Monday, 23 March 2009

Olly wants us to keep consuming the seed corn

Paul Walker takes the Standard’s authors to task for their economic understanding, which as he describes goes from woeful to ‘wisible’ – although, unlike Paul, I suspect their understanding (or lack thereof) is more to do with too much university-based economics raining rather than too little.

Olly_7865_259 But such woefulness isn’t confined to the blogosphere.  Take dear old Olly Newland in yesterday’s Herald, in which he berates financial commentators who “regurgitate the hoary old theory that buying houses is ‘unproductive’ and [insist] instead we should be creating jobs and wealth by means other than investing in property.  Yet investing in property,” says Olly, “is one of the most productive enterprises in which a nation can engage… [Property] ownership automatically creates wealth by creating employment.”

Oh dear.  Apparently Mr Newland hasn’t been reading the papers for a year or two.  If what he says were true, then the United States should now “automatically” be wallowing in prosperity, since at the peak of America’s Greenspan-fuelled housing bubble some commentators suggest around forty percent of American employment – pretty much all the employment growth since 2001 -- was real-estate related.

What America and the world is now waking up to is that this was not at all productive.

Sure, Greenspan’s bubble “created employment,” for a while, but it did so by deluding home-owners that they had an increase in real wealth (i.e., in the goods and services that money income can buy) instead of just an increase in monetary value,  (a distinction first pointed out nearly two centuries ago by David Ricardo) encouraging them to consume their capital by using their houses like an ATM machine.  One could just as easily (and just as destructively) have “created employment” by paying people to fan out across the country and consume a nation’s seed corn.

Because that’s essentially what those employees were doing.

Let’s look at a basic distinction which Mr Newland seems to have missed.  The difference between a consumer good and an investment good (or a capital good, if you like) is a fairly simple one.  Capital is “wealth reproductively employed” – physical assets used in the self-sustaining production of more wealth.  Capital goods (or investment goods, which amounts to the same thing) produce from their own deployment the funds whereby to replace them, with (hopefully) a profit on top.  That’s how a country, year on year, builds a capital structure.

Consumer goods, by contrast, don’t pay for themselves out of their own production. Their replacement cost needs to be funded out of something else – in the case of too many so called “investment” properties it might have been your fifty-hour a week job (which is how so many NZers were trying to pay off their “investment property”). 

By this standard then, only some residential property constitutes a genuinely productive enterprise (that is, those that return more income than they consume) but most of it is no more an “investment” than any other durable good , like a fridge or a car or a spa pool. The primary reason people think property is different is because central-bank fuelled housing bubbles inflate the monetary value of houses, without inflating by quite so much the prices of these other durable consumer goods. 

But this isn’t an increase in real wealth, just an increase in monetary value.

Sure, some people for some years who bought “investment properties” on the basis of an expected “capital gain” did well – if they sold before the bubble popped.  But their gain wasn’t based on real productivity, it was based instead on a transfer of real wealth from production into consumption. It was based on the consumption of real capital – a consumption we’re all now paying for.

A shame Mr Newland doesn’t seem to realise that.


  1. Don't forget taxes are levied against increases in monetary value. That's wicked.


  2. Peter, I have wondered whether there is any theory around already to this effect:

    Only activities that utilise resources are truly productive activities. In the long run, we will only grow our economy to the extent that we utilise resources.

  3. Hmmm, not exactly.

    I think the crucial distinction to understand is that between consumer goods and capital goods.

    Both use resources, but while the first uses them up (economically, at least), the second provides for their 'sustainable' use.

    Austrians maintain that what it means to "grow an economy" is to grow the capital structure.

    The purpose of an economy is consumption, for sure, but its capital goods themselves that produce the consumer goods and services: so in the long run if we produce more capital goods (in the quantities and locations demanded), then we are in reality growing our economy.

    And capital goods, as I imply in that post, are those that are "reproductively employed" rather than simply consumed -- unlike consumer goods they're not simply used up and spat out: they pay for their own reproduction out of their own sales.

    That said, it makes sense, as George Reisman argues, to define wealth as "material goods made by man." As he points out in answering the argument that today's economy is a "service economy," this notion he says is "superficial" since "all the so-called service industries center on goods":
    * the retailing and wholesaling of goods;
    * the cleaning, repair and maintenance of goods;
    * the transportation of and communications concerning goods;
    * the services of banking, finance, insurance facilitating the production, distribution or ownership of goods.

    If you're really keen to know more about this argument (if this is along the lines your question was going) then check out the first four pages of Reisman's chapter 'Wealth and its Role in Human Life' in his book 'Capitalism.'

    The whole book is now online in PDF at George Reisman's site. The pages you're looking for would be pages 39 through 42.

    Hope that helps. :-)

  4. Thank you for that, Peter, that is really helpful.

    I am still trying to think of how resource utilisation could be incorporated in a theory of money and prices. I really got off on the wrong track asking about how it related to production.

    Really, aren't money and prices, measures of "resource value"? Shouldn't money relate to an astronomical basket of "all resources under utilisation"? This is really the same thing as Reisman describing wealth as "all material goods made by man", is it not? I admire Reisman and his colossal intellectual work.

    Wouldn't any "bubble" or inflation in prices in an economy, relate to a disparity between the "resource based value" of assets, and the inflated value?

    I agree with Von Mises that these things cannot be measured, they are only of use as a conceptual framework.

    I agree absolutely that Ollie Newland's argument is completely wrong, on the basis that diverting investment into non-productive assets is destructive of economic growth. But conceptually, I like the idea of relating the EXTENT of this destruction, to a decline in resource utilisation, which fits in with the other theories concerning the diversion of investment.

    More productive assets/ "capital", will involve the utilisation of more resources in the future, but more nonproductive assets will involve the utilisation of less resources in the future. Resource utilisation is really directly related to productive assets/capital; a "productive asset" is one that utilises resources to produce more.

  5. Hi Phil,

    I'm not sure if I really follow your theory, but it's sounding to me a little like an updated Labour Theory of Value, except that in your theory a thing is more valuable if it uses more resources.

    Which would make a Lada more valuable than a Ferrari, which would be more valuable than a diamond ring.

    Goods are not wealth just because we made them. Goods are wealth because individual valuer(s) recognise them as being capable of satisfying their needs.

    Money and prices are not measures of "resource value," whatever that might mean.

    Prices are the sum of an interaction between the individual marginal valuations of buyers and sellers in a market.

    Money -- a commodity-backed money anyway, such as a metallic money -- is simply a medium of exchange that is valued in the same way as every other commodity: in numerary terms, as a ratio between the commodities exchanged.

    The result of what Ollie advocates is not destruction of resources, but consumption of capital. That's something very different.

  6. Of course, a Ferrari is more valuable than your typical diamond ring.

    I should have said more valuable than a diamond ring made with the Hope Diamond.

    Or something like that.

  7. Thanks again.

    I really only mean it as a concept. The example of the Lada versus the Ferrari would make a good example of a distortion under the concept.

    Capital accumulation and utilisation under free markets allows us to make the most efficient connection between resources and utility. Interfere in this process, and you will end up with the Lada, or with $450,000 80-year old shacks representing first home buyers "best option".

    You can also consume more resources than you would have otherwise; like subsidised public transport does. In this case, where highly complex systems are very difficult to analyse in terms of total resource consumption per passenger km, might it be valid to go by total cost including subsidies, divided by fare revenue; using the result as a multiplier to discern true "fares"; then compare the costs of running a car to provide the same trip, which is a simple matter, the comparison of "resource consumption" being indicated by the outcome? I am sure I have read a theory along these lines somewhere.

    If that outcome was well adrift of the "complex" studies done by typical activist groups which purport to take all resource consumption factors into account, wouldn't that be substantial enough disproof?

    In the case of the Lada or anything produced outside a "price" system, it would not be possible to run such a simple comparison. But in the case that governments are obliged to produce accounts and state the value of subsidies, does that not enable valid comparisons to be done on that basis?

    In the case of the diamond, yes, that is the value of the diamond; it happens to be a resource plus a range of additional resources, that has had a value allocated to it under the free market. The value allocated to the diamond makes no difference to the concept; just as values allocated to bushels of wheat, or cows, or oil, are resources that have value allocated to them. Money is indeed the convenient medium in which those comparitive values can be expressed, but the fact remains that all those things are resources and a blend of resources.

    More productive assets/ "capital", will involve the utilisation of more resources in the future, but more nonproductive assets will involve the utilisation of less resources in the future. Resource utilisation is really directly related to productive assets/capital; a "productive asset" is one that utilises resources to produce more, whether it is diamond rings or cornflakes or more capital goods.

    I love Reisman's points about wealth as "material goods made by man", and also about mankind re-ordering the earth's RESOURCES to turn them into "goods". (In "Environmentalism Refuted"). The value of these goods could be traced back at root to the resources utilised; the higher the value of the goods, the higher the value of the resources. Differences will accrue due to clever entrepreneurship making more profit out of the same level of resources compared to other entrepreneurs; nevertheless such profit being made via resource utilisation still fits the concept that resource utilisation is the essential ingredient in long term economic growth.

    In the case of highly complex comparisons like car versus public transport, one assumes that resource utilisation differences induced by differing levels of entrepreneurship relating to all the various inputs, would be "smoothed out" in the overall.

    More productive assets/ "capital", will involve the utilisation of more resources in the future, but more nonproductive assets will involve the utilisation of less resources in the future. Resource utilisation is really directly related to productive assets/capital; a "productive asset" is one that utilises resources to produce more.

    I really like the idea of being able to use this as a conceptual principle to get across to people that long run economic growth will relate to utilising more resources; not bidding up the price of assets, or paying bureaucrats for doing nothing, or inventing financial instruments with which to gamble that are dis-linked from the purpose of providing finance for "goods". All such activities either need to be paid for out of the proceeds of resource-utilising activities, or by monetary inflation.

    Really, this is just taking a roundabout route to state common sense, and yet like so much other theories from people like Von Mises which are also common sense, it is not understood or rejected; Ollie Newland's reasoning being a prime example.

    I don't know if I have made a valid point to your mind yet, but thank you very much for your consideration of these views.