A friend of mine has been asking me to explain why free market friends insist that the economy is not a “zero sum” game. To him, it seems as if anyone who makes money must be getting it from someone else, who then doesn’t have it. On his understanding of the situation, there are winners and losers, and people who wind up with more money are the winners.
We live in a remote area at 4500 feet elevation. It can get quite cold, and there is no natural gas service underground. If you want to heat by burning gas, you have to buy propane. In our area, almost everyone has a large propane tank on their property, and has propane delivered once each month. It’s expensive, compared to natural gas, and with a large house in cold weather you can spend a lot of money heating the place.
We have a wood stove in my home. We put it in last year, because the propane bills were killing us. Last year, instead of spending up to $500 per month on propane bills during the coldest weather, we heated our home for the entire winter on about $600 worth of wood, which we had delivered. (It looks like the wood stove will pay for itself by the end of this winter.) Basically, it costs about $150 for a really big pickup truck full of wood. Four of those did it for the season. The guys who delivered it are mostly tree-cutters themselves. They are hired to cut down trees, and they simply cut them up and take them to their lots. They let the wood sit there for several months or a year to “season” it, then they cut it up into wood-stove size pieces with chainsaws and power-splitters, and they sell it.
So, this year, I thought I’d really save some money, and instead of having the wood delivered, I’d go get it in the national forest, where the forest service very kindly sells low cost permits for people to pick up wood that the forest service people have cut down already, and (with some help from a kindly brother-in-law with a trailer and a chainsaw) I’d cut it up myself. So far, I’d say I’ve spent about 10-12 hours of time messing with it (my brother-in-law has spent even more). My back hurts, and my legs are sore. And I’ve only got, so far, about as much wood as 1 and 1/2 pickup truck deliveries. So there’s plenty more work to be done.
For a really entertaining time, come and watch as I try to hit a splitting wedge with a six pound sledge hammer. I have one eye that works, and have never had any depth perception… so it’s really dumb luck if I manage to make solid contact with the wedge. My 11yr-old daughter comes out and watches sometimes…. she’s not very good at pretending not to laugh.
If you are forming the impression that, on an hourly basis, this attempt at economizing isn’t paying for itself, you’ve got the right idea. You may sing the glories of self-reliance, you may tell me I needed the exercise anyway, but the fact is that my brother-in-law and I are making not much more than minimum wage for doing this, in terms of the money we’ve “saved.” Since I can make money plying my trade, at a considerably higher rate, and work is generally available when I want it, I’m losing money trying to save money. And that doesn’t even count the money my brother-in-law spent buying a professional grade chainsaw. He’s a lawyer, which means he’s used to making enough money in a couple of hours to buy my whole season’s worth of wood. But luckily for me, he considers the whole thing something of an adventure.
So, what’s the point of all this?
I pay for wood to be delivered, and it comes relatively cheaply and with minimal work remaining for me to do. The people who sell it to me make money, so they get value from the transaction. I get value, because I can spend my time doing something more economically productive than chopping wood, at which I am singularly unskilled. Or I can just kick back. Or some of both.
The “zero sum” way of thinking doesn’t explain this transaction. The choice is not between one person collecting and chopping wood for himself (me) or someone else doing it the same way I would do it, but whom I have to pay. The choice is between an unskilled and ill-equipped person doing it (me) or a skilled and well-equipped person doing it (the people I pay). I MAKE money by paying them to do it, if I can use that time to do something else of benefit to me. They make money because of their skills and investment in equipment, which allows them to do efficiently what I would have to do very slowly and inefficiently. So they make more money, and so do I, and value is created in the economy that wouldn’t be there if I just chopped my own wood.
Even if we take money out of the equation, it’s clear that everyone isn’t equally skilled and well-equipped to do everything, and so even in a barter economy there is not a “zero sum” of net economic value in the society. Every time someone becomes more productive, the entire society gets richer, because there is more value available. When a lot of people become more productive, by a combination of capital investment, skill acquisition and greater efficiency, value is created, which in a money-based economy means that there is simply more money to go around in the system.
This basic fact of economics was best explained by Adam Smith in “The Wealth of Nations.” You don’t want to read the original, unless you have insomnia. But here is a very entertaining introduction to it.
In a more or less free market, and even in a mixed economy like what we have now (somewhat free, somewhat regulated), “zero sum” thinking just doesn’t reflect reality.
It never has, or we’d still be living in log cabins and riding around in horse drawn wagons.
November 10th, 2009 12:08 pm
So let me get this straight; Your brother-in-law bought a chainsaw. This paid the designer/engineer, cratsman who constructed it out of parts built by another craftsmen, the distributor who delivered it to the retailer, the retailer who paid the salesman. The saw required fuel, oil, maintenance,and a storage location. All of the businesses and people involved in this chain profitted, and, paid taxes so that local, state, and federal associatins of people called governments profitted. Value was aded at each link in the chain, and this process was repated for the trailer, truck, stove,work clothes, and every other item involved in the wood cutting process. All this so that the professional wood cutters would take their already overworked business elsewhere, and, the propane company would have sufficient supplies for it’s other customers.
Is that about right? or did you really just do this to entertain your daughter? No matter, value is always added by human endeavor. Thanks.
November 10th, 2009 1:28 pm
You big dummies! We should all be living in caves and only eating that which falls to the ground. We should clothe ourselves in fig leaves (only those which have already fallen to the ground). Isn’t that what Jesus did?
November 10th, 2009 4:14 pm
Not that I recall. There was something about some animal skin in a garden somewhere though, I think. Also, after their worldwide vacation cruise, one family was offered a bunch of animals (still on the hoof) for a barbeque.
November 10th, 2009 5:22 pm
So then, would it be fair to say that speaking strictly monetarily, economics is, in fact, a zero-sum game, however, when considering “the big picture”, other forms of profit (time/energy etc) must be considered as well and that’s what balances everything out?
Plus, I still don’t understand how wealth is created. For the sake of this example- if there is a total of $100 in the American economy, how can there ever be more than that? I understand that your hiring a wood man to bring you wood would allow you to make more money other ways, but there’s only $100 out there whether you “lose” money by chopping your own money or use your time to make more money. Does this make sense? Or put another way, how much would could a would chuck chuck if a wood chuck can only stand to make $100?
November 10th, 2009 6:21 pm
I understand your question to mean, “how does more cash get created” when extra value is created by human effort, skill and capital investment. That is, I’m assuming you’re not denying that *value* is created that wasn’t there before by productivity increases (from capital investment and skills interacting to create products and services).
So, if your question is really just about “the money,” not the *value*, it’s pretty simple: the government, in the guise of “the fed,” prints it and loans it to banks at interest.
If the government prints it and loans it to banks faster than the increase in *value* due to economic activity, we have inflation. If the government goes too slowly in this, we have deflation, and often economic stagnation, because people can’t borrow the money to make capital investments that will improve productivity. That’s why “the fed” meets every now and then and decides what the “prime rates” will be at which they will “loan money” to the banks. That’s the mechanism they use to keep the right amount of money floating around society to balance the amount of *value* that exists and is being created by economic activity.
But don’t confuse money with *value*. Even if we had a barter economy, four people could get richer just by each specializing in something and trading with the others, than any individual could get working alone. The total *value* available to them would be greater than if they each worked alone at everything.
If I raise cattle, you farm, he builds buildings, and she makes furniture, we’ll each live much better lives by being productive and trading with each other, and that’s what exposes the “zero sum” fallacy.
Read that Adam Smith book. It’s short, and funny. O’Rourke is a brilliantly clever writer.
November 10th, 2009 10:29 pm
Okay, I think I get it. I’ll just have to bounce it around in my head a little. I think my trouble is that I don’t have a complete grasp on the meaning of value. I will get the book too- hopefully that will help. Can you confirm this example:
Nancy manufactures manure
Harry manufactures packaging for the manure
Barack delivers the manure
Because Nancy only manufactures the manure she saves the time and energy of packaging and selling, thus increases the “value” of her life. The same for Harry and Barack in their respective duties.
Are you saying that the time and energy and “quality of life” translates into “value” and then the Fed assesses arbitrarily how much “value” has been created through this productivity and adds cash to the market match or represent this added value?
Is this correct?
Also, adding too much cash= inflation, adding not enough =?
November 10th, 2009 10:41 pm
A man lives in the woods. He cuts down excess trees to keep fires from running amuck. He uses the wood to make a cabin. He uses his tools handed down to him to make furniture. He farms for his food. He paints and creats beautiful paintings. He has created value. If everyone did something like this in a society, the value of the society has increased – without any money changing hands. Money is simply a method to simplify barter. If I need milk – I don’t have to sell my electric motor to someone who has milk. I sell my motor for money (placing a value on my materials and effort) and then I can trade for someone with milk. If I hadn’t taken the time to make the electric motor – the value of the society would be less. Since I was productive – society is worth more. There are people that add value, and those that take value away. It should be the duty and honor of every citizen in any country to add to the value of their society.
November 10th, 2009 10:50 pm
*Value* is not some amorphous philosophical thing as I’m using the term. It is hard economic reality. If you can do something twice as efficiently as I can, and I can do something else twice as efficiently as you, and we each do our thing, and trade, we are both richer. There are more total goods and services to go around, and we each get more than we could have on our own.
I don’t deny the philosophical value of various intangibles, but the sense in which I’m using the word *value* economically is not that.
And you’re correct that money simplifies trade, because it allows for fractional values and precise setting of prices and trading equivalents. How do you sell half a cow’s worth of value without killing the cow?
That’s why the proof that zero sum thinking doesn’t work can be expressed purely in barter related terms, inefficient as barter is.
Again, the larger point: if what I’m saying here wasn’t true, we’d still be in the horse and buggy era. In fact, we’d be in the stone age, because no one would ever have the time, capital investment or skills to mine, smelt and shape metal.
November 10th, 2009 10:59 pm
Darryl, you asked,
No. That is the “labor theory of value”, sort of, and that’s not what I’m saying.
I am saying that “productivity” leads to greater *value* in a society. Productivity is made greater not merely by “working harder” but by working *smarter*, which includes capital investment in appropriate tools (meaning facilities, locations, appropriate technologies, training, marketing, delivery, etc.).
One capitalist with a lot of money invested equals one factory employing 100 people making widgets. None of those people could make even ONE widget without the factory, the raw materials provided by the capitalist, etc. But working together, taking advantage of the investment in the factory, tools and raw materials, not to mention training, they can make tons and tons of widgets, and everyone in the society can have a widget at an affordable price. Before factories, only rich people could afford widgets, made at great cost by specialized craftsmen. And all those factory workers would have to find some other way to make a living.
WITH the capitalist’s investment, all those people have jobs, and each one of THEM can afford a widget, too, as well as wadgets and wudgets made at other factories.
That, in a nutshell, is why capitalism combined with rule of law and enforcement of contracts is the greatest anti-poverty program ever developed.
November 11th, 2009 7:52 pm
Bill- thanks for your input, it was very helpful. I especially appreciated the point about each person’s duty to add value to society. I’d never thought about it that way, nor thought about the fact that some people can only take from society.
Shack, thanks too. It’s getting clearer. If you’ll humor me a little more…
1. How does the Fed know when to add money or destroy it
2. Do thee laws of productivity and economic value transcend capitalism, or confined to it?
3. Does the value of the dollar fluctuate based on productivity/value?
November 11th, 2009 7:53 pm
*3. Does the value of the dollar fluctuate based on productivity/value OF SOCIETY?
November 11th, 2009 7:57 pm
Oh also, #1 has been answered by your first response- nevermind!
November 11th, 2009 10:35 pm
The laws of “productivity” and “economic value” (mostly, another way of saying the laws of supply and demand) do not “transcend” capitalism. Capitalism (combined with relatively free markets, rule of law, contract enforcement) is simply a way of maximizing productivity and the creation of economic value in a society.
The “value of a dollar” certainly fluctuates, but it is based in general on the amount of money available in society in comparison to the perceived value that can be bought with it. It is horrendously complex…. which is why it is not plannable by any central authority. Governments can’t “set prices” without creating bigger problems than the ones they are trying to solve.
November 12th, 2009 7:36 am
The law of supply and demand applies to money as well as goods. If the government suddenly printed 10x the money, and gave it out equally to the money you have (if you had $ 100 – they gave you $ 1,000) then you would see prices on everything increase. As the prices increased, each dollar would become worth less. Counterwise, if there was 10X the goods to purchase, without additional money printed and distributed, then all things would decrease in price and the money would become worth more. The law of supply and demand isn’t applied in a vacuum – it is relational to all other things vying for your investments (including cash).
November 12th, 2009 8:07 am
Oh so true. Which is why in many ways we were better off when banks printed and backed their own money before the Civil War. Modern folk can’t quite wrap their heads around the idea of “private money”, but it worked perfectly well in many ways. There was literally a market in money printed by private banks, and banks competed to have strongly backed money that the public would feel secure in holding and taking in exchange. It was against the interest of any bank to “over print”, because eventually it’s money would be devalued in the market place as the reality of its backing assets become known widely.
There is, of course, little such block on the government, which has a monopoly on printing money, and acts like it, as we can see from VERY recent history.
November 12th, 2009 10:06 am
So I pay a couple of guys to chop some wood for me.
I don’t have the cash on me right now, but not to worry!
I’ll use my Visa Card! yeah! The guys at the Visa Bank know that I’m good for it.
In fact, my credit rating is soooo good that the Visa guys can sell my debt for a profit.
But the guys buying my debt don’t have the cash on them right now, but not to worry!
They can borrow money from my 401K! yeah! My 401K manager knows they’re good for it.
But the 401K dudes don’t have my cash on them right now, but not to worry!
They can use their handy dandy Ben Bernanke card!
Moral of the story: It is more valuable to default on a loan and sell the debt than it is to actually pay off a loan with interest! In fact, we could all really make a killing if I get some guys in Indonesia to clear cut their forest at a dollar an acre and FedEx it to me!
November 12th, 2009 5:01 pm
Thank you Richard Nixon. You took our paper money off of the gold standard. Now Washington power brokers (both Democrat AND Republican) are able to print money that means nothing.
November 12th, 2009 6:26 pm
“The “value of a dollar†certainly fluctuates, but it is based in general on the amount of money available in society in comparison to the perceived value that can be bought with it.”
I think this is the missing piece that was holding up my understanding. I was not understanding this relationship between the issuance of money and the worth of society. I think I finally get it!
Money does not create the value, money is merely supposed to be a representation of every “dollar” of value in the society. When a guy makes an engine (to use Bill’s example) he creates value. Then, in theory, the Fed sees this and adds $200 to the economy and BAM! Value has been created. But then a Toyota plant blows up, destroying 30 cars and the Fed sees this and destroys $500,000 to account for the reduced value of society.
The trick of this capitalist game is to macro-estimate the value added or subtracted from society and match that value to our currency. I guess it would follow then that the Fed properly gauging the value of society is integral to making the system work, because if they don’t add enough money at the right time, then the value will not be represented and the productivity is wasted (maybe?). Anyway, I feel alot better about this now! Thanks guys!
November 13th, 2009 6:38 pm
a good class in macroeconomics taught by a Chicago school or Austrian economist would clarify.
names to read:
Adam Smith
F.A. Hayek
Milton Friedman
Ludwig von Mises
Thomas Sowell
November 14th, 2009 12:50 pm
Darryl, think about your checkbook. A check is merely a piece of paper you use in lieu of carrying around excessive amounts of cash. The check itself is worth no more than the paper it is printed on unless you have as much cash (gold) in the bank as the amount you have written on the check. Prior to Richard Nixon taking us off the gold standard, a dollar bill represented a portion of gold that ACTUALLY EXISTED at Fort Knox. This requirement kept the government (i.e. elected representatives) from printing useless paper to use in trade. While printing useless paper can work for awhile; it all must eventually come home to roost in the same way that your bad checks will eventually ‘bounce’ and your account will be closed and your debts will remain unpaid (at which point any real wealth you have, such as a car or house, will be taken from you. With the government, this little game can continue until enough folks realize that they haven’t been paid with real wealth and the system collapses. We can’t take anything from the government because the only things that government has are things that already belong to us. It’s like thinking the government is giving us money (remember those stimulus checks for $600.00?) when they took it from us to begin with.
November 16th, 2009 2:01 pm
Thanks enharmonic! It’s all getting through slowly but surely!
December 18th, 2009 4:24 pm
It seems that you’ve put a good amount of effort into your article and I want a lot more of these on the World Wide Web these days. I truly got a kick out of your post. I do not have a bunch to to say in reply, I only wanted to register to say fantastic work.
July 7th, 2014 8:50 pm
I was just reading through all this again- thanks again Shack for these great lessons!