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How wealth is created

how is wealth created

The recent credit crisis is making an end to the possibility of using an accumulation of debts to generate economic growth. The key question is where economic growth will come from ifhigh growth can no longer be prompted artificially by accumulating debts.

In principle, economic theory gives a clear answer to this question. Growth is caused by an increase in the working population and/or the use of more capital, and/or rising productivity. In other words, the GDP (Gross Domestic Product) number is nothing other than the sum of what everyone contributing to the production process achieves in the way of added value. Clearly, if more people are participating in the production process, the economy will grow, just as in the case where more is produced per participant (productivity, in other words). There are around a billion people in Africa who are mostly unemployed, though, and what they create in added value per person is also extremely low. In a country such as Switzerland, on the other hand, there are around ten million people, but those who want to work generally can find a job and achieve extremely high productivity, too. Theoretically, therefore, there is far more room for economic growth in Africa than in Switzerland. What is happening in practice, however, is the opposite. How can that be?

It is because, in practice, the number of people working, and how much added value they create in doing so, depends on many factors. A good example of this is that, in the past, the majority of the population was occupied with what is essential for human beings, namely producing food. Due to the introduction of modern machines, however, this only requires around 3% of the population. In other words, technological developments play a significant role. Except:

    Technological development does not appear out of thin air. It needs the population to have a high level

    of education. Moreover, it also requires entrepreneurs who have the courage to market new technological improvements. And that only happens if there is a legal system that guarantees that if they are successful they reap the profit. Naturally, the level of taxes is also a factor, as is environmental legislation, the right of dismissal if things don’t work out and so forth. Properly trained people who are encouraged to invent and market new products and services are not enough, however. The aim is that if far fewer people are needed to product food they start producing other things. And that requires the invention of new products and entrepreneurs willing to market them. These days, however, this makes enormous demands on the infrastructure and therefore the government. Are there enough roads and are there constant tailbacks? Are the communication channels good and have their prices been kept as low as possible? As least as important is that there is a system that makes it possible for and encourages employees who have become superfluous in a particular sector due to technological improvements – and therefore higher productivity – to go and work in an emerging sector. This has a lot to do with switching and financial stimulus (granting all kinds of subsidies to old sectors to maintain the workforce is therefore fatal for growth).

In principle, the free market mechanism is the best way of organizing all this in today’s extraordinarily complex world. It also often entails social injustices, though. Generally, the government then intervenes. Many claim that, the more it intervenes, the more inefficient the system becomes, and the more growth declines. Therefore, the governments have to walk a fine line between giving the invisible hand enough space, while preventing the social weak. However, it is important to recognize that the private sector is creating wealth, while the public sector is merely redistributing the wealth.

Category: Personal Finance

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