Tuesday, September 22, 2009

The Fundamentals

Let’s start with fundamentals and build the picture. Wealth, in the truest sense of the word, is generated when resources are developed that benefit human individuals, communities and nations. Such benefits graduate from the basics of survival (food, water, shelter, heat, health, etc) and go through the less necessary but important (communication, travel, comfort, education, etc) to the higher order wealth benefits such as (leisure, entertainment, art, culture, festival, the monumental, etc). Benefit is generated, at a cost, by the exploitation of resources which is to say by using labour to develop resources. If the benefits are greater than the effort to develop them then wealth is increased.
In civilised societies (ie for the last 5,000 years) we have also enjoyed the division of labour. Greater productivity results from specialising in what we are good at and trading our surplus production for items that we are not so good at producing. In early civilisations the trade was barter but since then the system has developed money and financial systems of tradable equivalents that represent goods and services. Therefore, a modern individual, community or nation maximises its wealth by developing resources using specialised labour (focusing on what it is good at) and using capital to procure the resources it doesn’t have or the skills it does not possess where the money is generated by selling raw resources or production surpluses. In addition, and again since ancient times, financial systems have been developed that allows a portion of future earnings to be traded away (at a cost) in return for capital now (debt and/or investment) so that resources can be developed that otherwise could not. Generally the system works quite well, but not always.
Finally technology plays a role as well as technology reduces the labour (ie cost) of developing resources and/or increases the benefit of those resources (eg colour TV over black and white) and also increases wealth.
Therefore, over time (that is to say ignoring timing differences in trading surpluses and the dispersion of technology – which we can only ignore theoretically) the wealth of a nation is fundamentally down to the amount of resources it has property rights over and the availability of labour to develop them. For developed countries like New Zealand labour is not constrained. Populations have stabilised and immigration provides a ready source of labour. Therefore, for a developed country (still ignoring for the moment short term effects) total wealth is constrained by the resources that the country has property rights over. Many people debate this and suggest that countries can ‘punch above their weight’. This is obviously true when timing differences are taken into account but the most fundamental principles of statistics suggest that, in the long run, no normally distributed population can have a relative advantage in terms of intelligence, entrepreneurship or work ethic compared to any other normally distributed population. Although larger populations will have absolutely greater amounts of every human attribute. Timing effects can create concentrations of wealth (that can encourage non-normal population distributions) but such advantages should ‘trade away’ over time.
Average individual wealth is total wealth divided by population. Therefore, a developed country with population growth that exceeds the ability of technology to allow for greater resource development over time leads to lower rates of growth of average individual wealth. Population growth in developed countries is not necessarily a good thing. Population growth can lead to increases in the total wealth as more people can consume more but consumption can be fuelled by debt, which seems to have been the case in New Zealand for many years. Debt, by definition, means spending now and paying back later. Therefore, debt fuelled consumption is not sustainable and does not mean that underlying wealth has actually increased. If the population has increased, without increasing true wealth (ie the economic development of resources), then the drain on future wealth will be even worse as the true underlying wealth is stretched even further, back to debt-holders and across a bigger base.

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