Wealth creation as more than a goal, it's your responsibility

From my management lecture notes...

Wealth creation: The purpose of life, not just business

There is a tendency today to think of business as a powerful, impersonal, multinational, global sector that needs to be closely monitored, well-regulated and heavily taxed, to promote the public interest or the common good. More so, these restrictions are often in place because of the assumption that businesses place profit above ethics, greed above people, and self-interest above the public interest. While there have been numerous egregious instances of corporations acting ruthlessly, as ‘bad actors’ without a conscience or ethics, the world marketplace and the trillions of created wealth would not exist today were this to be the norm rather than the exception. The focus on business is often about the bad things they do – negative ethics. We work from the assertion that business is the philosophy and practice of positive ethics – doing good things – rather than the selfish, greedy actions of the “one percent.” Our position is that it best to focus first on “doing good” (positive ethics) rather than to start by assuming businesses will do bad things (negative ethics), thus justifying their close oversight.

Economists, politicians and the public traditionally viewed business as a profit-maximizing entity that provides goods and services, and whose primary responsibility is to stockholders. And they often viewed management as a greedy, self-serving, manipulating occupation. Business is a process, the combination of various forms of capital to create value by serving customers with goods, services, information and knowledge. This voluntary exchange process provides value to the customer and generates profit for the business. Shared wealth is the result. Sustainable wealth creation requires the stewardship of all resources and the prosocial leadership of people.

Conversely, progressive politicians and social justice warriors assume positions that wealth creation is itself a bad thing, and that the ‘best’ thing to do in life would be to abhor wealth creation and instead give away, share or surrender whatever ‘excess’ wealth – and more – to others, primarily the poor and self-identified victim groups. In fact, wealth creation needs to be a personal responsibility, not a act to be avoided. For society to function, wealth creation must include the family and personal creation of wealth, primarily through savings from income in excess of consumption.

Debunking Third World myths: Best stats you’ve ever seen (TED; June 2006; 19:50)

"Which country has the highest child mortality of these five pairs?" The problem for me was not ignorance; it was preconceived ideas. And they said, "The world is still 'we' and 'them.' And we is Western world and them is Third World." "And what do you mean with Western world?" I said. "Well, that's long life and small family, and Third World is short life and large family."

Let's move over to another way here in which we could display the distribution in the world of the income. This is the world distribution of income of people. One dollar, 10 dollars or 100 dollars per day. There's no gap between rich and poor any longer. This is a myth. … the richest 20 percent, they take out of that about 74 percent. And the poorest 20 percent, they take about two percent. And this shows that the concept of developing countries is extremely doubtful. We think about aid, like these people here giving aid to these people here. But in the middle, we have most the world population, and they have now 24 percent of the income.

We heard it in other forms. And who are these? Where are the different countries? I can show you Africa. This is Africa. 10 percent the world population, most in poverty. This is OECD. The rich countries, the country club of the U.N. And they are over here on this side. Quite an overlap between Africa and OECD. And this is Latin America. It has everything on this Earth, from the poorest to the richest, in Latin America. And on top of that, we can put East Europe, we can put East Asia, and we put South Asia. And how did it look like if we go back in time, to about 1970? Then there was more of a hump. And we have most who lived in absolute poverty were Asians. The problem in the world was the poverty in Asia. And if I now let the world move forward, you will see that while population increase, there are hundreds of millions in Asia getting out of poverty and some others getting into poverty, and this is the pattern we have today. And the best projection from the World Bank is that this will happen, and we will not have a divided world. We'll have most people in the middle.

Analysis

1. The talk highlights misconceptions about developing countries, starting with estimates from students and professors re child mortality rates. Random guesses would have been better than the student or professor’s estimates.

2. “We” (western, developed countries) versus “them” (non-western, poorer countries) meant small families, long lives versus large families, short lives, or rich versus poor countries, respectively. “We” also tended to be more politically and economically free.

3. Contrasts family size (number of children) and life expectancy at birth in countries around the world. The old story of large families, short lives has evolved to smaller families in almost every country and higher life expectancies as well.

4. While life expectancy can be considered a form of wealth, social capital, such a claim about family size can be problematic. Couples with higher incomes in wealthier countries often choose to have smaller families because children are expensive to raise and more likely to live, as compared to conditions in poorer countries.

5. The gap between high-income and low-income countries (mistakenly labeled ‘wealthy’ and ‘poor,’ respectively) is disappearing. Yes, the top 20% earn 74% of the world’s income and the bottom 20% earn 2% of the income, but these are measures of income, not wealth or poverty. To say that the high earners “take out” income is a misleading smear.

6. Incomes range greatly not only by region but also within countries. Within countries, incomes range widely. The incomes of the top twenty percent of the people in a ‘poor’ country may be higher than the low incomes of the bottom twenty percent in a ‘wealthy’ country.

Wealth creation

Wealth creation has driven significant improvements in human development, the quantity and quality of life, life expectancy, and social progress these last two hundred years. But how did some countries create wealth to become rich while others floundered? Economic historian David Landes asked, “Why are some countries rich and others poor?”From the last thousand years he deduced key practices of those countries that were adept at developing wealth. Economic, cultural and social practices underlie these wealth-creating strategies that lead to progress, prosperity and human development.

Economic behaviors of wealth-creating development

The late Harvard economic historian, David Landes, identified six characteristics of wealth-creating countries, characteristics that enabled them to create great wealth and to become wealthy nations as a result of these practices. These six characteristics generally align with our basic management values. Societies – starting with the economic element – had to produce and incentivize value creation (production and retention) and create sustainable strategies (entrepreneurship, innovation, educate and education). People needed to be hired, promoted and rewarded based on merit to reinforce this system. The six concepts and their historical definition/role follow.

· Production. “Knew how to operate, manage, and build instruments of production.”

· Education. “Able to impart knowledge and know-how through education or training.”

· Meritocracy. “Chose people for jobs by competence and relative merit.”

· Innovation. “Knew how to create, adapt and master new techniques.”

· Emulation of success. “Encouraged initiative, competition, and emulation of success.”

· Entrepreneurship and wealth creation. “Afforded opportunities for enterprise, to enjoy the fruits of labor.”

The ‘secret’ to wealth creation is to create something that offers value to customers who, by labor and trade, secure the things they want and need. By educating the population, training the work force, and hiring and promoting people based on merit, businesses can sustain this ability to create and satisfy customers with better and more affordable products. Firms need to learn what customers want and the government needs to create and protect the atmosphere where this creative, customer-based capitalism can thrive. And how might the government best do that? That takes us to Development II and the role of government.

Political characteristics of wealth-developing countries

As important as the production and economic strategies are in the wealth creation process, social, legal and political factors are key societal underpinnings of these economic drivers that create a climate for wealth creation. These political rights, rules and responsibilities follow.

· Secure rights of private property, to encourage saving and investment

· Secure rights of personal liberty against the abuses of tyranny and private disorder.

· Enforce rights of contract, explicit and implicit.

· Provide stable government, not necessarily democratic, governed by rules.

· The majority wins but does not violate the rights of the losers.

· Provide responsive government that hears complaints, makes redress.

· Provide honest government, actors are not moved to seek advantage and privilege.

· Provide moderate, efficient, ungreedy government.

These economic and political conditions reflect economic freedom and political freedom, respectively.

In brief, business creates wealth and serves customers while government provides the needed national and domestic peace and security, education and the rule of law to allow people and markets to thrive. Sustainable markets require an informed customer and a well-educated work force.

Success has roots in common cultural (political and economic) characteristics that translate diverse economic resources into wealth, prosperity, human development, and the quality of life.

Landes notes a single characteristic separates American culture from other wealth-developing countries: Individualism.This characteristic positively impacts the entrepreneurial activity, self-reliance, personal responsibility and initiative needed for wealth creation.

America is more of a ‘salad bowl’ than a ‘melting pot.’ Great differences in race, religion, language, food preferences, are widespread. It is the critical parts of the common culture – personal and social beliefs and values – that determine wealth creation.

Niall Ferguson: The six killer apps of Western economic culture (2011; 20:20)

Economic, political and cultural factors drove economic development in the Anglo-European West over the past five hundred years, providing faster economic growth than what the rest of the world experienced. In 1500, the West trailed Asia in terms of economic power. Western progress accelerated after 1815 with the Industrial Revolution.

In 1500, the average Chinese was richer than the average North American. When you get to the 1970s, which is where this chart ends, the average Briton is more than 10 times richer than the average Indian. And that's allowing for differences in the cost of living. It's based on purchasing power parity. The average American is nearly 20 times richerthan the average Chinese by the 1970s. Western empires, in 1500 they were really quite tiny -- five percent of the world's land surface, 16 percent of its population, maybe 20 percent of its income. By 1913, these 10 countries, plus the United States, controlled vast global empires -- 58 percent of the world's territory, about the same percentage of its population, and a really huge, nearly three-quarters share of global economic output.

The ‘killer apps’

Competition and choice: Europe was politically fragmented, and within each monarchy or republic there were multiple, competing corporate entities offering people choices. NOTE: Competition is not about beating your competitor, it is about offering alternatives, choices to what the competitor is offering. The market is not a zero-sum, win-lose proposition. It is the “grow the pie,” not “how do we carve this pie into pieces.”

Scientific Revolution: All the major 17th-century breakthroughs in mathematics, astronomy, physics, chemistry and biology happened in Western Europe.

Property rights: It's not the democracy, folks; it's having the rule of law based on private property rights. That's what makes the difference between North America and South America. You could turn up in North America having signed a deed of indenture saying, "I'll work for nothing for five years. You just have to feed me." But at the end of it, you've got a hundred acres of land. Rule of law and representative government: This optimal system of social and political order emerged in the English-speaking world, based on property rights and the representation of property owners in elected legislatures.

Modern medicine: Western Europeans and North Americans made all the major 19th- and 20th-century advances in health care, including the control of tropical diseases.

Consumer society: The Industrial Revolution took place where there was both a supply of productivity-enhancing technologies and a demand for more, better and cheaper goods, beginning with cotton garments.

Work ethic: Westerners were the first people in the world to combine more extensive and intensive labor with higher savings rates, permitting sustained capital accumulation.

Max Weber thought that was peculiarly Protestant. He was wrong. Any culture can get the work ethic if the institutions are there to create the incentive to work. We know this because today the work ethic is no longer a Protestant, Western phenomenon. In fact, the West has lost its work ethic. Today, the average Korean works a thousand hours more a yearthan the average German.

I want to end with three questions for the future billions, … 2016, when the United States will lose its place as number one economy to China. The first is, can you delete these apps, and are we in the process of doing so in the Western world? The second question is, does the sequencing of the download matter? And could Africa get that sequencing wrong? One obvious implication of modern economic history is that it's quite hard to transition to democracy before you've established secure private property rights. Warning: that may not work. And third, can China do without killer app number three? That's the one that John Locke systematized when he said that freedom was rooted in private property rights and the protection of law. That's the basis for the Western model of representative government.

Winston Churchill once defined civilization: "It means a society based upon the opinion of civilians. It means that violence, the rule of warriors and despotic chiefs, the conditions of camps and warfare, of riot and tyranny, give place to parliaments where laws are made, and independent courts of justice in which over long periods those laws are maintained. In civilization’s soil grows freedom, comfort and culture. When civilization reigns in any country, a wider and less harassed life is afforded to the masses of the people."

Analysis

1. With globalization and economic freedom, the Rest has been able to ‘downloaded’ some of the killer apps. The “great divergence” has given way to a “great convergence.”

2. Property rights and the consumer society empowered the Industrial Revolution, primarily by enhancing trade through innovation, choice and task specialization.

3. The work ethic – frugality, savings, deferred pleasure – can conflict with the consumer society. In a ‘welfare state,’ there are disincentives to work when benefits, prosperity and progress are unlinked from work. The combination only works if the money earned from work exceeds the money spent on consumption.

4. Capitalism requires right to own (i.e., private) property and the right to trade. These are the killer apps of property rights and the consumer society, respectively. A productive, sustainable economic requires consumption, savings, and profits. An excess of any of the three damage the economy. Balance is generally facilitated by Adam Smith’s “invisible hand.”

5. People can engage in prosocial or antisocial behavior. They can collaborate or compete. Choice must be balanced by discernment and moderation, i.e., this shows the value of the self-regulating aspect of the work ethic.

6. Prosocial management goals and prosocial leadership are the management side or version of the consumer work ethic. Prosocial management is a positive ethic, i.e., doing good, rather than simply being ‘socially responsible’ or avoiding evil.

A system of wealth creation

Business must develop a sustainable strategy for creating wealth through customers, based on innovation, trade, and creating value for customers.

· Society survives, grows and prospers through the creation of wealth.

· Profit is the result of good business practices, not the primary goal.

· Wealth can be tangible (e.g., produced goods) or intangible, natural or produced. Tangible wealth can be natural (land) or produced (manufactured goods). Intangible wealth or social capital stems from the value we place in things such as comfort, safety, satisfaction, happiness and health. The primary sources of intangible wealth are education (knowledge) and the rule of law (security).

· The products and services a business produces creates value for their customers, not just for the business. People seeking this value become customers. Thus, business creates customers; without customers, a business does not (long) exist.

· An organization can continue to create wealth by creating a sustainable comparative advantage. This concept highlights the importance of for innovation, entrepreneurship, and competitiveness.

Capitalism and socialism

Business has been the driver of economic growth and well-being, helping to create more than six billion “non-poor” people in the last two hundred years and seeing life expectancy double in that period. This growth in economic wealth and well-being is the result of the expansion of capitalism, based on the expansion of markets and trade. The past two hundred years has also been marked by the stark contrast of results between capitalism and socialism. Note the key principles and differences between these two political and economic philosophies.

1. Capitalism requires the rights (1) to private property (ownership) and (2) to the exchange of property (trade).

2. The goal of capitalism is to maximize individual well-being and happiness without violating the rights of others, by maximizing individual freedom and responsibility.

3. The goal of socialism is to create (equal) social justice (outcomes), to maximize the collective, common good, using taxation, wealth and income re-distribution, regulation and other restrictions on individual behaviors.

4. Capitalism creates traditional wealth. Socialism re-distributes traditional wealth.

5. Most of what the American federal government does is transfer wealth. For example, in 1945, about 2% of federal spending in the United States was on wealth transfers, i.e., providing direct benefits to individuals. By 2016, federal wealth transfers comprised over 70% of federal spending.[1] This low 1945 percentage bottomed out with massive federal expenditures for World War II. The rate had peaked during the Depression at over 40%. The rate has only increased over the past eighty years, even during periods of strong economic growth and low unemployment.

Hans Rosling Two hundred years that changed the world (2010; 4:37)

1. Each country in the world is a bubble, the size of the bubbles represents the population size, color represents regions of the world, the vertical axis is the average life span, the horizontal axis is income per person.

2. In 1800, income is low and health is poor in all countries. Note the progress from 1800. Identify the link between income and health today: Why are money and health related? Can you see exceptions? Why do you think some countries are unhealthier than others with the same income? In 1800, Why was health poor everywhere, even in the richest countries? Why was the UK richest in 1800?

3. Key lessons: Health and economy were bad everywhere in 1800. Health – life expectancy -- is much better everywhere today. Income per capita is higher in the vast majority of countries today. Income gaps (between and within countries) are larger today. Most people in the world live in middle-income countries today.

Analysis

· In 1807, all countries had life expectancies pf less than forty years and per capita incomes below $4,000 (in today’s dollars).

· Income and life expectancy are surrogate measures of financial and social capital/wealth, respectively.

· Note the multiple impacts on family size: Income, child mortality, and fertility rates. There are economic, social and moral determinants of family size, not just health-based.

· Social capital and wealth improved dramatically with the Industrial Revolution.

· The West (North America and western Europe) surged first, Asia surged recently. Africa continues to lag.

· Note key inflection points in progress, events or periods that accelerated growth. The Industrial Revolution in nineteenth century; political freedom from the decline of colonialization in the middle of the twentieth century, and economic freedom over the past fifty years with the expansion of markets, capitalism, free trade, i.e., globalization.

Economic growth and social justice

Social justice is more than charity, altruism, wealth re-distribution, or “giving a man a fish.” Social justice is more about equal opportunity and equal treatment, not so much about equal outcomes. For example, in this misguided “social justice” lesson, children scramble for limited wealth, with some prevented from joining the pursuit, some encumbered in the scramble, and some given an advantage in the fight. The fundamental error is to assume that wealth is fixed and unable to be created and so then to not divide it equally is social injustice. This is another false claim by critics of capitalism, that for a capitalist to “win” an exploited person must “lose.”

The basis for economic interaction and power has evolved over time – repeated paradigm shifts. The dominant network, economic model, and the group in control have all changed, at least eight times in the past two thousand years, and the rate of paradigm change is increasing. We have moved from a world order based on mythology, then monarchies, then the military, then mercantilism, then manufacturing, then diverted by Marxism, then managerial, and now markets. From a time when almost all one billion people on earth were poor, we have moved to a global economy where more than half the world’s 7.5 billion are well out of poverty, and fewer than 10% are in traditional, extreme poverty.

[1] https://www.whitehouse.gov/omb/budget/Historicals (Table 3.1)