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What Causes Wealth?

AUGUST 01, 1981 by ROGER REAM

Roger Ream is Director of Seminars of The Foundation for Economic Education.

The poor are still with us. Despite tremendous advances in agriculture and industry, poverty persists. But why? Why do some people suffer lifelong poverty? Why do others enjoy high standards of living? What makes possible decent, even comfortable, conditions? These are age-old questions.

Over the centuries the normal human condition has been subsistence in a state of relative poverty. Wealth was the exception rather than the rule. The first major work of economics, written in 1776 by Adam Smith, was appropriately entitled An Inquiry into the Nature and Causes of The Wealth of Nations. It was the existence of wealth and prosperity that required an explanation, not the fact of poverty; henceeconomists and social scientists beginning with Smith have sought to discover the cause of wealth. An examination of the shortcomings of many common explanations for the existence of poverty offers insight into the real cause of prosperity.

Over-population. One popular claim is that poverty exists because of over-population. It is said that countries with large populations, such as India, Bangladesh, and the People’s Republic of China, suffer from poverty because production cannot possibly be great enough to feed, clothe and house adequately the millions of people. If leaders could only convince their people to prac tice birth control, so the argument goes, the standard of living would begin to rise to a decent level.

This explanation has shortcomings. It ignores the necessity for considering the size of the population in relation to the area of a country. For every country of high population density that is impoverished, such as Bangladesh, relatively populous and prosperous Japan, South Korea, Taiwan, the Netherlands, Singapore and Belgium may be cited. And among the sparsely populated countries, the prosperous United States may be listed along with some of the poorest countries of Africa. Actual population levels, as well as population densities, fail to explain why some countries are poor and others prosperous.

The poor are “lazy.” Another familiar argument is that the poor are lazy people with low levels of intelligence and few natural talents. This line of reasoning often takes on strong racial overtones. It also seems to be inconsistent with a number of basic facts.

We have the examples of millions of supposedly inferior people who left impoverished countries, became prosperous and made tremendous scientific, cultural and material con tributions in their adopted nations. In Wealth and Poverty, author George Gilder concluded after studying the remarkable achievements of several Lebanese families in the Berkshires: “Other immigrants in every American city—Cubans in Miami, Portuguese in Providence and New-ark, Filipinos in Seattle, Koreans in Washington, D.C. and New York, Vietnamese in Los Angeles, to mention the more recent crop—have performed comparable [to the Lebanese] feats of commerce, with little help from banks or government or the. profession of economics.” He goes on to observe that during the seventies, “America underwent one of its prime epochs of immigration, comparable to the great floods of Irish, Italians, and Jews in the nineteenth and early twentieth centuries. Four hundred thousand legal immigrants a year entered the country along with some eight hundred thousand undocumented aliens, and everywhere they went they found and created jobs.”

The peoples of East and West Germany have a common ancestry and history, yet one country flourishes while the other strains under economic difficulties. Likewise with the Chinese in Hong Kong and Taiwan, contrasted with their relatives and former countrymen in communist China. Compare the Ivory Coast with its neighbors. Clearly, poor people in genera] are not less intelligent, less talented, or inherently ill-disposed toward work; the cause of their poverty is to be found elsewhere.

Poor nations lack natural resources. Another reason people are poor, some analysts contend, is that certain countries are not endowed with the necessary type or the proper quantity of natural resources. It is difficult to sustain this assertion, considering the fact that many of the most resource-rich countries are poverty-stricken, while many wealthy nations are less well-endowed with resources. Examples of the former include most of the nations in Africa and South America, while in the latter group of poorly endowed can be found Taiwan, Japan, and most Western European countries. Even the member nations of OPEC, rich in oil, are unable to build a strong industrial base and raise the standard of living for their people to above average levels. There is more to prosperity than the mere presence of natural resources.

Prosperity causes poverty. One of the most extraordinary sentiments existing in the United States today is that high incomes and high profits are unearned or undeserved, while welfare payments are ethical and necessary for achieving “social justice.” According to this view, wealth is obtained through exploitation or luck and therefore is possessed unjustly. This sentiment is the cause of tremendous suffering and poverty. It is doing more harm to the poor than any other idea that has surfaced in the past several decades. Furthermore, it contributes to the conflict, hatred and envy that poison our society.

Derived from this sentiment is the explanation that prosperity causes poverty. As contradictory as this may seem on the surface, it is perhaps the most prevalent explanation. The creation and accumulation of wealth by some individuals causes others to be poor, so runs the theory. Poverty is the consequence of an unequal distribution of income; the prosperity of some comes at the expense of others. The acceptance of this fallacy has given rise to our conflict society, where the haves are blamed for the conditions of the have-nots. Feelings of guilt are often aroused in the former, while in the latter it stirs up envy and covetousness. Overall, it increases tension in society.

This fallacy results from a failure to understand the true nature of both poverty and prosperity. A survey of history and various cultures clearly shows that poverty is the natural state of mankind. It exists without external causes; it is just there. Wealth, on the other hand, is an achievement and requires specific conditions. Wealth will be created and the standard of living will rise only when the necessary preconditions are present.

However, under certain conditions there is some truth to the claim that wealth causes poverty; therefore it cannot be wholly dismissed. In a closed, collectivist society, the slave owner or communist party official does indeed gain his wealth at the expense of others, The wealth of the elite comes at the expense of the slave or the proletariat, thus typifying the theoretical model of a zero-sum society in which an increase in one individual’s slice of the pie causes another’s to shrink. However, this zero-sum (or more probably negative-sum) situation applies only to stagnant systems which are based on slave labor and collectivist economics. In closed societies, the slaveowner and commissar gain at the expense of others; greed, when backed by coercion, causes some to be poor.

Having stated this qualification, it must be made clear that in open, competitive economic systems, wealth and an unequal distribution of income do not cause poverty. It is a myth that the prosperity of some causes others to be poor. The United States is frequently condemned because with less than 5 per cent of the world’s population, we consume a large portion of the world’s re sources. This criticism is based on the fallacy of the fixed pie. Individuals in the U.S. are not consuming at the expense of others; what we consume must be either produced or acquired through voluntary exchange. We do not consume goods and services that have always existed and which we simply grab up; we consume only what we produce, transform or acquire through free trade. In a free market economy, you cannot consume unless you first produce or exchange.

The nature of wealth. Adam Smith recognized the nature and cause of wealth; it results from the development and extension of the division of labor. As Smith observed, “It is the great multiplication of the productions of all different arts, in consequence of the division of labour, which occasions, in a well-grounded society, that universal opulence which extends itself to the lowest ranks of the people.” This market process is the source of wealth, since it brings individuals freely pursuing their own interests into voluntary cooperation with others. For example, an individual who specializes in mechanics, cooperates, perhaps unknowingly, with those specializing in physics, chemistry, meteorology, mining, steel production, and hundreds of other fields to create travel by airplane and make it possible to fly to almost any major city in the world. It is through the division of labor, peaceful cooperation, and free exchange—the market process—that wealth is created.

Writing nearly one century after Smith, Herbert Spencer also recognized the source of wealth. In Man vs. the State he observed:


It is not to the State that we owe the multitudinous useful inventions from the spade to the telephone; it is not the State which made possible extended navigation by a developed astronomy; it was not the State which made the discoveries in physics, chemistry, and the rest, which guide modern manufacturers; it was not the State which devised the machinery for producing fabrics of every kind, for transferring men and things from place to place, and for ministering in a thousand ways to our comforts. The worldwide transactions conducted in mer chants’ offices, the rush of traffic filling our streets, the retail distributing system which brings everything within easy reach and delivers the necessaries of life daily at our doors, are not of governmental origin. All these are results of the spontaneous activities of citizens, separate or grouped.

The market process is the source of new wealth. It does not redistribute wealth to the powerful at the expense of others, such as in a collectivized economy; rather, it enables new goods and services to come into the marketplace. A free market system is a positive sum system. Remarkably, the standard of living can rise, even though the population is increasing, because the total amount of wealth is not fixed. Transfer payments, on the other hand, come at the expense of wealth creators—workers, businessmen, investors, and successful entrepreneurs.

Contrary to popular sentiment, high incomes and high profits are key elements of the process which generates our prosperity. High incomes and profits are the reward a person receives for serving his fellowmen. More specifically, profits are the reward for reducing costs and using scarce resources most efficiently in the competition to satisfy consumer desires. By rewarding with profits those who successfully satisfy consumer demand, the free market maximizes the incentives to create goods and services. By permitting the accumulation of wealth, it also maximizes the amount of capital available to produce more. Profits direct this capital to where it is most vitally needed in order to meet consumer demand. Even Samuel Gompers, father of the American labor movement, recognized that “the worst crime against working peoples is a company which fails to operate at a profit.”

Envy, covetousness and hatred toward those with wealth is ill-advised. As Ludwig von Mises pointed out in Human Action, “The very principle of capitalist entrepreneur-ship is to provide for the common man . . . . There is in the market economy no other means of acquiring and preserving wealth than by supplying the masses in the best and cheapest way with all the goods they ask for.” Evidence of this was the success of that creative genius, Thomas Edison, who fulfilled his pledge 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 captains of industry accumulated great fortunes, but they became wealthy through mass production of goods and services which raised the common man’s standard of living.”

Prosperity requires liberty. High incomes and profits, the incentives to invest and produce, are put to work, provided they are not confiscated by government. The motive for wanting a larger income and higher profits should not be a concern of economics; whether for a base reason or a high-minded objective, the only way to get more, in a free market economy, is to serve others. The way to lessen poverty is to create a favorable environment for investment and wealth creation. In fact, when William E. Simon was Treasury Secretary, he suggested to a Senate committee that, “If you really want to help the poor, help the rich. They’re the ones who will invest, build more factories, create more jobs.” The only “help” the rich need is the same freedom to which all men and women are entitled, the freedom to produce, to trade, and to use their property peacefully and as they choose. Ultimately, the extent of the market process is in direct relation to the amount of freedom in society.

A free market can be restored and the division of labor extended only as barriers to saving, investment, the accumulation of wealth, and the maximization of profits are removed, and most essentially, laws regulating or prohibiting the performance of productive labor are repealed. It will also require government to perform better one of its key functions: protecting every citizen’s right to own and exchange property. This fundamental human right is necessary for the production of wealth.

The free market is in the interests of the poor. The alternative, the transfer system, is not humane. It locks people into poverty by destroying opportunities and prohibiting many kinds of productive work. The welfare state encourages dependence, rather than self-reliance. The welfare recipient is deluded into believing there is such a thing as a free lunch. In a free market it is necessary to give in order to receive; in the welfare state, the scheme is to try to live at the expense of others.

Scarcity, and therefore relative poverty, are part of the nature of this world in which we live. Historically, mankind has subsisted in what, by today’s standards, is abject poverty. However, poverty need not be a permanent condition. It can be and has been overcome by people at various times in history. Our Pilgrim Fathers overcame starvation by replacing their communal system of economic organization with a private property order. The experiment worked. A turnaround occurred again in Great Britain in the first half of the 19th century when Parliament replaced mercantilism with free trade policies. Standards of living rose, not just for Englishmen, but for countless individuals throughout the world. And, of course, we have evidence of what relative freedom in this country has meant for not only the American settlers but for the millions of immigrants who came to these shores, not to share the existing material abundance, but to share in the freedom to try to create their own. With this relative freedom a more humane and prosperous society has emerged.

Perhaps the clearest statement concerning the threat we face today, and which all free people will always face, was expressed years ago by President Woodrow Wilson. He observed, “The history of liberty is a history of the limitation of governmental power, not the increase of it. When we resist, therefore, the concentration of power, we are resisting the processes of death, because concentration of power is what always precedes the destruction of human liberties.” This astute comment can be aptly rephrased to include the concepts of poverty and prosperity, for concentration of governmental power and poverty go hand-in-hand, while human liberty and prosperity have always accompanied each other. Regardless of the sincerity of the intentions, to restrict freedom in the name of helping the poor is to engage in a destructive endeavor. The creative way to help the needy is to secure the freedom for individuals to pursue their interests voluntarily and peacefully. In such pursuit, free men will bring about an expanding economy, unlimited opportunity, and enduring prosperity.

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August 1981

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