Capitalistic net wealth creation?

Question

On capitalism, people will talk about individual producing goods with $0.5 and selling it for $1, for example, thus earning a profit of $0.5 (some sort of wealth creation, or is it really?) and we all start assuming everyone is a winner.

If that's the general understanding, then let me give an example. Suppose India suddenly becomes so effective and efficient that it becomes a net producer, that 1 billion of the population each spend $0.5 and produce $1 worth of goods. Suppose the Indians spent $0.5 billion ($0.5 x 1 billion Indians) on Country A's human labor to produce the goods. Suppose the people of Country A, feeling grateful for the employment, spend all of their $0.5 billion worth of salary/wages on the Indians' finished goods of $1 billion. Now that the people of Country A only has $0.5 billion, so where should the other $0.5 billion comes from to buy the other half of the Indians' finished goods? Assume there's no other buyer from other countries other than the people of Country A, then the Indian economy will have 0% (zero) growth. Now we all know that the more money is introduce into the market, the higher will be the inflation rate. Since the global economy recorded net growth every year, where in the world does the extra surplus of $0.5 billion, in this case, comes from?

Note:
1. Assuming this extra $0.5 billion is net wealth after taking into consideration the inflation.
2. We all know in reality no country can be as effective and efficient as India in this simplified story-telling example, so the equation will be far more complex.
3. This country of India and Country A can be substituted with individuals, small companies, big corporates, government, etc.

The actual equation will also involve human labor being substituted with automated machineries (to save costs and increase shareholders' value) and consumer credit that officially make the credit card holder a debtor.

Answer 1

Let's simplify it a bit more:

two people India and X live on an island.

India pays x $1 to bake bread which he plans to sell for $2.

Question why can't X bake it himself and be the one to sell it to India for $2? India must have something X doesn't have. What about an oven? O.K. and the ingredients also.

Finished product Bread, $2. X can only pay $1. Does he buy it? No. He can't. Next day X realizes how stupid he is and stops working for India. (Grateful my a**!) He looks for other sources of production. He hunts and finds a herd of goats. He herds them and get their milk. Then he sells the excess milk to India. India pays for it using the bread he now bakes himself since X left him.

Now both have produced more than they originally did, because each one was free to do what is best for his self interest. That's capitalism. They don't simply do things for being grateful for the other. That would be the start of communism.

Your question seems to have neglected the human factor of innovation and self-interest which are the moving forces of civilization. Capitalism will not succeed if people do not keep coming up of new ways of doing things that will give them the best benefits.

Answer 2

It looks like India has spent $500 Million to create and secure a stream of income from Country A.

Lets assume for the moment that India paid for the construction of a harbor. We could just as easily assume that it was an airport, or housing, or a factory. The constructed asset has an associated income stream, some part of which has to be allocated to repaying the Indians for their capital investment.

Now, the Indians can set up a series of payments that end with the entire debt (be it the $500 million outstanding or capitalize the entire billion) repaid at some point in time, call it thirty years for most industrial assets (and 27.5 years for housing). Or they can set it up as a non-terminating, perpetual stream of income, a sort of annuity.

Assuming, as we must, that the asset generates an income stream in excess of what is required to cover the debt payments, the difference between the operating costs and the remaining income is the additional wealth that is created each year. This additional wealth stays in Country A. Repaying India the money spent on constructing the asset does not generate new wealth. In theory, we could construct an asset that at the end of the payment schedule has zero value and has generated zero additional economic value. We could even construct an asset that has negative value (think Chernobyl or a chemical plant where toxic chemicals were dumped over the life of the plant).

The wealth is not always tangible, as in the case of an airline seat mile. However, if you follow the economic chain of events you can substitute quatloos or any other notional marker of economic value for dollars (or, in the case of India rupees) and you will find that there is a class of people who benefit economically from having a harbor (or airport or housing or factory). They are able to use that asset in common with others of that same class of beneficiaries to produce more economic value (or wealth) than they could have produced without that asset.

So, each year the Indian economy will realize a net gain the exact size of the debt payments made by Country A. Country A gets the money to make those payments from the additional economic value or wealth generated by the asset (harbor, etc) in Country A. In essence, it would be a direct transfer of credit (or wealth) from Country A's economy (or GDP) to India's. It would end up on India's current account as a positive Net Factor Income From Abroad (one part of the current account). The first year would show a negative Net Factor Income From Abroad, obviously.

Answer 3

Well I applaud your desire to ponder the nature of wealth creation. but you're a bit confused here. In your scenario's universe, there is never more than $ .5 Billion, and there is no wealth creation. The Indians have that amount of money initially, they hand it over to Country A, which hands it right back to the Indians. Indians have NOT created a profit; they have not created $1 billion of goods.

Their goods are not worth $1 billion just because the Indians think they are entitled to a profit. Their goods are only worth what the market will pay, which is only $ .5 billion. They thus did not create any value; no one profited, no one created wealth.

In an attempt to simplify the problem you've only managed to make it meaningless and unrealistic. Instead of trying to create a conundrum, I suggest you think up a simplified but more realistic scenario in which someone actually creates value -- they make a product and sell it for a profit.

Answer 4

You assume that it is a zero sum game.

In other words, you assume that if the laborer is paid $0.50, they only add $0.50 to the product. This is not the case.

And before someone jumps in and shrieks that the laborers are "exploited"; the laborer is paid $0.50 regardless, perhaps they only end up contributing $0.40 to the product. Regardless, the owner bears the risk/reward.


You may want to glance at a labor market econ course.

Answer 5

Wealth creation is not really about money. It's about value. Let's forget about money for a little bit.

I'll go with the island example. You're on the island by yourself. You spend 10-12 hours a day just trying to gather enough food and water to survive. You barely have enough time to build a shelter, keep the fire going, build tools and weapons, etc. because most of your time is spent gathering the calories you need.

Now I get stranded. Working together we find that we gather the caloric needs for both of us in 7 hours. That gives us each 3-5 extra hours to do something else. Ding! Ding! Value was just created.

Now, in my 3-5 hours of spare time I've discovered my green thumb and I've cultivated a garden. In your's, you've trapped a few animals and you are raising and breeding them. I trade some of my crop for some of your meat, eggs and milk. Ding! Value created.

In a few months we've become quite proficient with our food cultivation, so that means that we don't need to spend as much time hunting and gathering. Now we only spend 3 hours gathering calories from the wild and 3 hours cultivating, creating more time for us to start specializing in other things.

I use that time to make my shelter watertight, comfy, warm and posh. You use it to improve your clothing to provide better protection from the elements and less chafing (ouch). You offer to hook me up with some dope threads in exchange for making your shelter more homey. I accept. Ding! Value created.

Do you get it yet? What's happening. In each transaction we're both trading something we value less for something we value more. We're each coming out ahead. Wealth tends to come to those who figure out how to add A LOT of value to a few people's lives (e.g. doctors) or a little bit of value to A LOT of people's (Bill Gates) lives. Money is just the lubricant to this big tapestry of value trading that goes on, because in the end it wouldn't as efficient to negotiate how many boxes of Microsoft Office we'd have to trade for a quadruple bypass. So, like everything else, the presence of currency itself adds value to economy by improving trasaction efficiency.

Now go create some value.