That's rich

What is wealth, anyway?

Sometimes when I’m paying my bills, I think about Engels’ pause. Phew, it feels good to finally say it. Now, let me explain why.

The Engels in Engels’ pause is of course Friedrich Engels, who among other things chronicled the condition of the working class in England in a famous work, The Condition of the Working Class in England, at a time when the condition of the working class in England was not great. Indeed, for quite a long time, industrialization did not work out particularly well for most of the people living through it. From the late 18th century to the middle decades of the 19th, Britain urbanized rapidly and experienced a dramatic economic transformation, but the workers caught up in this process had a rough time of it. Cities were foul and deadly places, the work was hard, and wage rates scarcely kept up with the rising cost of living. It was not without reason that revolution was in the air in the 1840s.

But in the second half of the 19th century, things began to change. Institutions evolved in ways that made daily life less miserable, in the cities especially. But just as importantly, real wage rates began rising in earnest. Robert Allen, an economic historian, wrote a clever paper which attempts to explain this two-stage industrialization, in which he labels the earlier, dismal period “Engels’ pause”. The paper opens with a quote from Engels’ Condition:

Since the Reform Act of 1832 the most important social issue in England has been the condition of the working classes, who form the vast majority of the English people... What is to become of these propertyless millions who own nothing and consume today what they earned yesterday?... The English middle classes prefer to ignore the distress of the workers and this is particularly true of the industrialists, who grow rich on the misery of the mass of wage earners…

Here, in simplified fashion, is the story that Allen tells. In the first phase of industrialization, you had the emergence of these new labor-augmenting technologies, like mechanized looms. These technologies stood to raise productivity and output, but growth in both was constrained by the supply of capital; that is, the limiting factor was the availability of these wondrous new machines. Because capital was so scarce, the return to capital and profit rates for owners of capital were extremely high. So, during this phase workers experienced wage stagnation while the capitalists got rich.

But the rich capitalists were savers, and their savings funded investment in new capital, which they gladly undertook because rates of return were so high. Over time, this investment made capital ever less scarce relative to other factors, and so the initial phase in which productivity rose a lot but wages didn’t gave way to one in which productivity and wages grew in step with each other. 

What I like about this paper is that it gives a concreteness to the capital-letter concepts like labor (L), capital (K), saving (S) and investment (I) that you’re taught in economics courses. Economic growth requires investment. For investment to occur, there must be saving. What saving means is that some economic actors refrain from consumption, freeing up productive capacity that can then be used to make more of the equipment that the economy needs to grow. 

In Allen’s story, there was no saving on the part of the workers; they consumed what they earned, which was barely enough to live on. The rich capitalists, though, were earning boatloads of money. Their rising incomes enabled them to consume more than they otherwise would have. But they didn’t consume all of what they earned. And so some of the machinery and labor which could have been used to satisfy still more of the rich capitalists’ appetites for consumption wasn’t in the end needed for that purpose. Those unused resources could instead be used in the service of investment: to build more factories with more looms. There’s such a tangibility to the chain of events: saving as an act of unrealized consumption which liberates resources that are used to add to productive capacity.

This is what I think about when I’m paying my bills. I am now entering what is generally the high-saving portion of an adult’s life. I’m in my early forties, which means I am approaching my “prime earning years”, although I work in journalism so we’ll see. I’ve managed to pay down the debts I accumulated earlier in adulthood, which has given me more room to save. And I have a few very good reasons to save what I can. I have two children, which means that I may soon have two college educations to pay for. And the all too glaring reality of encroaching old age reminds me, constantly, that retirement is looming—or it will be, if I manage to put away enough to stop working.

So it is with a sense of relief that at month’s end, after the expenses are paid, there is a little left over to be moved into the savings account. While I’m doing that transferring, I typically have a look to see what my accumulated savings have earned in interest over the prior month. Rounding to the nearest dollar the answer is: zero.

There are a good number of people out there who feel this to be an enormous injustice—the fact that interest rates are so low—and who like to lambast the Federal Reserve for denying them the opportunity to earn a hefty chunk of money on what is essentially a risk-free investment. I don’t feel this way. For one thing, it isn’t the Fed’s fault. What the Fed generally attempts to do is set rates in a way which balances the desire to save money with the desire to borrow money. The Fed does this because one person’s spending is another’s income, and when purchasing power (money) is saved, income across the economy is reduced—unless someone else comes along to take out a loan, spend the borrowed money, and in so doing pump more income back into the system.

Or alternatively, recalling the example of the rich capitalists above: saving is the act of refraining from consumption, an act which frees up resources to be used by others engaged in the business of increasing the economy’s productive capacity. If those freed-up resources—idled people and machines—aren’t used by others, then they remain idle, which is to say unemployed. The Fed keeps rates so low because there is such an excess of idled resources—of saving—relative to the demands to use idled resources to create new capacity.

What gives? Why should there be such a cussed determination to idle resources? I had intended to write a bunch of paragraphs here setting out the various contributors to what is sometimes called the “global savings glut”, but let me instead direct the very curious here, to a post by Alan Cole at what looks like it will be a fantastic newsletter written by him and Tim Lee. The upshot is that you have many people and institutions which wish, for various reasons, to save, and who can’t easily be deterred from doing so by low interest rates. So, consider my own saving, to take one example. Those tuition bills are looming, and I need to build up a pot of money in order to pay them. I’m going to build up that pot even if the return on my savings is zero. Now, if the return were to become very negative, then to protect my savings I might put them somewhere else: maybe in my mattress, but more likely in an investment account. There is a reason that retail stock trading has soared in recent years and asset prices along with it. But the effect of putting money in an investment account is broadly the same: I am idling resources by refusing to consume, and choosing instead to shove my purchasing power at someone else who will maybe do something useful with it which utilizes those idled resources. 

But then on the other side of the coin we have a surprising lack of interest in borrowing in order to make use of resources which have been idled. That may sound strange to you; isn’t there a ton of borrowing going on out there? In fact, there is. The prolonged idling of resources—unemployment—is extremely painful and costly, and central banks and governments work hard to resist it. In the 2000s, both worked hard to encourage people and firms to borrow and spend, by reducing interest rates and weakening restrictions on who could borrow what. But attempts to push individuals and firms to take up the slack run into trouble when incomes aren’t growing particularly fast; they can lead to crises, like the one we experienced in 2008-9. And so since that time slack has increasingly been taken up by government borrowing—though it’s worth noting that despite large-scale borrowing in recent decades, advanced economies still struggle to sustain full employment and a “normal” level of interest rates.

But to return to the focus of this dispatch: why aren’t things working as they did in the 19th century? Why aren’t big successful firms with large profits investing massively, adding to their productive capacity, and moving us beyond the realm of Engels’ pause? There are a few theories. One is that capital doesn’t look like it once did. Scaling up a business no longer means building massive factories filled with hulking machines; it means paying for some space in the cloud, which is way cheaper. So, try as firms might, they can’t soak up idled resources; the economy just doesn’t work that way anymore.

Alternatively: maybe they don’t want to scale up. Maybe high profits aren’t really about nifty new productivity-enhancing technologies, but are instead about dominating certain corners of the market. If you’re a monopolist, or something like one, you don’t want to scale up output too much because that reduces your profits. So maybe the problem is that we simply don’t have enough competition. 

Or: maybe there are bottlenecks across the economy that are beyond firms’ control, and if we could eliminate them then there would be much more investment, but we’re not eliminating them. It’s really hard to build new housing and office space in America’s most productive, highest income cities, for example, because of a bevy of regulatory restrictions on construction. I’m idling resources and if markets had their way those resources would be un-idled by a building bonanza, but that’s not legally possible and so instead we’re stuck in our current morass. 

All of these are factors to some degree. And yet, I kind of feel like none of them adequately capture what’s going on.

What might? Start with this, from Cole’s description of the savings glut:

There are about 700 million senior citizens in the world, and this number grows by about 30 million each year. These people need to save. As they approach retirement age they lose the relative certainty and predictability of future paychecks. They naturally benefit from a more conservative investment portfolio. That means holding more bonds.

The bolding is mine. That’s basically what I wrote, right? But wait: do these people need to save? What if they didn’t? What if instead governments committed to provide everyone with a generous income during their retirement, like Social Security but maybe a lot bigger? Then they wouldn’t need to idle resources in middle age; they could consume with them instead, safe in the knowledge that they’d be taken care of when they got older. Or return to my example. What if I didn’t need to build up savings for my kids’ college educations? What if a college education at a public university was provided to people for free? Then I could consume now, safe in the knowledge that my kids could go to university without taking on loads of debt. 

Well this sounds like a recipe for disaster, you say. Those retirees won’t save, and then in a decade or two we’ll face a crush of retirement payments, which will bankrupt us. But the way this was supposed to work, remember, was:

Less consumption -> more investment -> bigger economy in future -> now we can retire comfortably!

That is, my saving is supposed to generate new investment; the wealth I’m building up is supposed to relate in some way to the production of new productive capital. But if me idling resources doesn’t accomplish that, and merely adds to a pile of money which chases around a slow-growing stock of real assets (and vast new classes of more or less fake assets created solely for the purpose of absorbing suckers’ money) then what’s the point? Would it not be better, actually, for those future retirees to simply consume, and to at least add consumer demand to the market which companies will have to work to meet, which might encourage them to do a bit more investing in actual expansions in productive capacity? Or for governments to just pay for kids’ educations today, since education is in fact an investment in something useful and enduring?

I’m creating personal “wealth”, ostensibly to make the economy bigger, but it’s not clear that it’s working. But if I knew I could count on a generous public pension and free education for my kids, then that status would also feel like wealth to me. It would feel like wealth even if I paid more in tax now so that the people now attending university didn’t have to pay to attend. If my tax bill were larger and my savings balance were smaller, then I suppose I wouldn’t be able to think of myself as such a moneybags big shot. But, speaking for myself at least: it would be a relief to be free of anxiety about these looming expenses. We think of wealth as a pile of money rather than access to a future flow of useful services, but that’s kind of silly. The latter is what’s actually of value.

But let’s not stop there. If we think of wealth as a flow of future services, then one good way to increase that flow is to equip many more people to provide valuable services in the future. There are, as it happens, many people in the world struggling to get by, struggling to get access to quality education and quality public health services, in ways that reduce their welfare, but which also mean they’ll be less able to provide valuable services in the future. We can fix that now, not by idling resources but by spending. We can vaccinate the entire world as urgently as possible. We can invest in infrastructure and public health in poor countries. We can make it much easier for people in poor countries to come here, to live and study and work. We can give people money. If I were to suggest that advanced economies come together and create a plan to provide $100 a month to every person in every country which meets a few basic criteria, that would sound like a crazy idea. Come on, man, that’s like ten trillion dollars, every year.

It is a lot. But the world economy has increased in capacity by about that much roughly every 3 years over the past 40. And it would be, in the most meaningful way, an investment. Giving people the ability to adequately feed and clothe and house themselves and their families, the ability to make modest investments in education or in their local economies: that improves their lives and enables them to contribute more to the global production of actually useful stuff. And in any case, is it dumber than rich people in rich countries idling resources in order to shove money at whatever crazy new scheme seems to promise a financial return? Is it dumber than bidding up the price of Facebook shares to $400 or bitcoin to $45,000?

If you don’t like that, I have other ideas. We all rely for our lives and livelihoods on a flow of services provided by the earth’s environment. Earth very kindly gives us air to breathe and water to drink and a climate which allows us to live and work in much of the world in reasonable comfort. Regrettably, we are working hard to screw that up, and as we do so we diminish the value of the services Earth provides: we make ourselves ever less wealthy. We can fix that though. We can invest massively in renewable energy. We could build a ton of new and more efficient homes with access to new and more efficient transport systems. I idle resources each month when I make a payment on my Honda Civic, but I might feel wealthier if I had ready access to a flow of high-quality transportation services: from shared electric vehicles of all sorts that whiz around low-density neighborhoods to high-quality rapid transit. We could build all sorts of amazing new physical stuff that would provide a flow of valuable services to the public. That would make us wealthier. Like, actually wealthier: not with bigger numbers on our brokerage accounts, but with access to high-quality services that make us feel like we’re living in an amazing future, because we are.

Built by whom? Paid for how? We can do some of it some ways and some of it other ways, and of course there will be headaches along the way and, even worse, inefficiencies. But I’m prepared to live with that. And you should be too.

What’s most important is that we revise the way we think about wealth and saving and investment and how we get from here to some place better. Because the world we live in now is one where some guy who sits in a busted house an hour’s commute from the office thinks he’s wealthy because he’s got a $3m Zestimate and a Lexus SUV. Where a few billion poor people staring down the barrel of climate change while some asshole makes a mint selling cryptographically secured GIFs is capital markets at work.

We’ve lost the plot. We have a mental model of the economy which looks like the mechanism behind the end of Engels’ pause, and we seem to think that if we just keep at it and if asset prices just get high enough then the big company that’s willing to manufacture with unfree Chinese labor but not to pay American corporate tax rates will eventually build us the gleaming future we used to imagine to be possible. But it won’t, because we’ve structured so much of the economy in such a way as to generate “wealth” rather than wealth. We don’t have to be dogmatic about how we fix that—indeed the less dogmatic we are the better—but we need to realize that it’s a thing that needs fixing.

And so yeah, that’s what I think about, sometimes, when I’m paying my bills.