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The Materialism Fallacy

By Arnold Kling - January 5, 2006 12:00 AM

"most of a country's wealth is captured by what we term intangible capital...Intangible assets include the skills and know-how embodied in the labor force. The category also includes social capital, that is, the trust among people in a society and their ability to work together for a common purpose. The residual also accounts for all those governance elements that boost the productivity of labor. For example, if an economy has a very efficient judicial system, clear property rights, and an effective government, the effects will result in a higher total wealth and thus a higher intangible capital residual...human capital and rule of law account for the majority of the variation"
-- Kirk Hamilton, et al, Where is the Wealth of Nations?

Economists are gradually shifting the way we think about the determinants of economic well-being. Traditionally, the focus was on resources. Increasingly, we appear to be moving toward a focus on beliefs.

A new study from the World Bank, called Where is the Wealth of Nations? (which I first saw mentioned in Ronald Bailey's article in Reason magazine), is a landmark event in this transformation of economic viewpoint. First, it adds to the growing body of evidence that institutional factors, such as property rights, play a significant role in economic development.

Moreover, the study comes from an organization that was founded on the opposite belief. The World Bank was created at the end of World War II in order to promote economic development by providing capital to poor countries. Given its history and raison d'être, the conversion of the World Bank to a belief in intangible factors as determinants of economic development would be equivalent to a fundamentalist religious group's endorsement of gay marriage.

From Tangibles to Institutions

Over the past 50 years, economists have become less materialistic. No, we have not become hippies, rejected consumerism, and discovered spirituality. As social scientists, however, we have noticed that a large share of wealth comes from factors other than basic labor and capital. This phenomenon was first documented by Nobel Laureate Robert Solow, and came to be known as the Solow Residual. The term "residual" suggests something small, mysterious, and unexplained. But the Solow residual is not small -- it is several times larger in importance than the stock of physical capital.

Because the Solow Residual is too large to ignore, much recent research has focused on explaining it. The current consensus is that institutions matter. The rule of law is important. Clear property rights are important. On the negative side, protectionism, corruption, and barriers to entrepreneurship are important.

From Institutions to Beliefs

If institutions are important, then this raises questions about how institutions get to be what they are. Are there strategies for achieving institutional reform, including ending corruption or strengthening property rights? Can institutions change suddenly, or do they evolve gradually? Why are we fortunate enough to have institutions that are conducive to growth, while other societies are stuck with dysfunctional institutions?

George Mason University economist Tyler Cowen believes that this line of thinking leads to an inquiry into The Cultural Foundations of Economics. He writes, "Imagine economics is no longer built around the dual of preferences and constraints. We would instead have the following starting points: ...beliefs ...peers ...stories..."

Here, I wish to focus on the role that beliefs play in determining economic institutions and performance. I claim that:

1. People behave differently based on what they believe. Someone who believes that hard work in school is (a) admired by peers and (b) ultimately rewarding will work harder in school than someone who believes the opposite. Someone who trusts the mechanisms for trading with strangers will trade more than someone who fears trade with strangers.

2. People support different institutions and policies depending on what they believe. Someone who thinks of wealth as something to be earned and created will support property rights and policies that reward work. Someone who thinks of wealth as something to be controlled and allocated will support a welfare state. People who see positive-sum possibilities in trade and technological change will be less protectionist than people who view such phenomena in zero-sum terms.

3. Some patterns of beliefs are self-reinforcing. For example, if people believe that all government transactions involve corruption, then they are more likely to go along with corruption when they encounter it.

4. People's beliefs tend to reflect the beliefs that they are exposed to in their immediate family and peer groups. For that reason, differences in beliefs across nations or religious groups tend to persist. However, I suspect that religion per se is over-rated as a determinant of beliefs, although interest in that topic appears to be on the upswing among economists.

5. Because of the importance of peers and family, beliefs among a group can remain stable for a long time, and then rapidly evolve when a critical mass of people experience a change of mind.

Ironically, one of the most difficult beliefs to change is the belief that physical resources are the main causal factors in economics. From Karl Marx's Das Capital to Jared Diamond's Guns, Germs, and Steel, the materialist belief captures people's imaginations. However, as the evidence for the intangible sources of wealth becomes more and more salient, our beliefs will adapt accordingly. When a book produced under the auspices of the World Bank challenges the materialist assumption, a broader change of beliefs may be imminent.

Arnold Kling is author of Learning Economics.

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23 Comments

Efficiency
Wealth is still ONLY derived from what can be mined or grown.
How efficiently that wealth can be acquired and distributed is what makes individuals and nations wealthy.
Knowing that the state will protect your land from squatters will enable you to devote more time and energy into production.
And if you discover gold on you property, if you want more wealth, you will need to hire people to help extract that wealth.
Mugabe is a great negative example.

Distinguishing the source of wealth from the wealthy
As President Lincoln pointed out wealth is only created from labor. Most of the wealthy people however, come from making profit in real estate, an occupation that in and of itself does not involve creating wealth through labor but concentrating wealth through the vagaries of the economy and political mani****tion through the use/misuse of political power.
One must always keep in mind the things that create more wealth and a better life such as hard work, innovation, cooperation, the rule of law and protection of civil liberties, protection of property rights, and social stability are not necessarily connected at all with the wealthy who often strive to subvert the system to their own ends.

Social democracies hold their own economically
Despite all the bashing France receives on American free-market Websites, the World Bank study back in its appendices shows that France has a per capita wealth of about 91% of the figure calculated for the U.S., and almost double the rate of savings. Other developed social-democratic countries also compare favorably.

Uh...no
The 'savings' those studies look at don't include:

(1) 401(k), IRA and other retirement account assets.
(2) Real estate asset values

In America, we have far more in savings than the French do, it is just in different forms and is not looked at in traditional savings statistics.

France has a 1% - 1.5% GNP growth rate vs our 3.5% average rate. And, they are not having enough babies to replace their current po****tion, let alone fund the social welfare state. Nobody at the World Bank was brave enough (or ideologically willing enough) to look at that, either.

No, wealth is derived from the human brain
"Wealth is still ONLY derived from what can be mined or grown."

What is mined or grown to produce Microsoft Windows? (The reason I ask is because Bill Gates and other owners of Microsoft stock seem to be quite wealthy.)

And when power from fusion becomes commercial, what will you say the heat and electricity is derived from...the mining of water?

Wealth is not derived from what can be mined or grown. Wealth is derived from how the human mind is utilized. (And in a couple decades, it will be derived significantly from how computer minds are utilized.)

Computers
Computers made the process of transforming raw materials from the earth or from plants and animlals more efficient.
Human inginuity has continued to impove the effiency of satisfying the needs and wants and wealth will flow to those who satisfy that need.
And I agree that fundamentally wealth is energy. More effiecient energy production from fusion (what is being fuzed?, stuff from the ground)will increase the wealth of those using that energy source.
I would also suggest that human needs plateau. As society's rules allow more and more people to more effeciently meet their needs, wants will take over. No one needs to watch a movie or play a computer game or listen to music. These are wants that have a market because human ingenuity in science and society have enabled needs to be met.

Division of labor
I have always looked at Adam Smiths Division of labor as an organizational think rather than a capital/resource thing. So the change is more in degree than in substance. IMO the non-economists have and still do look more at resources. Ask the non-economist why the USA is rich and most will say natural resources even today.

Are People Motivated By Money?
Economists finally woke up to the reality that notions such as the importance of trust, relativity of risk, and perceptions of the immediate family, peers, culture on trade, matter.

I’d seen this play in unlikely places, for example in compensation plans that guarantee minimum wage but also promise commissions based on individual performance. It works this way: the company forecasts total revenue and labor costs, divided by the number of workers, to reach average pay. Then, the company decides how many workers to hire based on the assumption that average hourly pay equals minimum wage. Most workers get their minimum wage, and the better workers get a slightly higher pay. The scheme maximizes productivity (pay for performance) without compromising costs (fixed liabilities).

Point is, financial incentives work (check out Freakonomics). Up to a point. After all, money buys tangible things but it does not guarantee happiness.

Labor
Your definition of labor is way to limited.
Labor also includes those who spend their time thinking.
Investors (of whom the speculators that you denounce are correctly listed) labor by using their brains, not their backs.
Buying something when it is in low demand, and hence cheap, and then selling it back when demand picks up, serves a valueable economic service.

The real wealth that we need to export
The quote of Kirk Hamilton at the beginning almost led me to not read the piece. It was almost as if Kling were quoting from Jeffrey Hart’s essay on the “Burke Habit” – see Kern’s airing of Hart’s flatulence elsewhere on this site. Luckily, I *****vered. I liked this article very much and it left me optimistic for the ole dismal science.

When liberals advocate foreign aid they envision a deputized Robinhood from the State Dept. appearing at Scrooge McDuck’s front door with orders to partially drain his swimming pool filled with cash and coin and remitting it to the starving masses of the third world. They deserve a cut of what America is extracting and greedily consuming of the good earth before we use it all up. In return, Scrooge will get free lessons on environmental sustainability. This is a “fair-trade,” so to speak – “You make it and we allocate it.”

The reality is that the treasure is mostly diverted for jets and palaces for the local despot and make-work for his relatives/tribe/political party. Over the decades we’ve financed a lot of Large Living and subsidized even more poverty and squalor. Give a man a fish and he’ll get to eat a fish head for a day. Teach a man to fish and he can support a despot, keeping some of the fish heads for his family.

The real wealth that we need to export, as this article brings out so well, is democracy, the rule of law, personal responsibility, and capitalism. Free people, free minds, free markets. Amen.

A rock is a rock
until someone applies ingenuity to turn it into something else.

Does a book or a song have no value?

Energy
Until we devolop telekinetic powers, energy will be required to turn that rock into a brick.
Where does that energy come from? (agriculture and mining)
A book or a song's value is based upon two things, the value of the paper it is written upon or (electrons it is stored in) and what the audience thinks the value should be.

Rocks, paper, scissors
Without intelligence applying energy to a rock just gets you a puddle of melted rock.
Energy can also come from concentrated solar power, wind, anything.
I can take a piece of paper and write random words on it, and not add any value to the paper.
The reason why people value a song is due to the efforts put into it by the author and the artist. The songs value exists without the use of any resources other than time.

Uh...no
Counting land values would be wrong. A country cannot change the stock of land. Also, if their po****tion is declining, it means their per-capita wealth is increasing faster than the GNP growth; if a po****tion is increasing the reverse is true.

Materialism Fallacy -- Loaded with Cheap Shots.
Prof Kling write:
Ironically, one of the most difficult beliefs to change is the belief that physical resources are the main causal factors in economics. From Karl Marx's Das Capital to Jared Diamond's Guns, Germs, and Steel, the materialist belief captures people's imaginations.

This is a gross distortion of Guns, Germs, and Steel. Furthermore, the placement of Diamond's work with Marx's work is far beneath Prof. Kling.

Diamond's book is an exploration of how the material world affects human development. It does not dispute the importance of human ingenuity; just explains that the ability to apply it depends on the material world.

If someone disagrees, read
Jared Diamond's talk on "How to Get Rich" where he points out:

In China one despot could and did halt innovation in China. Instead, China's experience of technological innovation came during the times when China's unity fell apart, or when China was taken over temporarily by an outside invader.

You've seen that effect even in modern times. Twenty years ago, a few idiots in control of the world's most populous nation were able to shut down the educational system for one billion people at the time of the Great Cultural Revolution, whereas it's impossible for a few idiots to shut down the educational system of all of Europe.

Artist value
"The reason why people value a song is due to the efforts put into it by the author and the artist. The songs value exists without the use of any resources other than time."

Time is money. Why? The artist needs to eat, have a source to buy or make paper and pen. All of this requires energy and raw materials (wood, graphite).
Art is a measure of societies advancement because the division of labor has speciliezed to the point where not all members are needed for survival.
I don't value the efforts of just any 'artist' who puts effort into something. The value of the work is based upon how much the audiance values it.

Quality of Economic Education
"Ask the non-economist why the USA is rich and most will say natural resources even today."

Opinion is certainly divided among 'certified' economists whether Adam Smith was right.
It is too bad economics is not a real science other wise the evidence would be overwhelming.



the renaissance


Some say that is why the renaissance flourished in Germany and Italy. They where both made up of small sates and thus had had weak governments.


Anglosphere
Several recent works on what has been termed the Anglosphere, posit that one of the major reasons why Britain flourished while other countries did not, is that the nobles had been able to hobble the King's power.

ain't that a fact!!!
Hi Joanie
I'm still trying to figure out how to by a 100-300 f2.8 (I would take a 70-200) for my D70. The lens cost 4-times the price of the camera!!
But my audience doesn't care. Nor do they care how much time or effort I put in. Nor do they always agree with me on what is "good photo art". Some of my best work was done purely by accident; i.e. I just happened to have my camera at exactly the right time and caught a very unusual or precise shot. ( Examples: a scenic of the peaks of Glacier Park from the top of Big Mountain when the sun just happened to peak out at the right time of the day; A golden eagle on the hunt and I just happen to stop and watch as he nails a quail on the ground. There are a ot more and none of them took nearly as much time as my four -day hiking adventures to get the perfect shot of a black bear or a moose, neither of which I managed to get. but my B&W shots of a group of Big Horn Sheep happened when I was in Glacier Park taking pictures of my wife and oldest daughter, no time spent in the pursuit of that photo. My best planned shot is probably a picture of the Hale-Bopp comet as it came into alignment above the Sweetgrass Hills. It took me two days to set that one up, but I got what I wanted!!)
Still, there is no substitute for experience and planning, especially with wildlife or human interest shots.
Later,
Paul

Distinguishing the source of wealth from the wealthy
I agree. http://www.scoop.co.nz/stories/HL0407/S00040.htm is a good article regarding this subject.I liked it and I put it on my BLOG at http://bigokieguy.blogspot.com/.I found the article on the following website today. http://solari.com/index.html

Weak Kings And Poland
"Hobble" is the wrong word to use. The state remained fairly powerful, and was capable of decisive action. If mere decrease in centralized power resulted in an increase in innovation and national power, the Polish Sejem and the veto should have ensured the national power of the Kingdom of Poland. Needless to say, that did not occur.

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