Hello. I’m very pleased I discovered this great forum, where people who appear to know something about the subject have discussions about economics.Here’s something I need some insight on. My understanding is that wealth is created in an economy through manufacturing, and that manufacturing is how value is added to raw materials, making a finished product more valuable than the sum of its parts. This contributes to increasing the size of the overall economic pie, rather than continuing to divvy up and distribute one constant-sized pie. So value added through manufacturing potentially makes everyone in the society richer.So, first question- is this hypothesis correct? Second question- Do other sectors of the economy contribute to this macro-wealth creation? For instance: service industries, banking, advertising, hospitals- do they grow the overall economy, or just support the existing economy, which, again, grows only through manufacturing? And so these non-manufacturing sectors are simply moving money around in a constant-size wealth pie? Third question- In this context, then, what is manufacturing? Is Microsoft a manufacturer, in regard to their software? They don’t make a physical product, but intellectual property. How about Hollywood? A lot of creative energy and intellectual property, but no tangible product. Does it create new wealth, or simply provide something of value for society to spend its existing wealth on? Are these industries contributing in the same manner as the traditional industries mentioned in Question 1?I have only a smattering of formal education on economics, so please keep answers in somewhat layman’s terms, if possible, a la “Broken Windows”.
Thanks for any insight!
David
Goods are valued for the wants they fulfill(or alternatively, for uneasiness revealed). Manufacturing occurs when the sum satisfies more wants than the parts could, an economic gain.
Services work the same way. A person must sacrifice their time to produce a service, like a back rub. In order for people to consume more back rubs, more back rubs must be produced.
What you are over looking is the role of capital. What determines output is the amount of capital accumulated. In order to provide ipods we need to build a factory and in order to perform surgeries we need hospitals.
All capital is formed through savings. Building the factory or the hospital is a form of real saving, as no wants are satisfied by building the factory but the work is completed because of the expectations of later satisfaction(in the form of ipods).
It is capital that is the true wealth of society, as it determines how many goods can be produced. Savings increase wealth, while consumption, which depletes capital, reduces it.
If capital wears out more quickly than it is replaced(ie too much capital is devoted to producing consumer goods and not enough to creating new capital goods) the capital stock will deplete and production will fall.
Peace
Fohaba:I have only a smattering of formal education on economics, so please keep answers in somewhat layman’s terms, if possible, a la “Broken Windows”.
I find that people with formal education in economics are typically the worst economists.
Thanks for your thoughtful reply, Jon.
This was a good refresher on what capital is. I guess I hadn't given it much thought lately, but assumed capital was simply investable money. But from your description, it appears that a factory is capital also. (Probably something I should have remembered from Econ 202). So it is obvious that capital is essential.
So you equate a hospital with a factory as far as accumulated capital which produces a good or service. But if a hospital doesn't also build capital goods (which it appears they don't), does this mean that a hospital, however necessary, is producing only consumer goods (or services), thus depleting capital, and making the society poorer overall? As described in your last paragraph.
Is capital the only way to build the overall wealth of a society? I look at a place like Hong Kong, which is a rich and colossal hub of commerce, finance, etc., but doesn't seem to produce much in the way of manufactured goods (except fake LV handbags). Assuming this is true, if Hong Kong were isolated, and could not trade internationally, would its capital get depleted, because the same money is just being moved around in a circle?
This is starting to get very interesting!
Fohaba:My understanding is that wealth is created in an economy through manufacturing, and that manufacturing is how value is added to raw materials, making a finished product more valuable than the sum of its parts.
NO. Production per se doesn't create any wealth. Wealth is created only by producing those things that consumers want. The subjective valuation of the final consumer product by the consumer himself is what establishes the value in the first place. This value is imputed backwards to establish all the different values (expressed in prices) of the different factors of the entire production process. If the value that consumers attribute to the final product is higher then the total value (cost) of all the different factors of production required to produce the good (or service), then a net of wealth has been created. If the value of the final product is less, then a net loss has occurred, that is,scarce resources have been utilized inefficiently and could have been employed differently to produce other things that consumers value more.
Fohaba: This contributes to increasing the size of the overall economic pie, rather than continuing to divvy up and distribute one constant-sized pie. So value added through manufacturing potentially makes everyone in the society richer.
This contributes to increasing the size of the overall economic pie, rather than continuing to divvy up and distribute one constant-sized pie. So value added through manufacturing potentially makes everyone in the society richer.
NO. The "pie" increases only when the total sum of profits is greater then the total sum of losses. This is a progressive economy (or growing economy) as oppose to a retrogressing economy. A net gain (profit) in society means the value of the total output of goods and service (again, value is attributed by the consumers) is greater then the previous value of all the factors of production in society. This is only possible by savings. New or fresh savings are channeled into investments (capital) to finance the expansion of production, i.e. increase in machinery and tools, new technological processes, labor recruitment and training, etc..... This new capital on top of the previous capital allows for the increase in production output (in terms of its total value). Capital accumulation is what makes an economy grow. Capital comes only from real savings of individuals.
Fohaba: Do other sectors of the economy contribute to this macro-wealth creation? For instance: service industries, banking, advertising, hospitals- do they grow the overall economy, or just support the existing economy, which, again, grows only through manufacturing? And so these non-manufacturing sectors are simply moving money around in a constant-size
Do other sectors of the economy contribute to this macro-wealth creation? For instance: service industries, banking, advertising, hospitals- do they grow the overall economy, or just support the existing economy, which, again, grows only through manufacturing? And so these non-manufacturing sectors are simply moving money around in a constant-size
All sectors of the voluntary market (free market) contributes to wealth creation. The mechanism of profit & loss regulates/coordinates all individual actors participating in the market so that they produce and service only those things that are valued by the consumers.
Your distinction between manufacturing and other productive elements is superficial. Anything that renders a valuable service is productive and generates wealth. Wealth is a mental concept. It is derived from our minds and it is purely subjective. There is no objective value to anything. Tangible assets derive their wealth also from the service they render.
Think about it this way: Any exchange that results in a net gain for both parties, that is, both parties value the good that it receives more then the good that it forgos, is a net gain (wealth creation) to society. Only voluntary exchange can produce such a result, thus, only a free market can create a net gain of wealth to society.
Fohaba:So you equate a hospital with a factory as far as accumulated capital which produces a good or service. But if a hospital doesn't also build capital goods (which it appears they don't), does this mean that a hospital, however necessary, is producing only consumer goods (or services), thus depleting capital, and making the society poorer overall?
Services in a hospital are consumed, but its not so simple as that meaning we are getting poorer. Capital goods are created in order to produce consumers goods. Our standard of living is determined by the number of goods we consume, but there is the issue of time. If we were to divert our entire capital stock towards consumption we could experience a very high standard of living, thus the appearance of having become richer. However, because no new real savings(ie accumulation of capital) were going on during this time, this boom could only last until our current savings(capital stock) are depleted.
How much consumption occurs vs savings is called time preference: how highly present consumption is valued versus future consumption.
Fohaba:I look at a place like Hong Kong,
Actually, Hong Kong is a manufacturing center. It is remarkable because it has grown rich despite lacking any natural resources other than a good harbor and human labor.
Fohaba:Assuming this is true, if Hong Kong were isolated, and could not trade internationally, would its capital get depleted, because the same money is just being moved around in a circle?
If it could not trade internationally it would be very poor because it would lack raw materials.
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Fohaba: So you equate a hospital with a factory as far as accumulated capital which produces a good or service. But if a hospital doesn't also build capital goods (which it appears they don't), does this mean that a hospital, however necessary, is producing only consumer goods (or services), thus depleting capital, and making the society poorer overall? As described in your last paragraph. Is capital the only way to build the overall wealth of a society? I look at a place like Hong Kong, which is a rich and colossal hub of commerce, finance, etc., but doesn't seem to produce much in the way of manufactured goods (except fake LV handbags). Assuming this is true, if Hong Kong were isolated, and could not trade internationally, would its capital get depleted, because the same money is just being moved around in a circle?
A hospital isn't depleting capital because it is providing an essential service for less than it would take to provide the same service in the absence of the hospital. Among other things, labor is more productive because sickness and injury take less of a toll on their productivity than they would without the hospital.
If Hong Kong were isolated, it would have a very different economy than it does. The population would be much smaller and the economy would center around providing only this population with whatever goods and services they could support. The fact that they are not isolated means that they can provide international commerce and finance services to the rest of the world in return for goods and services that can be produced more effectively in other parts of the world. This benefits everyone.
This is all giving me some new insights on things. It seems that economic growth basically boils down to profits. That after you've paid all the people in the production chain the value of their work, you sell your product , and if you have a little chunk left over, that is what almost magically makes the pie bigger. It seems so obvious looking at it like that.It's interesting that this could be applied to a service industry, too. Although perhaps not really a traditional service industry, a hospital is an interesting example. Huge amount of capital, huge amount of labor going into creating a final product (the patient's healthy life) that the end consumer (the patient, even if through the insurance middleman) pays for. A hospital may not exactly be the best example, because of so many complicated external factors, and the fact that many never turn a profit.Juan's reference to Bestiat's assertion that all the economy is based on services makes sense. That manufacturing is simply another kind of service. I will have to read Bestiat's work that he references.In some way, Bestiat's theory seems somehow related to an economic theory I daydreamed up some years ago. That when you boil it all down, the cost of any item is based on only two things: labor and land. By labor, I mean all work- physical, scientific, intellectual, etc. By land, I mean ownership of property that has natural resources on or under it. That when you take even the most complicated finished product, it took just these two elements in possibly thousands of different variations, all of which added to the product's cumulative cost. But now there appears to be a third element to the cost: profit, apparently at every little step of production. I'll have to ponder this some more, when I get some time to stare off into space for a while.
Hopefully, this will all be ultimately related to addressing my real concern, which is the decrease in manufacturing in the US, and our trade deficit. I need to get a firm grasp on these fundamentals first, though, and truly appreciate the effort everyone has put into answering my question so far.David
Fohaba:It seems that economic growth basically boils down to profits.
True, but its important to remember that the money profits are just a signal. Economic gains occur in the exact some way in a barter economy.
Austrian Economists often choose to teach economics starting with a very simple scenario, a single person along an island, introducing more complexity as they go. Because thats exactly what the economy is, many simple actions adding up to create an extremely complex emergent order.
You post an excellent question. It seems to me to be the same one Adam Smith posed in the Wealth of Nations.
Please reconsider your concept that the "cost" of any item is based on labor and land. I do not disagree, but the essence of the free market is not the analysis of the "roll up" of costs, but rather the "structure of production". The "cost" may be $100, but the "value" of anything is determined subjectively; the value in free market exchange may be zero or $10,000.
Read the essay "I, Pencil" by Leonard Read. This essay describes in simple terms how the incredibily complex structure of production is automatically coordinated and organized by free market exchange. A socialist would have no hope of coordinating everything necessary to build a simpe wooden pencil. The free market coordinates the structure of production automatically. This was a paradigm shift for me. So, I suggest shifting your focus away from cost "roll ups", and toward the structure of production, and how free market exchange coordinates the structure of production. Search these terms on Mises, you should find a weath of knowledge. Google "I, Pencil". It may not seem like it, but this will place you on the right path to understand the source of wealth creation.
"The market is a process." - Ludwig von Mises, as related by Israel Kirzner. "Capital formation is a beautiful thing" - Chloe732.
Libertarianmonarchy.com
Where does Wealth come from?
Professors of economics, philosophers, professional economists and socialists. What do they all have in common? Answer: They have no idea where wealth comes from.
Poverty programs, urbanization, women’s rights, wealth inequality, credit, savings, capital, health, education, foreign aid, democracy, good government, regulations, trade agreements, environment/geography, technology, efficiency etc., or the lack there of, have all been blamed for the poverty seen all around the world. Some of these factors may be technical reasons as to why some countries are poor and others are rich but they are all irrelevant in relation to how wealth is actually derived.
The one and only answer is that wealth is derived from private property.
The profit incentive comes from the desire to acquire private property. Factors of production will all be allocated efficiently if private property rights are respected. Savings only exist because of the ability to accumulate private property. Risk-taking only exists because of the fear of loss of private property. Natural resources are found across the world yet some countries are poor and others are rich. This is because natural resources stuck in the ground are not wealth. Natural resources will be extracted and refined if private property rights are upheld. Credit is only unavailable in poor countries because of the lack of private property rights. Law is the enforcement of private property rights. Contracts are agreements about future private property. If health or education were what poor countries lacked, then why wouldn’t entrepreneurs invest in the health and education of the citizens in exchange for the income that comes from the higher productivity? See more specific examples.
The profit incentive, the economic calculation problem, the ability to invest/take risk, the innovation problem, the desire to save, all require and are rooted in private property rights.
To put it simply, there is no way for wealth to be formed except by allowing humans to have private property rights. This should be clear intuitively. Each person will try to use their private property to make themselves as happy as possible. Any hindrance(coercion) regarding private property will cause distortions and diminish the amount of happiness that can be achieved.
Most economists waste time engaging in rigorous investigation of proximate causes of wealth in hopes of discovering how wealth is formed and how to pull countries out of poverty. Ironically, it is their socialistic mindset that has pushed many into poverty. Their strategy of attempting to identify concrete causes of wealth, or even erroneous fundamental causes such as democracy or good government, is fallacious and hopeless. It is a fool’s errand.
It does not matter how much effort or time the empiricists spend searching. They will never succeed. This is because wealth/utility does not exist in reality. Utility exists in the mind only. Wealth is purely subjective and is clearly synonymous with utility. A photo of a loved one can be worth infinitely more than a monetary fortune.
In order to further understand it must be explained from a different perspective. A more complex and accurate answer to the question is that wealth comes from Human Action. Clearly, this is a praxeological deduction. It is not a stretch from the fundamental praxeological axiom; humans act to remove uneasiness. If humans act to maximize utility then it is clear that utility/wealth is derived from human action.
Put simply, if you allow humans to engage in action, by giving them private property rights, then they will produce as much wealth/utility as possible.
A more precise explanation is as follows. Human action is the bridge between the mind and reality.(Hans Hermann Hoppe, http://mises.org/esandtam/pes1.asp) Reality is private property because ideally you could not disturb or interact with someone else’s property. Access to private property must be possible for human action to occur. If you restrict access to private property(namely through government coercion) you break the link between the mind and reality and therefore prevent Human Action, which prevents any wealth creation.
If we assume that every action is chosen to maximize utility then any coercion will, by logical deduction, lower utility for the individual because it forces someone to choose an alternative to the action that would maximize utility. This statement alone is enough to discredit any government policy.
Instead of wasting billions in foreign aid, attempting to increase health and education, or enforcing other central planning within the economy, the way to unleash infinite amounts of wealth is to enforce private property. The poorest nations on the planet could easily become the wealthiest in a very short period of time if security was provided for these countries so that private property could be safe.
Mises, Rothbard, Friedman and Adam Smith, as well as other giants within the field of economics, intuitively came to the conclusion that free societies would be more prosperous than nations that were socialistic. All of these economists pointed out practical flaws with socialism and described the efficiencies of the free market. However, none have decisively explained what the true source of wealth is.
The answer to where wealth comes from is based on three fundamental insights:
1) Wealth is subjective.
2) Humans act to maximize utility.
3) Humans only have the ability to act if they have freedom(private property over their own body).
Put in any scenario, humans will use their available private property to maximize their happiness. There is no way for government to create additional wealth because humans are already acting to maximize their wealth.
Consider a spectrum that measures varying degrees of private property. With 0% private property rights, the extreme left, we wouldn't own our own bodies and therefore suffocate to death. No one could produce because they don't own anything. This fact is what makes socialism so unproductive. The less private property there is, the less wealth there will be. With full private property rights, human potential would be maximized. People always act to maximize utility and therefore if there are no impediments based on private property they will maximize the amount of wealth in society. Countries such as Cuba, North Korea, or the Soviet Union restricted private property and therefore had very little wealth. Countries such as Hong Kong, Singapore, Taiwan and South Korea have strong private property rights and therefore have become some of the wealthiest nations on the planet.
Fohaba it looks like you've gotten some good responses here. I thought I might recommend you to some other resources that will help expand your understanding...
For resources on the concept of "capital", see here.
Also see "The Importance of Capital Theory"
As for "wealth", this is a nice little introduction:
Finally, check out these Reading lists. You won't be without anything to do as long as you have that ;) To see the top recommendations, see Two books highschoolers must read (it only says high schoolers because everyone should read them, and that's the latest everyone should read them...if you're past high school, and you haven't, you're behind )
But before you do anything, I suggest you start with these three vids. Watch them in this order. They will blow you away...
(Bear in mind, these are full lectures...roughly an hour each...so be sure you have the time available to finish one before you start it. I realize it can be tough to watch something on a computer that long (especially a lecture), but you may be surprised. Grab a snack and get comfortable. These will give you the best foundation you can get in this amount of time.)
(If it would be easier to listen to them on an mp3 player, you can download the audios....here, here, and here.)
Then, over time, this series of interviews with economist Thomas Sowell. That'll get ya started
Lawrence you have been asked repeatedly to stop posting simply to plug your website. If you want to link it in your signature, fine. But please refrain from displaying it in every single post you make (let alone as the opening line).