Net National Wealth vs Consumption

This is a fairly short posting. The point is just to point out the difference between Gross Domestic Product, that contains all sorts of consumption “goods” vs Net National Wealth creating activities. Things that make the “pie” bigger instead of smaller.

It is not a complete thesis, just a sketch. There will be lots of things folks will want to argue are NOT consumption, but are instead creation, or things that span more than one column. The point here is not to make a perfect distinction, but rather to illustrate that the distinctions need to be made and that not making them leads to the decay of our economy.

GDP takes all forms of economic activity and treats them as equal. It holds that the same value accrues to creating a new home with new windows as accrues to replacing broken windows. This is often talked about as the Broken Window Fallacy in economics.

It is well recognized that replacing broken windows does not create an increase in wealth. Yet GDP makes no distinction between a window manufactured to be placed in a new home, vs one placed in an old building due to destruction. This leads to all sorts of broken behaviour, especially by our Political Class, who seem incapable of remembering the difference. They can spend $Billions (oh, sorry, now we’re spending $Trillions…) on schemes that do “economic stimulus” and “job creation” that really amount to breaking windows and replacing them.

This is at the core of why most government “stimulus” plans do not result in the world being a better place at the end of them. So, for example, a National Park might tear down an old entry station and build a new one, employing some folks in the process and spreading some money around, yet at the end of the day we still have a national park with an entry station. ( I saw this at The Pinnacles where they were proudly touting their new greeting station built with ‘stimulus money’.)

Private companies must pay close attention to what is a consumption good, what is simple maintenance, and what is a net wealth creation. If they do not create more wealth than they consume, they go out of business and cease that consumption. Government does not. It simply raises tax levels and continues to consume in the name of higher GDP. This taxation, though, takes resources from the hands of net wealth creators and puts it into the hands of net wealth consumption. The “end game” is a bankrupt country and economic collapse. (Currently in the middle stages in Greece and Spain).

So, as a ‘first cut’ illustration, I would sort things into buckets rather like this:

Wealth Creation

Mining and extractive industries.
Refining and upgrading.
Materials fabrication.
Oil and Energy extraction and refining.
Nuclear power facilities.
Electrical generation facilities (that create more value than they consume…)
Parts Manufacturing.
Chemical and Paint Manufacturing.
Assembly (cars, computers, cameras, toaster ovens, etc.)
Shipping and haulage.
Home Construction.
Industrial Construction.
Machine Tools and Tooling.
Work Computers and Communications.
Industrial R&D.
Farming and Agriculture.
Agricultural Products processing to final products.
Retail Distribution ( a very fine sort of hauling and shipping, in essence. The ‘scatter’ part of the ‘gather / scatter’ that happens on each side of manufacture and assembly.)

And similar such things that result in more wealth at the end of the process than entered at the beginning.

Maintenance

A fair amount of effort goes into just fighting entropy. Pushing the rock up hill each morning so that the work day can happen. No net wealth is created, but it needs to be done to avoid loss of wealth or loss of wealth creation ability. This is valuable work, but it does not create net national wealth.

Cleaning & Janitorial
Maintenance and Repair of facilities and tools.
Vehicle Maintenance. Tires, batteries, carwashes, auto parts stores.
Painting and roofing repairs.
Plumbing service.
Electrical repairs.
A/C Maintenance and HVAC repair.
Gardening Services and related.
Medicine and Medical services.
Home Repair.
Clothing (basic).
Driving to work.
Insurance (it rearranges the wealth, but does not create it)
Financial Services. (more wealth rearranging).

Education. (It might have been wealth creation before we had more degrees than needed, now it’s just maintenance and to some extent entertainment…)

MOST Academic Research. (Yes, some leads to improved productivity later, but frankly most of it is for the amusement of the particular researcher. Study of different kinds of ladybugs may interest an entomologist, but much of it is just self interest. I put the ‘package’ here as some IS good for production increases, but some is also just personal consumption / entertainment, so net it’s about a wash. Frankly, that’s likely over generous as I suspect far more is ‘playing with themselves’ than actually creates value. Pretty much all of Sociology and various Philosophy “research” for example.)

Legal Services. (One could similarly make the case that much Legal activity is just ‘consumption’. At the end of a Tort process, for example, much money has been spent, with at best a rearranging of who owns the wealth. So I’m going to toss Torts in the consumption side with liability practices. A corporate lawyer may well preserve the value in the company so is ‘maintenance’.)

Consumption

As a reminder: Calling these consumption is NOT to disparage how much we like them. In many ways, they are the end point of WHY we indulge in all the wealth creation and maintenance. We want the consumption part.

That does not mean we can have more consumption than we have creation of wealth.

Similarly, we might well be able to trade some consumption goods (like a fine dinner, for example) for a set of machine tools. It still has worth, it just is not a creator of net wealth.

Some items are ‘arguable’, so for example, a movie is essentially a consumption good. People waste their time watching it and at the end of the process there are more worn seats, a somewhat worn projector, and a load of resources consumed in making the movie. Yes, it’s a fun process, but does not create more wealth in the watching. Yet you could make a case that the object itself, the movie, was an object of value, so was ‘wealth’. It might make sense to have “creation of art” in the ‘wealth creation’ step, yet ‘beauty is in the eye of the beholder’, which means that there is no way to really say that a given book or movie is “wealth” vs “trash”. I could also see, perhaps, a 4th category that would divide “fundamental physical wealth” from “intellectual wealth”, but that opens a Pandora’s Box of false claims of wealth creation. IMHO it is better to call them “consumption”, and just recognize that they are valuable consumption goods.

Movies and entertainment.
Restaurants & Dining.
Fashion Clothing. (We LIKE it, but overalls are the functional part…)
Makeup.
Cosmetic Medicine.
Driving for pleasure / vacations.
Vacation Resorts and Theme Parks.
Air Travel.
Personal Care products and services.
War and Military Spending.
Home computers.
Tort and Liability law.
Sports events and recreational facilities.
Housing in excess of that needed to maintain life and modest comfort.
SOME amount of “research” that is mostly to make the researcher happy with little other benefit.

All of these things are things we could live without with no net decrease in our ability to produce (and often a net increase). We consume these things as we want them, for personal pleasure, or because we are pushed into that consumption by others (war, for example).

The Problem

The basic problem is that we have a LOAD of money being spent in the last two groups with ever less being spent on the first group. Most of the first group is being moved to China or various 3rd World Counties (with honorable mention of Canada and Saudi Arabia as other destinations).

We in the USA have focused on a “service based economy” – Movies, entertainment, vacation destination, financial services, and a whole load of spending on wars and military hardware. That’s fine, and all, unless, of course, the “banker” in China decides they don’t want to pay for the movies, or don’t want to loan us the money for a little war in the Middle East. We simply MUST either find some net national wealth to trade to them, convince them to consume our consumption products, or have them agree to give us the wealth we want. So far, we’ve been mortgaging our Net National Wealth for the money to do maintenance and consumption. That can not go on much longer.

China, in comparison, has concentrated strongly on things in the first group. Mining, energy plant, materials and manufacturing, shipping and haulage, refining and upgrading, assembly, and even increasing amounts of agricultural product processing to finished goods.

Normally this imbalance would show up as a shift of currency exchange rates. China has followed a mercantilist policy of a currency peg (and more recently a very slowly drifting peg). The “end game” of these Mercantilist Policies is that net national wealth creation moves to China. That is clearly visible in the dramatic growth of their economy (variously 8% to 12%) and the stagnation or shrinkage of their ‘trade partners’ (visible in the recession / stagnation in the USA and EU zones). Eventually we reach a point where we have nothing left to trade to them that they want, and they no longer care to loan us the money to buy their goods at a discount for our consumption. At that point the transfer of wealth is pretty much completed and we enter a relatively impoverished state. Essentially we can provide personal services and maintenance to them. We become the maids, butlers, and janitors.

A further point is just to point out that to the extent we do things like encourage tort via liability laws, or fund “education” to have a lot of gratuitous “research” into non-productive topics, or conduct unnecessary wars, we are reducing our ability to create net national wealth and spending more time on wasted consumption. Do too much of that, you fail at the maintenance tasks needed to maintain your economic productivity or erode your National Wealth to the point of decay. I would assert that we are already well into that phase. By about the $Trillion per year which we must borrow just to hold where we are. Europe is a bit further ahead.

What’s worse, to the extent the maintenance fails, we can enter a rapid and accelerating decay into collapse. The process of wealth creation, and the creation of the economically productive facilities to create wealth, is very slow. The breakage of it is much more swift. That can be seen in Greece where tourism ground rapidly to a halt once riots began. Nobody wants to spend a lot of their wealth to look at broken windows and littered streets. The transition from ‘net gain’ to ‘net loss’ may not be noticed at first, as most economies grow in the 1% to 3% range. But once the decay sets in, the rate of shrinking can be 10% to 20% a year. (Even faster during wars. Germany essentially went to zero in about 4 years of W.W.II). Even a couple of percent increase in consumption or maintenance can turn an economy from growing to shrinking.

It is imperative to the maintenance of a free and prosperous people that the first group of activities be maximized, while the last group of activities is minimized. Eventually the increase of wealth becomes so large that an even larger amount of consumption can be indulged without a large impact on wealth creation. Compound growth works that way.

This is the thing that is understood by business creators, and substantially missing from the understanding of most folks in politics and government. It is the self discipline of the “Protestant work ethic” we hear about as important to our early economic growth.

In many ways, the nutty nature of PC projects can be easily seen by comparing them to this paradigm. The “Return On Investment” metric is widely used in businesses to decide what projects to fund. Sometimes in government you will see the same ROI idea used, but with wildly inflated numbers for “return” and strongly reduced numbers for “investment” costs. The ‘return’ may well be measured in very fuzzy terms like “self esteem enhancement” or “validation”. Not wealth. Desirable outcomes, but NOT economic goods.

Similarly you will hear the word ‘investment’ corrupted to mean “things I like”. It is not an “investment” to build bridges to nowhere or to educate a citizen in some non-economic field (such as a degree in Sociology or Liberal Arts). They may well be desired outcomes, but they are NOT an investment and do not increase net national productivity of wealth.

Being able to appreciate a Picasso is valuable, but creates no new wealth; whereas a farmer at the end of the day creates a few bushels of corn and a miner makes several tons of useful coal to keep the lights lit so you can see that Picasso… To talk about the ROI of “investment” in liberal arts degrees is to make an error. It would be more accurate to say that we desired more consumption of liberal arts understanding. (And we do! Movies are great fun, and a day at the museum is one of my favorites.)

Realize, too, that there are “bads” in addition to goods. One of the worst is the loss of a species that might have some future economic benefit. Once an extinction happens, ALL the future wealth that might have come from that species is lost as well. Dumping toxins into a river that makes the fish inedible is also an economic “bad”. We need to reduce these “externalities” as much as possible while preserving net wealth creation. This is where the EPA, in the early days, had a large benefit. Getting smog down to where sickness was reduced and the consumption of medical care reduced was a great benefit. Now not so much. We long ago past the point where benefit was realized. Removing a couple of ppm of NOx at this point does effectively nothing, but consumes a great deal of wealth. In an ideal world we would balance things to have the largest net national wealth creation net of externalities.

In Conclusion

There you have it. To the extent a party advocates for real investment in wealth production, mitigation of “bads”, and reduction of losses to natural causes, it will prosper. To the extent a party advocates for more consumption than there is wealth creation, or mitigation of “bads” at higher cost then their damage, the net national wealth will diminish. To the extent a party advocates an economy based on the maintenance and consumption industries they are creating a dependent state; one beholden to real wealth creators for the largess of their wishes to consume.

We simply must be in the wealth creation business to thrive, otherwise we become the serfs of those who do.

Economics answers the question “Who makes What for Whom?” (“How” is engineering and “How Much” is Operations Research. “Why” is politics. “When” and “where” are for business managers, while “with what money?” is finance. When politics strays into ‘for whom’, when, where, and how much, and especially into ‘with what money?’; it goes off the rails and fails.) We can either make wealth for ourselves, or we can do maintenance for others, or we can be consumed by others.

Others will not make wealth for us. It really is that simple.

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