It is hard to measure, but we know it when we see it.

Image by Paul McGowan from Pixabay

We know that wealth is transferred using money, but what exactly is wealth, and where does it come from?

Unlike money, wealth cannot be simply conjured into existence somewhere in the basement of the Federal Reserve. Wealth can only be created via the application of labor, i.e. work. More specifically, specialized labor that is creating something needed and useful, that will be sold to others.

In other words, wealth must be earned the old-fashioned way.

Wealth at the individual level can take the form of goods and financial assets, and is required to acquire food, shelter, clothing, etc. Wealth is also required to raise children, care for the elderly, clean the environment, explore space and to pursue leisure activities.

The wealth of a society tends to be reflected in its infrastructure, its standard of living, the advancement of science and technology, and its education and healthcare systems.

All good, but exactly how is wealth created?

Consider the case of a farm. An organic one, of course. By applying specialized labor over the duration of the growing season, the farmer’s hope is that wealth will be created at harvest in the form of a valuable, sellable, edible crop.

How does one know if the farmer’s specialized labor was productive, that wealth was created, as reflected in the crop having value? If the farmer can sell this crop at an open, competitive market, where buyers are making individual decisions as to how to invest their own earned wealth, then it is safe to assume that the harvested crop has value and represents some amount of wealth. On the other hand, if no one at the market wants to buy the organic brussel sprouts before they spoil, then regardless of the amount of labor, it was not productive, and no wealth was created.

While goods could be sold at a closed, non-competitive market (i.e. government purchases), as this market is more the result of legislation than free-will, it increases the possibility that products with no value will be purchased anyway, creating a market distortion whereby unproductive labor is rewarded.

Let us assume that someone buys the brussel sprouts at an open market. Can it now be concluded that the farmer’s labor over time resulted in the creation of wealth, that it was productive?

Not necessarily, because even though the farmer’s labor created wealth, during the same period the farmer was consuming wealth, because like all humans, the farmer needs to eat, an unavoidable form of wealth consumption. Other types of unavoidable consumption of wealth would be the heating of homes, transportation requirements, replacement of clothing, etc.

If the wealth created by the farmer exceeds the wealth consumed, then yes, net wealth was created, resulting in the very desirable excess wealth. Unfortunately, unlike currency, wealth cannot be directly measured. And to make it even more challenging, both the rates of wealth creation and wealth consumption are difficult, if not impossible to directly measure.

The only way to determine if net wealth was created over time is if the farmer’s personal standard of living improves, that the proceeds of the crop sale allow for the farmer to buy all needed goods and services, with some wealth left over.

This can be extrapolated to the whole society, that over time the overall economic needs of society will be met, if not exceeded, leading to noticeable improvements in the standard of living for all.

Given that it is productive labor that creates wealth, then it stands to reason that if one want to maximize the amount of wealth created, then the labor needs to be as productive as possible.

An economic urban legend has it that upon observing that workers were using shovels instead of tractors to dig a canal, a visitor asked, “Why are there so few tractors?” The government official explained, “This is a jobs program. We need to employ as many workers as possible.” To which the visitor replied, “Oh, I thought you were trying to dig a canal. If it is more jobs you want, then you should give the workers spoons, not shovels.”

(Quote Investigator.

Common sense tells us that a single worker driving a tractor can be as productive as one hundred workers using shovels, and perhaps as productive as one thousand workers equipped with spoons.

So while the amount of wealth created is somewhat proportional to the amount of productive labor applied over time (as measured in person-hours), it better correlates to the amount of productive labor applied over time multiplied by how productive that labor is, or how “enhanced” that productive labor is, enhanced by the usage of capital resources such as a tractor, computers, machinery, etc.

Given this, why not use capital resources everywhere and all the time to make labor as productive as possible? Because today’s excess wealth must be consumed to create tomorrow’s capital resources, the cart must follow the horse. If there is a shortage of excess wealth today, then there will be a shortage of capital resources tomorrow. The availability and investment of today’s excess wealth to create tomorrow’s needed capital resources is an indication of a well-functioning economy.

Which societies have more capital resources at their disposal? The wealthier ones, of course, as this is part of the definition of what it means to be a wealthy society. It is a positive feedback loop whereby excess wealth can lead to even more excess wealth, thanks to the ever-improving development and utilization of capital resources.

And the opposite can happen, a negative feedback loop as the wealth of a society diminishes.

The ultimate purpose of an economy is to create this excess wealth, to create wealth faster than it is being consumed, to enable a society to become wealthier. This excess wealth can be consumed to develop capital resources, to expand scientific knowledge, to build needed infrastructure, etc.

Which implies that an economy should be structured such that the amount of excess wealth created is maximized, implying among other things that productive labor is encouraged, and non-productive labor discouraged.

How to structure an economy so that this is achieved?

Want to learn more?

Eric Johnson is a husband, father, engineer, pilot, surfer, investor and amateur astronomer who has read a lot of books on economics.