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A catalog of wealth-creation mechanisms

One of the guest lecturers aboard the ship [1] (Donald Gibbs, of Pearl-Harbor conspiracy-theory infamy) gave a very interesting talk a few days ago about some of China’s semi-recent history. He opened with a little pop-quiz, which I thought set the stage particularly well, so I’ll co-opt it here to make a different point:

  1. Why was the Panama Canal built?

  2. Why was the Lewis-and-Clark expedition funded?

  3. Why was the transcontinental railroad built?

The popular answer to these questions, taught to schoolchildren throughout the U.S., is: to link the east and west coasts of the United States. But that answer is wrong, as can be shown by examining historical records of the time. The real reason for all three of these mammoth endeavors was to link the east coast of the United States with China. And the reason for linking the east coast of the United States with China was that a ship full of goods from China (including, for example, high quality china with a lower-case ‘c’, which at the time was produced nowhere else) could be sold in the east-coast cities of the U.S. at about a 300% profit. The wealth created by this trade ultimately financed the industrialization of the U.S., so this is no mere historical trifle. (Bonus question: what did the U.S. give to China in exchange for its china?)

But the point I want to draw attention to is that at the root of all wealth creation are a very few, very simple and easy-to-understand core mechanisms. It’s easy to lose sight of this in today’s complex technological world, so I thought I’d draw up a catalog of them.

It’s important to keep in mind that there is a distinction between wealth and money. Wealth is a measure of how much stuff people have that they actually value for its own sake. Food, housing, clothing, shelter, and artwork, are all examples of wealth. Money, by way of contrast, is merely an accounting mechanism that humans have invented in order to facilitate trade. Money and wealth often go together, but they are completely different things. You can transform money into wealth, and vice versa (which is the whole point of having money), but you can have money without wealth and vice versa. And you can make (or earn) money without creating wealth, and vice versa. But historically, the most reliable and the most socially beneficial way of making money is to create wealth. So to help encourage that, here’s a more or less comprehensive list of fundamental mechanisms of creating wealth.

  1. Move things from one place to another. Most things have value only when they are in a particular place. Food, clothing, and shelter only have value for you if they are close to where you happen to be. So you can create wealth simply by moving something from somewhere that it isn’t useful to somewhere that it is. It sounds simple, but this is the basis for the shipping industry, which is what more or less what financed the industrialization of the United States of America.

  2. Store things. Just as the values of things are often bound to their location, value is also often bound to a particular time. A winter coat, for example, is more useful in winter than summer. Keeping things in serviceable condition until they become useful is often a non-trivial exercise (consider the problem of keeping fruits and vegetables available when they are out of season). So you can create value simply by holding on to something and maintaining it in working order until it becomes useful to someone. Just as moving things around is the basis for the shipping industry, storing things is the basis for the retail industry. Stores are called stores because they used to be places where things were stored, not necessarily places where things were sold.

  3. Transform things, either chemically or mechanically. This is the basis of the manufacturing industry. I don’t think I need to say any more about that. [Update: actually, it turns out I do need to say more about it. This is indeed the basis of manufacturing, but it’s also the basis of a lot of other things, including service industries like automobile repair, plumbing, cooking, hairdressing, painting and sculpture, carpentry, etc.]

  4. Farm. Technically, farming could be considered a subset of #3, since you’re transforming water, carbon dioxide and fertilizer or animal feed into other, more useful things like crops and livestock. But I put this in a separate category because it relies so much on natural processes. Some day we may be able to engineer entirely artificial crops, but until then I think it’s useful to think of farming as an endeavor separate from manufacturing.

  5. Build buildings. This could also be considered a subset of #3, but I put it in a separate category because buildings are not easily moved from one place to another, so they have to be manufactured in situ. This fact makes real estate development significantly different enough from manufacturing that it deserves its own category.

  6. Extract natural resources from the earth or space. This category includes things like mining, oil drilling, and fishing. It used to include hunting (the answer to the question I posed above about what the U.S. traded to China in the 19th century is “fur”) but no longer.

  7. Cure disease, or at least ameliorate the symptoms. This is medicine.

  8. Find entirely new ways of doing any of the above more efficiently or effectively. This is “research” or “invention.” (Note that this is decidedly not the same thing as “having a brilliant idea”.)

And finally, the granddaddy of them all for the 21st century:

  1. Provide people with useful information.

This one can be broken up into a number of major sub-areas:

9a. Help match supply and demand. The world is so complex and diverse that you can create wealth simply by identifying sources of supply and demand and matching them up. This is the basis of modern markets. I say “modern” to distinguish them from “old-fashioned” markets where merchants display their wares directly. In this case, the information about what is available is tightly bound to the physical goods themselves. Of course, “old-fashioned” markets of this sort are still common. All brick-and-mortar stores are “old-fashioned” markets. But modern commerce decouples information about goods from the physical goods themselves. It is not uncommon nowadays to buy something without ever laying eyes on it. Amazon, EBay, ECNs and Google are all examples of “modern” markets.

A sub-category of 9a is entrepreneurialism. A company is nothing more than a bunch of people providing goods and services for each other with the matching of supply and demand being coordinated by a central planner (management) rather than by a market.

9b. Help people figure out the rules. Modern economies operate by an often byzantine set of laws, regulations, customs and conventions. Lawyers and management consultants fall into this category.

9c. Provide information that is useful in and of itself. This includes journalism and creative writing. Most blogs are an example of 9c.

This last category is of particular note because so many people seem to focus on it. Every scholar, blogger, reporter, novelist, screenwriter, composer and choreographer is working on 9c. A lot of wealth gets created this way, but of all the ways to make money it is arguably the least effective. It is very hard to transform information directly into money. Once upon a time, information was strongly bound to physical objects like books or vinyl records, and you could make money by producing these things because they were instances of #3. But with modern computer technology you can reproduce information essentially for free without doing any physical transformation. The result has been an unprecedented, almost overwhelming creation of wealth, but very little of it gets translated into money because the marginal cost of production is so close to zero. There’s a reason Google doesn’t charge for its search services. Google makes money via 9a, not 9c.

There is one sub-category of 9c where it is possible to make money, and that is providing information that is difficult to obtain and useful to a narrow vertical market segment. The Y-Combinator company Octopart is an example of this.

I’m pretty sure this is a comprehensive list. Can anyone think of anything I’ve left out?

  • Reference

[1] For those of you coming from Hacker News, I’m on a cruise ship going through Asia at the moment.

This article worth to read more and again.