What is ‘Wealth’?

Amidst all the furor over the Goldman Sachs fraud scandal and the drama surrounding bank reform – actually lack of drama since the Republicans have wheeled out their ‘just say no’ policy platform – I noticed a little discussed letter going from the Congressional Budget Office to a Republican Congressman evaluating the impact of climate change legislation on household wealth.

Which leads to a very interesting topic: what do we mean by wealth?

The point is simple.

Any legislation that imposes limits on climate affecting activities is almost bound to reduce household wealth. A good example of this which is already in effect is the mileage requirement on cars. In order to make cars that meet the law’s guidelines the auto manufacturers add stuff to engines and exhaust systems that raise the cost of a car. That additional cost represents a loss to the household who buys the car – that extra cost is money not available for buying something else. So household wealth is diminished by the environmental impact law.

It is hard to imagine any environmental impact law that would not reduce household wealth.

Why?

Because that’s the point of most such laws: to make pollution more expensive. That implies making people pay for dumping waste into the atmosphere of anywhere else for that matter.

We can reduce pollution in two simple ways: make it more expensive; or make it illegal. Either way we are reducing wealth. We are either making something more expensive or we are removing it altogether from the menu of things people are allowed to do. Since both these strategies reduce individual choice they impose a cost on those individuals affected.

So it easy to see why a Republican would ask the CBO to evaluate climate change laws in the light of the impact on household wealth. It is the political equivalent of a ‘gimme’ in sports. The Congressman can easily turn around and bemoan the loss households suffer – and the massive cost that environmental policies usually represent.

But that misses a huge point.

The answer is distorted by the way in which we measure wealth.

Because economists talk about wealth in terms of GDP, or the amount of stuff we buy each year, they miss anything that is not explicitly purchased. Anything that someone does for themselves rather than by buying it doesn’t count as wealth in this calculation. So when you paint your own house that doesn’t add to GDP, but if you pay to have it painted it does – the painters wages count, but your use of your free time doesn’t. This is odd, since the additional value that you may perceive by looking at a freshly painted home is the same in both cases.

The reason economists ended up with this method of scorekeeping is rooted in the efforts of the early economists – back in the 1800’s – to place a value on work. Since they saw work as a cost because it diminished your leisure time, it was work and all the stuff you buy with the money you earn from work, that ended up being the thing they wanted to measure. Leisure time is never counted in household wealth, even though its loss is the starting pint for all economic thinking. Anyone who is self-sufficient and does not buy things is counted as being ‘poor’ – they fail to register much in GDP terms.

This is obviously a flaw in the system economists use, and it is a flaw they are well aware of. In their defense it is practically impossible to place a value of free time. It is too subjective. And so the best objective way is to look at what goes on when people give it up – in other words we can get at the value of free time by evaluating the things people do instead of enjoying leisure. We assume that they would prefer free time, but that when they work they get more ‘wealth’ from that work than they would from the same amount of time spent in leisure.

In a sense we look at the negative of a picture to get a view of the positive.

Another distortion in wealth comes from another basic premise of economics. This is the focus on the individual person as the epicenter of wealth creation. This focus has a huge downside in that anything that does not belong to a specific person or household is not counted as belonging to anyone. It simply disappears from the calculation of wealth.

A very clear example of this distortion is the environment. None of us own it. yet we all use it. It clearly factors into our view of life and thus into our wellbeing, but since no one ‘owns’ it we don’t count it as part of our wealth.

This is obviously major problem, and produces some of the most difficult issues in economics. When a person acts in such a way as to diminish the environment, that person is passing on a ‘cost’ to us all – our way of life is diminished. But there is no way of adding up what that cost would be so as to reduce GDP appropriately, because the value of the environment was never part of GDP in the first place.

Again this error in economics can be traced back to the subject’s origins when no one particularly cared about the environment and the entire focus was on measuring the extraordinary growth in material wellbeing that the industrialization was producing.

This essential materialism haunts us to this day. Anything that is not material fails to enter the lists of wealth even tough we all agree that such things are plentiful and very valuable.

Most of would agree that the things in life we most treasure are not material but intellectual, cultural, familial, or spiritual. None of which make the grade for economics.

Those ‘treasured’ memories may be the most valuable things you have but they don’t ad a dime to GDP unless you can sell them.

Which brings me back to the CBO and its letter.

Clearly the question being asked of the CBO is loaded. Off course environmental legislation is likely to reduce household wealth – as long as we are restricted to looking at wealth through the prism of privately owned or generated material stuff.

If we expand our horizon and include publicly accessible things like the environment then the answer is not clear. In fact it is likely that the sum total of our society’s wealth increased. Yes a particular household had less wealth. But the rest of us no longer had the cost of paying for the clean up of that pollution.

A good example of this is the famous GE toxic dumping case.

The shareholders of GE got a free ride on society for decades because the company whose shares they owned dumped waste into a public space – the Hudson river. This meant that the cost of cleaning up that waste was borne by the public and not by the person[s] messing the place up. Consequently the profits of GE and its stock price failed to take into account to full or ‘true’ cost of its operations. They benefitted from the inability of economists to measure the value of the Hudson being clean. In fact they took advantage of that failure, and pocketed the profits. Eventually environmental laws forced GE to pay for the clean up. This meant that GE’s wealth went down as a result of those laws.

But was that the end of the discussion?

According to the Republican congressman soliciting the CBO advice, the answer would be yes. Household – or in the GE example, business – wealth went down.

But total social wealth went up. We, the non-GE folks, got our clean river back. We no longer were subject to the ‘cost’ of a dirty river.

Reasonable people argue both sides of this kind of discussion.

But at its heart the debate is not about our environmental laws, it is about the way in which we measure wealth.

Right now we get it wrong.

It is trite to say that there’s more to life than money. Economists have never found a way to measure the entirety of our wellbeing. So we are stuck with things like GDP, which is a very poor substitute.

But since it is true, that there is more to life than money, we should all be very wary when we discuss laws and policies that appear to reduce ‘household wealth’. That measure is only a fraction of our true wealth and occasionally reducing it adds immeasurably -literally – to the total elsewhere.