Making money is not a reliable guide to creating wealth

1 September 2015 by Catherine Holdsworth in Business and finance, Nine visions of capitalism

By Charles Hampden-Turner, co-author of Nine visions of capitalism.

Unhappy is the economy which cannot distinguish the making of money from the creation of wealth for these are not the same. While creating wealth includes the making of money, the latter is a more narrow activity which can and does in many cases exclude the creation of wealth. Indeed it may even destroy wealth on an epic scale as occurred in 2008. This happens when money is made by taking it away from other people and/or appropriating this from Nature’s bounty. Profits can be made by plundering other people and the planet. So what is the crucial distinction?

The distinction we must bear in mind and was pointed out in the nineteen eighties by Lester Thurow and more recently by Gideon Rachman, is between the zero-sum game or system of competing and the positive-sum systems of wealth creation. In a zero-sum world all gains come from other people or at the expense of the environment. All resources are finite or scarce as economists still teach us, so that what one person gets another must forgo. Alternative value can be extracted from Nature’s bounty, leaving the rest of us poorer for this. Inequality escalates and as the song of the ‘roaring twenties’ put it, “The rich get rich and the poor get poorer, in the meantime, in between time, ain’t we go fun!” Making money by exploiting others creates no wealth. The others are soon too poor to buy very much. Pay-day loans were almost certainly wealth destroying as is loan-sharking in general.

So-called casino capitalism is very much a zero-sum game. Roughly half of all financial advisers are going to score below the Dow Jones average. This is not because they are stupid. Were they twice as clever this would still be their fate, since the average is the zero-sum of all their efforts which cancel each other out. Indeed there is a small overall loss since those running the casino need to be paid.

What then is a positive-sum game? This is where relationships between people generate more wealth than they began with. There is a surplus over and above the cost of what they generated which the parties share. The better wages and the higher share price put money into people’s pockets which they spend anew. Also the value delivered by the supplier may be hugely increased by the use to which the customer puts it. Both live in a world of abundance and this moulds their characters. We will cite examples of each.

In the case of Josiah Wedgewood, the world’s first tycoon, he took loads of red Staffordshire mud and with the help of pottery skills, new instruments he had designed, heat, paint and glaze he made a Portland Vase, Jasperware and other pots. Even in the currency of the times these were at least one hundred times more valuable than their ingredients and graced the royal tables of Europe. His medallion of a kneeling slave in chains culminated in the abolition of the slave trade after his death and it well symbolizes the two faces of capitalism in the distinctions which follow.

Or consider a more modern example. For a decade or more there have been more microchips than people in the world. It must be at least two or three times by now.  A chip installed in your automobile can inflate an airbag before your child’s head can hit your windscreen in a crash. It can unlock doors so you can escape or rescuers can reach you and it sends out signals of your plight. In such cases it saves lives, reduces insurance premiums and enriches all concerned. Yet bits of metal and silicon sand cost next to nothing. You have put human intelligence and purpose into the chip and this comprises its value. Intelligent design followed by intelligent manufacture saves what is most precious to us, the lives we hold dear plus our own. As East Asians like to say, microchips are “the rice of industry”. They feed other businesses and give thousands of products meaning and direction.

This leads us to consider business-to-business wealth creation where the supply of one device allows a second task to be accomplished. Suppose we make number-controlled cardigan knitting machines. Once installed, these knit 2,000 cardigans in one day with sizes altered in seconds. The supplier creates wealth by the method already described. The whole machine is of far more value than its components, but his customer creates wealth by way of the machine functioning. Indeed the machine by itself is valueless. But the garments created at an attractive price make both money and wealth. Supplier and customer have engendered wealth between them, despite their different aims and purposes. In a further example, Rolls Royce aero-engines produce power-by-the-hour to convey people to far destinations. Wealth lies in what they do, not in the engine itself. Contracts even specify this.

We are now in a position to contrast Zero-sum money making with Positive-sum wealth creation.

Zero-sum money making	Positive-sum wealth creation
Money is made by direct manipulation of the individual for his exclusive purposes. This money derives from other people	Money is made indirectly by first benefitting a customer who then reciprocates by bestowing more money upon you.

We are getting ever more individualist, so much so that relying on the favour of other people is deemed unreliable. To be totally independent you need you need to outsmart them by taking their money. “Never give a sucker an even break” is our watch-word and we need “to make a quick buck” which is not possible when you rely on another’s gratitude. The real individualist acts unilaterally whether people like it or not. Our wits entitle us to this.

In contrast all genuine wealth creation inheres within relationships, so that the Chinese word for “rich” is “well connected” and guanxi or relationship is their chief business value. The whole must be more than its parts and design and manufacturing are all-important to being productive. Between us we create more than we started with and trust is vital. A research group at MIT studied what motivated 800 creators of open-source software and make this available to all. The originators said it was a gift by them to the online community and they were repaid in many ways. Such action triggers the productive efforts of others on a wide scale.

Making money is via transactions in which one person receives money from another and gets goods or services back. The parties compete to get more from others at the least expense to themselves

Wealth is created by transformation of money into goods and services & their transformation back to money when sales are made. This is the source of the surplus value generated

If the above statements are correct then we need to ask whether banks and financial institutions create wealth at all. They would appear to be sterile by dealing exclusively in money or “financial products” as they like to call them, but there is no transformation and no wealth creation. No two coins or notes cohabiting ever produced a third coin or ever will. So long as we stay with money there is endemic scarcity as economists teach, not the abundance of related brain cells and their associated meanings. Whatever trades’ unions receive shareholders and managers must forgo and the strategy of the latter is to pay as little as possible to remain competitive on costs. Taking money and creating a product and/or service from this is a transformation from currency to valued things and services and then back to money revenues when the sale is made. It is these conversions or metamorphoses from one state to another that generate wealth.

On the other hand we need banks to advance loans to industry so there is little doubt that they facilitate wealth creation by the real economy. What this means is that banks create no wealth on their own but make it possible for industry effect transformations. In short the role of banks is to serve industry and not principally themselves. Bets made in the world casino are zero-sum, with some of the big boys able to skew the markets in their favour by the sheer size of their wager and by using their clients’ money.

Banks do “make money” in one sense. They leverage funds and lend out as much as twenty to thirty times what they hold in assets. This conjuring trick should not be confused with genuine wealth creation, because where asset prices collapse leverage goes into reverse and banks LOSE twenty to thirty times as much. This is how trillions disappeared in 2008, an error for which we have been paying ever since. Banks need asset prices to hold up and only genuine wealth creation can do this. They create derivatives from these assets and then derivatives from those derivatives in a veritable house of cards. But unless they serve industry better these foundations will remain unstable, as were their subprime mortgages and their liars’ loans.

By distributing money to worthy persons and institutions banks aim to make the most profit with the least possible risk plus the highest level of collateral. Banks are simply one more industry and should compete with best of them

The receivers of the banks’ money are the real contributors and wealth creators, whose products are risky, uncertain and hard to assess, so banks avoid them. Banks are NOT simply one more industry and competing with customers hurts all.

One reason bankers pay themselves so much is that vast sums pass through their hands for which they are responsible. Surely that deserves compensation? But the real reason they pay themselves so much is that they can. As distributors, the money reaches them first and what they skim off is up to their own discretion. Of course, industries will then lack funds with what amounts to a private tax levied across the board. Less money reaches the genuine contributors. Banks are not just another industry but a means of distributing money to industry and the tricks they use have abused this powerful position

But even these diminished amounts go to the wrong people. Catering to the already wealthy is a highly conservative process. They have much to lose and too little to gain. But even worse is funnelling money to the housing market. This is low risk, high collateral because most people pay off their mortgages and houses can be repossessed if interest is not paid. But it is also very low productivity. The house holder sits tight among his/her own possessions and waits for the property to increase in value. It often beats working! Two groups of American economists examining international comparisons have shown that faster expansion of the financial sectors triggers slower growth in the real economies. Talent and resources are attracted away from contributors towards distributors. The success of the City may be a doubtful blessing. UK industry has been in steady decline for more than 150 years. Manufacturing is down to 10% of the economy and productivity is faltering, not enough of the money is reaching the genuine contributors.                                    

Conclusion

Wealth-creation is a social, transformative, positive-sum activity. It needs at least two persons to create wealth and this is generated by the relationship between them. Merely making money may be sterile and speculative. The customer may have no choice but to accept your terms and this too is corrupting for the supplier and impoverishing for the buyer. The making money by itself can and sometimes does weaken the economy as a whole. All speculative activities are zero-sum with losers matched to winners. There is evidence that uncertain money rewards can be addictive and where capitalism imitates a casino we are all ill-served, even where the finest minds are attracted to a speculative enterprise, half will lose. We need to identify genuine contributors and get the money to where it can be used to create wealth. Banking is a service to industry and to people and it competes with its customers to the detriment of us all.