– June 24, 2020
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In recessions, people ask: “Where did the wealth go?” For example, it was estimated that between 2006 and 2009 “homeowners’ equity has fallen by over 50 percent, or about six trillion dollars.” Well, that’s a lot of wealth. Where did it go?

The common, but naive, answer is “Rich people took it; in fact, that’s how they got rich in the first place!” Given that most of the wealth was lost by “rich people,” who disproportionately own stock or the other assets whose values fell, that seems unlikely. This view takes wealth as fixed, and therefore zero-sum: for me to be wealthy, you have to be poor. That fallacy underpins many misguided regulatory and tax policies

Remember: market systems are platforms that nurture specialization and voluntary mutual aid. If we all specialize, and then exchange, we all become wealthier because specialization creates sharply increasing returns to scale in output and innovation. More stuff plus better stuff equals more wealth. Profits, and financial wealth, are simply the reward for enabling many voluntary exchanges, as I explained here.

Wealth is not the only thing we should care about, of course. But the folks telling us we shouldn’t care about wealth come from wealthy countries, and take their wealth for granted. It’s much easier to manage problems, ranging from social problems to climate change, if you have the resources to respond. And that takes wealth. That’s why the failure to understand wealth is so important.

Wealth is the result of the stuff that is exchanged, not the money. As Alfred Marshall said in his landmark book Principles of Economics, “All wealth consists of desirable things; that is, things which satisfy human wants directly or indirectly.” Marshall goes on to note that not all desirable things are wealth, because we also desire family affections and trusted friends. But all wealth consists of access to desirable things; poverty is the lack of such access, not a shortage of money.

And that suggests an answer to the question about “where does wealth go, in a recession?”  A recession is a reduction in access to desirable things. As I have argued in talking to Russ Roberts on EconTalk, the most important idea in economics is opportunity cost, often taking the form of transactions that fail to take place. Those are real losses: if I want some potatoes, and have money, and you have some potatoes and want money, we should exchange. Failing to exchange is hard to measure of course, and that’s why Bastiat was concerned with “the unseen.”

The misconception arises in conceiving wealth as money, and even worse as physical currency. The latter mistake is easily dealt with, since only about 10% of the total “money” we use takes the form of pieces of paper and coins. If you consider wealth the value of assets and financial instruments, currency is far less than 1% of the total.

But even when we think of wealth as “value,” it is easy to become confused. The problem is the premise that wealth is an objective thing. It’s not: value is subjective. My financial wealth, at one level, is simply the liquidated value of all of my assets. To “liquidate” something, I have to convert it to cash or some other exchangeable form of value. Suppose I own a restaurant, or a farm, or shares of stock; it’s cumbersome to offer those in payment at the grocery (plus, it’s hard to make change: “Okay, you paid the farm. But this food only costs 1/1 millionth of the farm, so I owe you a lot of dirt back.”)  The problem is that the value of the restaurant, or the farm, or the stock, is only what someone will pay me for it; the value is not intrinsic.

From that perspective, it’s easy to see “where the money went:” It never existed in the first place. If my stock had a quoted price of $100 on an exchange, and that price fell to $75 per share, that means the forecast of the present value of future earnings for that company fell. The stock is a claim on the future stream of profits; the estimated value of the stream fell because of new taxes, new regulations, changes in consumer preferences, or the invention of a new competing product.

That still doesn’t really explain what happens to wealth, at the national level, though. We all feel like we have been made poorer by the government policies locking down the economy since March. Some have been harmed more than others, but almost everyone has had their wealth reduced.

How? The answer is that wealth is stuff, and services, or rather wealth is the use of stuff and access to services. There was a “Planet Money” episode recently on NPR where they got the “Where did the money go?” question from a listener.

(Listener) “In the past several months of the pandemic, we’ve lost hundreds of millions of dollars. And I’m curious where all of that money goes. It can’t just disappear. Where does the money go?” (Actually, estimates of the costs of the government-imposed lockdown are as high as $80 trillion…)

(Berkeley Econ Prof Martha Olney): In a normal time, one person will spend money, and that becomes the income of the next person…And so we have this flow of funds through the economy, and that’s what generates income for a person….So for instance, if I take my car to my mechanic who lives across the street and I pay him for his service, that becomes income for my mechanic. The mechanic then goes to the grocery store and buys groceries at the grocery store. His spending becomes income for the grocer. The grocer goes to the drugstore and buys some medicine, and the grocer’s spending becomes income for the people at the drugstore.

That notion of wealth is what most macroeconomists will tell you. And it’s not technically wrong. But it is entirely useless for understanding what wealth is, and what has been lost in the lockdown. To see the problem, consider this: suppose I have a lot of bread, and you have a lot of cheese. On Monday, you pay me $50 for some of my bread; on Tuesday, I pay you $40 for some of your cheese. Then we both eat bread and cheese. How would we measure the wealth in that system? The total economic activity is the sum of all the sales of goods, in this case $50 plus $40 = $90. Many macroeconomists look at the money moving around and take that to be the relevant measure of wealth.

This smacks of the “Midas Fallacy,” of course, in which the King of Phrygia, desiring to be wealthy, asked Dionysius for the ability to transform anything he touched to gold.  It quickly became clear that true wealth was not money, but the ability to acquire the things that money can buy. Midas would have starved if he had not renounced the “gift of the golden touch.”

Which brings us back to our example: the increase in wealth is not the money, it’s the bread and the cheese! Wealth is not money, it’s access to things, and to services. In Prof. Olney’s example, look at what is “unseen:” The professor does not get her car fixed. The mechanic does not get any groceries. The grocer doesn’t get the drugs she needs to buy.

The cost of the economic lockdown is not the loss of income; that’s just a way of accounting or measuring value. In my earlier example, the loss of wealth was not the money that the farmer lost, or that the restaurateur gave up; it was the fact that the farm shut down, and the restaurant closed.

The cost of the lockdown is the forgone economic activity, all the meals and haircuts and vacations and flights and trips to the theater and the movies and the nightclub. Those things are gone, and they cannot be made up. We had access to fewer desirable things; that’s where the wealth went.

The wealth didn’t go anywhere. No one took it, and it won’t be coming back. An economy is a way of using prices, with dollars as an accounting tool, to encourage division of labor and the exchange of physical goods and services. If you block the movement of those goods and services, you destroy wealth.  It’s not the money, it’s all the exchanges that failed to happen that are the loss of wealth.

Michael Munger

Michael Munger

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research. His degrees are from Davidson College, Washingon University in St. Louis, and Washington University. Munger’s research interests include regulation, political institutions, and political economy.

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