Sunday, March 01, 2009

Economics and Ethics II

I realised belatedly that the month of Feb has come to an end and I have yet to post anything!

A quick and (unfortunately) somewhat raw piece:

When a person obtains a substantial stash of cash, he gets richer. But when a nation increases its stock of money, it very often ends up poorer. In the 16th-17th century, Spain imported huge stocks of silver from its mines in South America, especially the fabled caverns of Potosi. And for a while, it was good. Its financial and military power appeared supreme. Yet, as the supply of silver, which was essentially money in those days, grew without any proportional increase in its demand, the value of silver began to fall. Or to put it another way, prices across the continent began a steady climb. Spain’s silver mountains did not in the end translate into lasting wealth. Inflation took away much of the silvery lustre, and tempted by financial hubris into unsustainable wars, Spain soon lost its brief place in the sun.

Put succinctly, the wealth of nations does not consist of silver or gold or dollars. Nor does finding caves of gold or silver, or printing lots of money, translate by themselves into the true wealth of nations.

Real national wealth, as Adam Smith pointed out 200 years ago, is the amount of goods and services produced in a nation, which in turn is inextricably related to the productivity of its citizens. Money is fundamentally a medium of exchange that circulates a given amount of goods and services. If we increase the stock of money but do not proportionally increase the goods and services it is meant to circulate, the value of money falls, or to put it another way, the prices of goods and services increase. Money is only worth as much as the amount of goods and services it can command or circulate, and it can only serve as a store of value, of wealth, if it is suitably scarce.

And thus economics supports the notion that the real determinant of national wealth is more the values of its citizens, than the amount of gold/money stashed in everyone’s coffers. Simple old-fashioned diligence, frugality and integrity are the foundations of productivity and true prosperity:

A hardworking population is one that is inherently more productive than a lazy population with the same skills and technology. Beyond that, diligent workers are more likely to discover technological innovations (if only because they spend a longer time at their jobs and are more motivated to do their jobs better) that elevate productivity. For the young, diligence tends to improve educational achievement, and hence increase the accumulation of productivity-enhancing human capital. And in the long run, a more highly skilled population in turn is more able to innovate.

A thrifty population is one that saves. Ignoring the conditions of a financial panic (where lending can grind to a halt), higher saving rates generally leads to greater investment in productivity-enhancing capital goods and innovations. One main reason is that interest rates tend to fall in nations with high saving rates (due to the abundant supply of loanable funds), easing credit conditions and thus promoting business and government investment.

A population with integrity is one in which contracts are respected and where trade can flourish. The main utility and marvel of trade is that it allows specialisation, allowing individuals and nations to produce goods and services that they are best at (they produce in their areas of comparative advantage). This in turn increases productivity and national wealth. Trust, which results from a citizenry with integrity, is also the foundation of finance, which oils the wheels of commerce and industry.

It is therefore not so much accumulated cash that increases wealth, but accumulated virtue.