wealth

I'm usually pretty good about backing up, but a few Fridays ago I didn't, and two days later my hard drive up and died. I lost a couple weeks of work. I've been scrambling since. I haven't been reading blogs and I obviously haven't been writing any.

I'm still playing catchup, but I thought I could at least post a few emails I've written in lieu of original posts. I've been meaning to post something on Austrian value theory and the nature of wealth for a while, but I seem to respond better to direct questions than my own vague intentions. This is why iceberg is such a valuable correspondent.

I am not an economist, just someone who has been reading economics for a couple of years and focusing on the Austrian school for the past year. I'm also editing a book on the evolution of Mises's thought, so my Austrian reading has been particularly intense for the past half-year.

Iceberg was asking about the wealth-generating potential of government-business projects, such as tax-funded sports stadiums.

What is the Austrian explanation of how true wealth is created/generated?

This is my favorite question. Focusing on this one question -- and on the answer -- has revealed plenty to me about the workings of the free market and the dysfunction of government. It is the one question I emphasize with economic newbies and illiterates, especially leftists.

When I was a kid, I seem to remember being schooled to believe that wealth was in natural resources. The US was wealthy because of the continent's resources. This explanation was important to my New Deal "liberal" schoolers, because it implied that culture, attitude, division of labor, etc. had nothing to do with the successes of the West. I didn't know enough back then to ask about Hong Kong or Japan, to contrast them with Africa and South America.

Not until I started to read economics and learned a little value theory did I see how simple wealth is. Unfortunately, it's so simple (and so abstract) that few people are able to sit with it easily. Even if they "get it" they also soon forget it.

I'm still trying to disentangle neo-classical and Austrian value theory, so please forgive me if this comes out a little muddled.

Wealth is our ability to satisfy our wants.

(And for good economists, as I understand it, there are no needs, only different degrees of wants.)

There are two (related) paths to wealth:

1. trade;
2. capital formation.

If I trade you my apple for your orange, it's because we valued these fruits differently. You valued what you got over what you had, and I valued what I got over what I had. In the exchange, we have created wealth. That's the part that's so hard for so many to grasp. Without increasing our resources, without inventing anything or digging anything up, just by the simple act of exchange, we've increased the amount of wealth in the world.

Oranges and apples are consumer goods. Consumer goods directly satisfy our wants. They are, in a sense, the basis of wealth, although the fruit-swapping example should caution us from thinking of the fruit as wealth, since we had the same amount of fruit before and after our swap. Rather than saying that wealth is in the consumer goods, we might say that wealth is in the arrangement of consumer goods.

The other kind of good is capital goods. Capital goods are those indirect means we have of satisfying our wants. The ladder I used to climb the apple tree does not directly satisfy any desire of mine, unless I just like climbing. But it allows me to get more apples than I was able to get by picking the low-hanging fruit, or shaking the tree, or picking the few still-good apples that have fallen to the ground. The more capital goods, the more wealth, but again, the wealth isn't in the goods.

Here's another interesting feature of the Austrian emphasis: the structure of capital. The tools I use to build the ladder are even further away from the satisfying apple than the ladder was. Some capital goods produce consumer goods, and some capital goods produce other capital goods. The division of labor and the structure of capital are closely related, and understanding them is the basis for understanding Austrian Business Cycle Theory. Meanwhile, I'll just say that more division of labor and capital isn't necessarily more wealth. The most wealth will be created by the most productive divisions and structures, where productivity is the ability to produce the goods that consumers want most. You therefore can't measure either capital or wealth with dollar signs, because dollars can't tell us which structure is most productive. (This is the fatal flaw in traditional macro-economics -- thinking in terms of numerical aggregates.)

As I said, there are some critical conflations of neo-classical and Mengerian value theory in the above. Want-satisfaction is what neo-classicals mean by utility. Austrians don't think in terms of want-satisfaction, which posits unobservable psychological states. Austrians speak in terms of preference and ranking. This is what Mengerians mean by value -- how I rank something in my array of preferences, as demonstrated by my actions. Wealth is my ability to have more of what I prefer more by giving up some of what I prefer less. I'm going to have to do some work integrating my understanding of the production of wealth with Austrian value theory.

But here is where the neo-classicals and Austrians split most critically: neo-classicals believe that we can do arithmetic with our wealth, you and I. They treat wealth as quantitative. Austrians, if I understand properly, see wealth as qualitative. You can talk of more or less wealth, but you can't talk in terms of arithmetic units of wealth.

So for instance, if I have an apple and you have an orange, and you hit me over the head and take my apple, you have increased your wealth (assuming you don't suffer too bad a conscience from injuring me -- let's just say that some hypothetical robber might increase his wealth by stealing from me). In contrast, I as the victim have less wealth, both because my apple is gone and because I'd rather not be in pain. Trade is a positive-sum, win-win game. Robbery is considered zero-sum or win-lose. (Or possibly negative-sum, lose-lose.)

The neo-classicals are now willing to ask how much was gained compared to how much was lost. Austrians deny the very possibility of such quantitative, intersubjective comparisons. The neo-classical model became Coasean Social Cost Theory. I reference the Coase article in my Spectrum essay at Mises.org.

And I might as well interrupt to quote some of the relevant section, Trespass: Rothbard versus Coase ...

In other words, it is not only the case that the mugger harms me if he takes my wallet, but also that I harm the mugger if I keep him from doing so. The question of social cost is: does the thief gain more than the victim loses? If so, then society benefits from the mugging. If not, then society is hurt by the mugging. Any claim I might make that the wallet is mine by right is irrelevant to the question of social cost: "The comparison of private and social products is neither here nor there."

We might go on to say that the mugging has negative costs beyond the immediate context, that society loses out if I now divert critical energy into protecting myself from muggers, or if the location of the mugging develops a bad reputation and business is harmed. But the cost-benefit analysis is to be done in a value-free, utilitarian calculus, without any interfering concepts of right or wrong.

[...]

Rothbard, of course, rejects the entire social cost theory. There is no cumulative "cost" borne by "society" -- there is only the cost to individuals. You can't sensibly add my pain to your pain and deduce a measurable sum called our pain. Same with pleasure. Same with value. Same with costs.

And back to the email:

A good article from the Austrian perspective is Rothbard's "Toward a Reconstruction of Utility and Welfare Economics" [PDF].

If you're an iPodder, like me, you might want to listen to Hoppe's "Law and Economics" or Hülsmann's "Foundations of Welfare Economics".

In theory at least (according to the Chicago School / neo-classical / Coasean Social Cost Theory model), we could say that the robber benefited more than I lost. In his talk, Hoppe tries to illustrate some cases in which this might be the case. So the Coasean model allows for a net gain in wealth as the result of involuntary win-lose "exchanges" such as confiscation. To the Austrians, such intersubjective comparisons are absurd, and to Rothbardians (as opposed to value-free Misesian economics) the confiscation is wrong no matter what the aftereffects.

So from an Austrian perspective, you can compare different government spending projects either for the damage done by them or the good achieved by them, but you clearly cannot compare voluntary investment-based projects to involuntary taxation-based projects. To do so would require ignoring the wealth-destruction involved in the initial confiscation.

And we haven't even gotten into incentive problems with tax-funded projects, or the calculation problems inherent in all government projects. When someone asks you to compare equally successful business ventures, one funded voluntarily and the other funded coercively, they're already asking you to imagine something that is economically impossible -- or so unlikely that I'm willing to call it impossible.

The market has to eventually respond to consumer demand. The satisfaction of consumer demand is the creation of wealth. Coercively funded projects are famous for going over-budget, for producing less after-project business than officially projected, etc. That's what's seen. What's unseen is the market-based projects that don't take place because

1. potential investors were taxed, and
2. the resources that went into the "public" project can't be used in private projects.

If you ignore the inherent damage of taxation, and then you posit away the indirect damage of taxation (and imagine a miracle: economic efficiency on the part of a coercive institution), then you can begin to compare public and private projects. But that seems awfully close to assuming away reality.

I think it's significant that such comparisons would require Coasean models, and yet most Coaseans disapprove of government-business partnerships of the sort we see in the building of sports stadiums. Even when your model allows for the possibility of net-wealth-gain from coercion, you tend to find in reality the same things Austrians see: wealth destruction.