EKIP– Expert Club for Economics and Politics A Different Opinion
The following is a translation of an article published on August 1, 1981 with the original title "What Causes Wealth?" by Roger Ream. The subtitles and formatting are by the translator. The original article can be found on the FEE website . The current translation is published under the Creative Commons Attribution 4.0 Int. license.
Hint: prosperity requires freedom.
Poverty is still with us.* Despite tremendous innovations in agriculture and industry, it persists. But why? Why do some people suffer from poverty their entire lives? Why do others enjoy a high standard of living? What makes it possible to have decent, even comfortable, living conditions? These are questions as old as the world.
Poverty is the natural state of things
The usual condition of humanity throughout the ages has been survival on the edge of the possible in a state of relative poverty. Wealth is the exception, not the rule. The first serious economic work, written in 1776 by Adam Smith, is aptly titled "An Inquiry into the Nature and Causes of the Wealth of Nations" (often incorrectly abbreviated as "The Wealth of Nations"). It is the existence of wealth and prosperity that needs to be investigated and explained, not poverty . Therefore, economists and social scientists since Smith have sought the origin of wealth. An examination of the shortcomings of the common explanations for the existence of poverty will give us insight into the real reason for the existence of prosperity.
Four common explanations for the existence of poverty
1 - Overcrowding
A popular claim is that there is poverty because there are too many people. It is said that countries with large populations such as India, Bangladesh, and China are poor because their production cannot possibly be large enough to feed, clothe, and shelter their many millions. The argument goes that if their leaders could only persuade their people to practice birth control, then living standards would rise to a decent level.
This explanation is flawed. It fails to take into account the size of the territory over which this population lives. For every poor country with a large population like Bangladesh, one can point to the relatively populous and prosperous Japan, South Korea, Taiwan, the Netherlands, Singapore, and Belgium. And among the less populous countries, the prosperous United States stands alongside the poorest countries in Africa. Population, like population density, does not explain why some countries are poor and others are prosperous.
2 - The poor are lazy
Another common argument is that the poor are lazy people with low intelligence and few natural gifts. This line of reasoning often takes on racist overtones. It is also incompatible with some simple facts.
We have the example of millions of supposedly less gifted people who leave poor countries and succeed, making enormous contributions to the science, culture, and business of their host countries. In Wealth and Poverty, George Gilder studies the remarkable achievements of a number of Lebanese families in the Berkshires and concludes: "Other immigrants in every American city - Cubans in Miami, Portuguese in Providence and Newark, Filipinos in Seattle, Koreans in Washington and New York, Vietnamese in Los Angeles, to name but a few - have made incredible achievements in commerce almost without the aid of banks or governments or professional economists." He also observed that in the 1970s, "America was experiencing an era of great immigration, comparable to the influx of Irish, Italians, and Jews in the nineteenth and early twentieth centuries. Four hundred thousand legal immigrants a year entered the country, as well as eight hundred thousand illegal ones, and everywhere they created jobs."
The people of East and West Germany share a common ancestry and history, and one country prospers while the other faces serious economic problems.** Similarly, the Chinese in Hong Kong and Taiwan differ in material well-being from their relatives in communist China. Compare the Ivory Coast with its neighbors. It is clear that poor people are not generally less intelligent, talented, or lazy. The reason for their poverty must be sought elsewhere.
3 - Poor countries lack natural resources
According to some analysts, another serious reason for the poverty of certain nations is that their countries do not have the necessary type or quantity of natural resources. This argument is difficult to sustain, given that many of the most resource-rich countries are mired in poverty, while the rich are less advantaged by the availability of resources. Examples of the former can be seen in most countries in Africa and South America, while the latter group includes Taiwan, Japan, and most Western European countries. Even the oil-rich members of OPEC have failed to build a stable industrial base and raise the standard of living of their populations above average levels. The presence of natural resources alone is not enough to explain the existence of prosperity.
4 - Prosperity causes poverty
One of the most prominent public beliefs in the United States today is that income and high profits are unearned, undeserved, and that public assistance is ethical and necessary to achieve “social justice.” According to this worldview, wealth is acquired through exploitation or luck and therefore its possession is unjust. This worldview is the cause of immense suffering and poverty. It does more harm to the poor than any other idea that has emerged in recent decades. It also contributes to the conflicts, hatreds, and envy that poison our society.
This worldview is based on the explanation that poverty is rooted in prosperity. As contradictory as it may sound at first glance, this explanation is perhaps the most widespread. According to this theory, the creation and accumulation of wealth by some is the reason why others are poor. According to it, poverty is a consequence of the unequal distribution of income: the prosperity of some comes at the cost of the misery of others. The adoption of this erroneous worldview leads to a clash in society, in which the haves are blamed for the condition of the have-nots. In the former, this gives rise to a feeling of guilt, and in the latter, it leads to envy and greed. Overall, it increases tension in society.
This misconception stems from a misunderstanding of both poverty and wealth. A review of history and different cultures clearly shows that poverty is the natural state of humanity. It exists without external causes, it simply is. Wealth, on the other hand, is an achievement and requires certain prerequisites. Wealth will be created and the standard of living will rise only when these necessary prerequisites are present.
However, there is some truth to the claim that wealth causes poverty, and we cannot dismiss it entirely. In closed, collectivist societies, the slaveholder or communist bureaucrat does indeed acquire his wealth at the expense of others. The power of the elite comes at the expense of the slave proletariat, and the theoretical model of a zero-sum society is realized, in which an increase in one person's share makes another person's share smaller. However, this zero-sum (or rather negative-sum) situation is relevant only to systems based on slave labor and collectivist economies. In these societies, the slaveholder or commissar gains at the expense of others. Greed, when supported by violence, leads to some being poor.
After this clarification, I must clarify that in open, competitive economic systems, wealth and unequal distribution of income do not cause poverty. It is a myth that the prosperity of some causes poverty for others. The United States of America is regularly criticized because, with less than 5 percent of the world's population, we consume a large percentage of the world's resources. The criticism is based on the error of thinking about one pie. People in the United States do not consume at the expense of others. What we consume must either be produced or acquired through voluntary exchange. We do not consume goods and services that simply exist and that we only take. We consume only what we produce, process, or acquire through free trade. In a market economy, you cannot consume unless you first produce or exchange.
The nature of wealth
Adam Smith understood the nature and manner of wealth creation: it is the result of the development of the division of labor. As Smith noted, "The great multiplication of the productions in the various occupations, resulting from the division of labor, is what causes, in a well-organized society, the general abundance, which extends to the lowest classes of society." This market process is the source of wealth, since it results in the voluntary interaction of free men pursuing their own interests. For example, a man specializing in mechanics interacts, perhaps unknowingly, with those specializing in physics, chemistry, meteorology, mining, steelmaking, and a hundred other professions, to make possible air travel to almost any large city in the world. Wealth is created through the division of labor, peaceful interaction, and free exchange—the market process.
Writing almost a century after Smith, Herbert Spencer also correctly identified the source of wealth. In Man Against the State, he notes:
It is not to the state that we owe many useful inventions, from the shovel to the telephone; it is not to the state that long-distance navigation is possible through the development of astronomy; it is not to the state that the discoveries in physics, chemistry, and other sciences that guide modern manufactures are made; it is not to the state that the machines for the manufacture of all kinds of fabrics, for the transportation of people and things from place to place, and for the service of our comfort in a thousand ways are invented. The transactions of world trade, carried out in the offices of merchants, the traffic that fills our streets, the system of distribution of products in retail trade, which brings everything to our fingertips and supplies the necessities of our daily lives, are not of state origin. All this is the result of the actions of citizens, collectively and individually.
The market process is the source of new wealth. It does not distribute wealth to the elite at the expense of the rest, as happens in a collectivist economy. Instead, it allows new goods and services to enter the market. A free market system is a positive-sum system. Remarkably, living standards rise even as the population increases, because the sum of wealth in society is not fixed. Wealth transfer systems, on the other hand, are at the expense of the creators of wealth—workers, businesspeople, investors, and successful entrepreneurs.
Contrary to popular belief, high incomes and high profits are key elements in the process that generates our prosperity. High incomes and profits are the rewards that one receives for serving others. More precisely, profits are the rewards for reducing costs and using scarce resources more efficiently to satisfy consumer wants. By rewarding those who successfully satisfy consumer demand with profits, the free market maximizes the incentives to create valuable goods and services. By allowing the accumulation of wealth, it also maximizes the available capital to produce more things. Profits direct capital to where it is most needed to meet consumer demand. Even Samuel Gompers, the father of the American labor movement, acknowledged that "the greatest crime against working people is an enterprise that fails to operate at a profit."
Envy, covetousness, and hatred of the rich are all wrong. As Ludwig von Mises pointed out in Human Action, "The very principle of capitalist enterprise is to provide for the common man... In a market economy there is no other way to acquire and preserve wealth than by providing the masses with what they want, in the best and cheapest way possible." Proof of this is the success of the creative genius Thomas Edison, who fulfilled his promise to make the light bulb so cheap that only the rich could afford candles. As Brian Summers commented in the spring 1981 issue of the Lincoln Review: "It is true... that a few leading industrialists amass great fortunes, but they become rich through the mass production of goods and services that raise the standard of living of the common man."
Prosperity requires freedom. High incomes and profits, the incentives to invest and produce, work as long as they are not taken away by those in power. The reason why people want higher incomes and profits should not concern economists. Whether for low or high passions, the only way to get more in a free market is to serve others. The way to reduce poverty is to create an environment conducive to investment and wealth creation. In fact, when William E. Simon was Treasury Secretary, he told a Senate committee that "If you really want to help the poor, help the rich. They are the only ones who will invest, build factories, create more jobs." The only "help" the rich need is the same freedom that is due to every person: the freedom to produce, trade, and dispose of their property in a nonviolent manner. After all, the market is only free to the extent that society is free.
The free market can be restored and the division of labor increased only to the extent that the obstacles to saving, investment, wealth accumulation, and profit maximization are removed. It is essential that laws that regulate or prohibit the performance of productive labor be repealed. This will also require the state to better fulfill one of its key roles: to protect the right of every citizen to own and exchange property. This fundamental human right is necessary for the creation of wealth.
The free market is in the interest of the poor. The alternative, the welfare system, is inhumane. It traps people in a state of perpetual poverty, destroying their opportunities and prohibiting many kinds of productive work. The welfare state encourages dependency, not self-reliance. The welfare recipient is deluded into thinking there is a free lunch. In the free market, you have to give to get, and in the welfare state, the scheme is to try to live off the backs of others.
In conclusion
Deprivation, and therefore relative poverty, is part of the nature of the world we live in. Historically, humanity has lived in a state of what we would call absolute poverty by today's standards. This does not mean, however, that poverty must be a permanent phenomenon. It can be and has been overcome by different peoples at different times in history. Our ancestors, the first settlers of America, overcame hunger by replacing their communal system with an economic organization based on private property. The experiment worked. A major turning point occurred again in Britain in the first half of the 19th century, when Parliament replaced mercantilism with a policy of free trade. Living standards rose not only for the English, but for countless people around the world. And, of course, we have the evidence of what the relative freedom in this country does not only for the first settlers but also for the millions of immigrants who come to these shores, not to share in the existing material abundance, but to share in the freedom to create their own. With this relative freedom comes a more humane and prosperous society.
Perhaps the clearest description of the threat we face today, and that free people will always face, was made by President Woodrow Wilson. He noted, “The history of freedom is the history of the limitation of the power of the state, not of its increase. When we oppose the concentration of power, we oppose death, for the concentration of power always precedes the destruction of human liberties.” This insightful comment could easily be paraphrased to include the concepts of poverty and prosperity, for the concentration of state power and poverty go hand in hand, just as human liberties and prosperity go hand in hand. Regardless of sincerely good intentions, to limit freedom in the name of helping the poor is to act destructively. The creative way to support those in need is to ensure that people are free to pursue their interests peacefully and voluntarily. By doing this, free people will bring about a growing economy, endless opportunity, and lasting prosperity.
About the author: Roger Ream is chairman of the Foundation for Economic Education and president of the Endowment for American Science. Mr. Ream has worked in education and public policy for more than 35 years.
Translator's notes:
* True in both 1981 and 2021, though to a much lesser extent than people 50 years ago might have imagined, thanks to the fall of a number of totalitarian regimes and the introduction of relatively free markets in others. For example, the percentage of people living on less than $1.90 a day (2011 PPP) fell from 42.5% to 9.2% by 2017, according to the World Bank.
** Another similar example, which is even more striking today than it was in 1981, is that of North and South Korea.
*** By definition, in a free exchange, both parties leave the transaction with more than they had before, with nothing added to the closed system of buyer and seller and the goods, services, and money exchanged. The very act of exchange creates wealth.
**** Talking about profit as a reward can be misleading, because in making a profit, the "winner" actually gives more value than he receives, from the perspective of the "giver". Paradoxically, from the perspective of the customer, the "winner" actually gives more than he takes, and the "giver" takes more than he gives, just as the opposite is true. In a voluntary interaction, both participants make a profit, i.e. both are rewarded. In this case, it is the monetary profit that everyone focuses on at the expense of the customer's non-monetary profit.
Translation: Georgi Georgiev
The translation was originally published on the translator's website here.
