Wealth, and why we don't have it

Wealth. What is it? Where does it come from? Why are some people in some places wealthier than others? And why does New Zealand have to borrow so damn much in pursuit of it?

These are the sorts of questions people have been asking for centuries, and since Adam Smith it's been something for which we have some pretty good answers.

We've all heard the commitments to get New Zealand back into the top half of the OECD, and many of us have seen those graphs that Rod Deane pulled out recently showing NZ's rise and decline in those rankings over the last century-and-a-half -- and we've realised that getting back into the top half of the OECD isn't as easy as politicians' promises would have you believe.

According to my dictionary, wealth is defined as "affluence, plenty and prosperity, a profusion, great plenty (of); prosperity." Clearly, wealth has something to do with productivity, with resources, with capital, and with what Julian Simon called the ultimate resource: the creative human mind applied to productivity. But how to explain and quantify the relationship?

Two years ago, the World Bank began examining questions such as these, and unusually for such an organisation, they came up with something worth studying. They found something that hadn't been accounted for in all their previous studies on the subject. Ronald Bailey explains:

Two years ago the World Bank's environmental economics department set out to assess the relative contributions of various kinds of capital to economic development. Its study, "Where is the Wealth of Nations?: Measuring Capital for the 21st Century," began by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal and mineral resources), cropland, pasture land, forested areas and protected areas. Produced, or built, capital is what many of us think of when we think of capital: the sum of machinery, equipment, and structures (including infrastructure) and urban land.

But once the value of all these are added up, the economists found something big was still missing: the vast majority of world's wealth! If one simply adds up the current value of a country's natural resources and produced, or built, capital, there's no way that can account for that country's level of income.

What's missing in those traditional measures is what links the human mind with productivity: the rule of law. In a sentence, the creative human mind is more productive the more that the rule of law is recognised.

The explanation for that is simple. You see, when the protection of law is weak, then the mind is only able to plan short range. When property rights are weak, for example, people tend to build their furniture before they build their roofs -- and you can see the evidence of this in shanty towns all over the globe. When time horizons are short, this is rational behaviour. But shanty towns aren't the natural human environment, are they. Take a shanty town dweller out of the shanty and set him down in a place where the rule of law is better recognised, and immediately his time horizons become longer, his prospects much brighter, and his house and his wallet much richer.

Extent time horizons by setting in place the rule of law, and immediately you bring the distinctive attribute of the creative human mind -- the ability to think and to plan long range -- to bear on the question of productivity. That's the real link between wealth and law, and it's something politicians actually can do something about.

You see, this is what the World Bank's researchers realised in their study. What's more important in determining wealth than natural resources or real capital is what they eventually termed this "intangible capital" -- that is, "the wealth product that comes from securing people's rights through the rule of law," so called "intangible factors" such as "the trust among people in a society, an efficient judicial system, clear property rights and effective government."

All this intangible capital ... boosts the productivity of labor and results in higher total wealth. In fact, the World Bank finds, "Human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries."

Once one takes into account all of the world's natural resources and produced capital, 80% of the wealth of rich countries and 60% of the wealth of poor countries is of this intangible type. The bottom line: "Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity."

This "intangible capital" can be quantified, and what we find when that exercise is done is that "the natural wealth in rich countries like the U.S. is a tiny proportion of their overall wealth—typically 1 percent to 3 percent—yet they derive more value from what they have."

Cropland, pastures and forests are more valuable in rich countries because they can be combined with other capital like machinery and strong property rights to produce more value. Machinery, buildings, roads and so forth account for 17% of the rich countries' total wealth.

Overall, the average per capita wealth in the rich Organization for Economic Cooperation Development (OECD) countries is $440,000, consisting of $10,000 in natural capital, $76,000 in produced capital, and a whopping $354,000 in intangible capital. (Switzerland has the highest per capita wealth, at $648,000. The U.S. is fourth at $513,000.)

By comparison, the World Bank study finds that total wealth for the low income countries averages $7,216 per person. That consists of $2,075 in natural capital, $1,150 in produced capital and $3,991 in intangible capital. The countries with the lowest per capita wealth are Ethiopia ($1,965), Nigeria ($2,748), and Burundi ($2,859).

So what does this mean for New Zealand, and any hope we have of getting rich, and getting back into the top half of the OECD?

Well, here's the bad news. In the rankings of "intangible capital," New Zealand comes a pitiful twenty-first with just $243,000 of "intangible capital" per head, behind Spain and Singapore at nineteenth and twentieth, and just ahead of Greece, Portugal, South Korea and Argentina.

That's a measure of how poor we are in the rule of law.

And just look at our performance as compared to Australia, often known as "the lucky country" because of its resource riches. But Australia's resource wealth only amounts to $25,000 per Australian, compared to our own resource wealth of $43,000 per head; the difference between the lucky country and us is that they're "luckier" in terms of the rule of law: in the "intangible capital" represented by that measure, Australians are half again as wealthy as we are, with $371,000 per head compared to our own $243,000 per head.

So the message is clear, and when you boil it all down it's not complicated. If wealth is your goal, and if ambitions to be in the top half of the OECD are genuine, then concentrate on the rule of law, and on the "intangible capital" of an efficient judicial system, of clear property rights and of effective government.

Simple.

• Ronald Bailey's article is here: The Secrets of Intangible Wealth - Reason magazine.
• The World Bank study is here: Where is the Wealth of Nations: Measuring Human Capital for the 21st Century [200-page pdf]