplifying the world by reducing it's population to the 20 students and were questioning yourself about how to generate money another way than the current capitalist fraud of credit debt system.
        • May 12 2011: Maxime -- Debra had posted something just before my response above that involved the students videotaping their antics, distributing it on the web, and then getting paid through PayPal. My response was addressed to that.

          The students can interact with each other in any imaginable way, physically, mentally, psychically, you name it. They just can't interact with the outside world. Except to order pizza and beer.

          The point was to simplify the global economy to illustrate its closed nature. We can't trade with space aliens. So these college students can't sell videos to the outside world.

          As Addison points out, a global economy is a very complex system. There are even potential opportunities for self-organization and what might be called "phase transitions" to higher-order homeostatic systems, though I'm not sure the global economy has the right mix of components for that. However, it is certainly complex enough for people to become very confused about what is really happening, and for other people to tell stories that hide the elephant in the room. That's why I wanted to reduce the complexity to a house full of college students.

          Tell me more about this idea of creating wealth from benevolent actions.
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          May 12 2011: Sorry guys, I meant to delete the post to keep it from being confusing and I only added to it!
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        May 14 2011: I shouldn't have had answered, it's my mistake, i don't really understand what these people would do with any money if they are in a confined space, similar to a prison. This puzzle maze game doesn't make much sense to me.

        I honestly apologize to you for this, i do not wish to harms anyones feeling but only to wake the sleepers.

        I have no interests in finding solutions to fictional problems, there actually are very real similar problems where real people have nothing or are losing everything so that someone who already have everything adds a small nothing to their overwhelm everything by the worse means imaginable.

        I thought this thread was dedicated to finding a solution to that kind of problem by analogy.