Peter Franklin: The secret of wealth

Here is a website you may not have heard of: Arts and Letters Daily is one of the hidden gems of the Internet, consisting very simply of links to some of the best online writing in the English language. There is no obvious ideological bias to the selections, just a preference for articles and reviews of real substance. Of course, ‘aggregator sites’ such as this one could not exist were it not for the various newspapers, magazines and online equivalents publishing original work. Sadly, it would seem that from ALD’s lofty perspective, not many of these are British. With all too few exceptions, our media gives very little space to the extended essay, with serious factual writing relegated to the ghettos of academia and wonkland. We do, of course, have a flourishing blogosphere – but that is a medium where individual posts are typically counted in tens or hundreds of words, not thousands. This leaves a gap in the market. If you want anything meatier than, say, an article in the Spectator, then you have to go for a full-length pamphlet or book – you won’t find much in between.

That’s a shame, because British readers are missing out on articles like this one from the freemarket journal Reason (and featured on Arts and Letters Daily). Entitled ‘Our Intangible Riches’, it sets out the findings of a recent World Bank report on the make-up of the world’s wealth. Three categories are used:

• natural capital, which is farmland, forestry, fisheries, mined resources and the like);
• produced capital, which is machinery, equipment, buildings and other manmade structures; and
• intangible capital, i.e. human resources – whether in the form of the labour, skills and knowledge of individuals or the value of various institutions such as a country’s legal system.

Now, here’s the important bit. According to the report, natural capital accounts for just 5% of humanity’s wealth, produced capital a modest 18% and intangible capital a whopping 77%. This represents a spectacular confirmation of the theories of Hernan de Soto, the Peruvian economist who argued that the key to development in poor countries is the strengthening of civil institutions – in particular, local systems of property rights. It also goes a long way to explaining why old-fashioned aid policies, which have focused on increasing natural or produced capital, have so often ended in failure. All along they were ignoring the most important source of wealth, i.e. intangible capital.

One of the stand-out findings of the World Bank report was that certain poor but resource-rich countries actually have negative levels of intangible capital. For instance, Nigeria’s oil has funded a political system so corrupt that it has had a net destructive effect on the country’s wealth. Generally speaking, the more concentrated and impersonal the sources of a Government’s wealth, the less interest it has in fostering the talents and enterprise of the general population. All that counts is the physical ability to exploit and secure the physical resources in question.  An extreme example is that of ‘conflict diamonds’ in Africa, a highly concentrated source of wealth, where violence is key to exploitation and ordinary people count for nothing.

An obvious lesson for international development policy is to ensure that flows of foreign aid bear as little resemblance as possible to revenues from concentrated natural resources. Instead of going to a very few people in large amounts, aid should go to lots of people in small amounts – and mostly for the purpose of building up intangible capital, rather than supplying tangible goods that can so easily go astray. If the excellent report of Peter Lilley’s policy group is any guide, then that is the direction that a Conservative Government would take Britain’s aid efforts – surely by itself sufficient reason to vote Conservative.

The balance between natural, produced and intangible capital has other important lessons for policy. For instance, as countries get richer, the proportion of wealth accounted for by natural capital shrinks. That means that natural resources are being used more efficiently i.e. more wealth being produced per unit of natural capital than in poorer countries. In this respect the popular image of a wasteful rich world versus a frugal poor world is a false one. Westerners may be wasteful as consumers, but as producers we make comparatively wise use of our resources. Given that resource efficiency is the cornerstone of environmental progress, the idea that the latter is incompatible with economic growth is fundamentally wrong. The same goes for the notion that industrialising nations like China and India have nothing to gain from environmental responsibility. Indeed, it is in these nations where resource efficiency has the greatest potential.

Back home, the predominance of intangible capital has other implications. Gordon Brown loves to talk about investment – but investment in what? We’ve seen a lot of money pumped into school buildings and hospital wings: examples of produced capital. But where is the investment in intangible capital i.e. in people and institutions? That, sadly, has been lacking. Anyone who doubts this should ask themselves why we have millions of working age adults marooned on welfare while desperate employers scour the world for qualified workers.

Of course, the trouble with intangible investments is that they don’t make for easy photo-opportunities. Being intangible, you can’t nail on a plaque proclaiming that such-and-such a project was funded by the European Union. You can’t add people or institutions to the assets column of some departmental balance sheet nor can you lease them back to the taxpayer in some convoluted PFI accounting procedure.

Despite accounting for four-fifths of our wealth, intangible capital eludes the best efforts of the bureaucrat to pin it down with any precision. It is a concrete part of our prosperity and yet more easily grasped by instinct than reason. All very frustrating for the socialist or liberal, but for the conservative a confirmation that what we see as virtuous in individuals – and in the relationships between individuals – isn’t limited to an ideal conception of society, but has a practical value in the economic sphere too.

Comments

[Ay up]

I love Aldaily. It sucks up almost as much of my time as this site!

Fascinating piece Peter.

Do you think the natural/produced/intangible trio is much of an improvement on talking about primary/secondary/tertiary industries?

[Ken Stevens]

"Of course, the trouble with intangible investments is that they don’t make for easy photo-opportunities."

They do, when described as genuine improvements in education, not just academic but vocational as well. Reverse the dumbing down!

As regards businesses, when the workforce started to be recognised as an asset rather than a cost, some companies did not go much further with this philosophy than to rename the Personnel Department as "Human Resources".

[Andy D]

Very interesting article.

[Angelo Basu]

I think that investment in intangible capital in third world countries needs first of all to be in civil institutions as the investment in human capital is pretty pointless in the absence of a system which provides a return for such investment. No point in being trained in a trade but living in a country where there is no economic incentive to practice that trade beyond subsistence level.

The difficulty this poses for aid policy is the difficulty of supporting and building good civil institutions such as a non-corrupt and effective system of property rights and dispute resolution.

How do you persuade corrupt officials to stop taking bribes let alone the ruling classes of robber barons of such countries without stepping in to set up and run their civil society for them?

[Victor, NW Kent]

Hardly a new concept but it is worth highlighting. Refer back to the Marshall Plan which had the objective of setting all hands in Germany and Japan back to work after their economies had been devastated. Inside 10 years they had the fastest growing economies in the world despite the fact that Japan has a very low stock of natural resources and Russia had pillaged the machinery from thousands of German factories. There we saw intangible capital hard at work.
At a comparative time Britain went on a long go-slow and was harried by a socialist government, industrial action and featherbedded practices. In turn we lost our shipbuilding industry, our vehicle manufacturing, coal and mineral mining and most of our food creation. We now exist mainly by taking in other countries financial laundry.

[Serf]

If intangible resources are the source of most of our wealth, then efficient allocation of them is immensely important.

Allocating vast intangible resources to the non productive sector is therefore a dead cert way of slowing down economic growth. Creating friction in the free flow of these resources is also stupidity. Bang goes all of Gimmick Gordon's ideas.

[Peter Franklin]

"Do you think the natural/produced/intangible trio is much of an improvement on talking about primary/secondary/tertiary industries?"

Not much of an improvement I guess -- but it helps us take a fresh look at the issues involved!