International Transfers of Wealth | Basic Economics by Thomas Sowell | Ch. 22

The term ‘transfers of wealth’ is often used these days to refer to the misguided idea of money going from the corrupt and wealthy to those who are somehow more morally deserving or responsible. Of course, this is not what Sowell talks about here.

Instead, in this 22nd chapter of Basic Economics, we’re taking a look at the positives and negatives of why and how wealth moves around the world.

If you want to see my previous chapter summaries and analyses, please click here. Otherwise, let’s get to it!

Chapter Summary

There are many ways in which an international transfers of wealth take place. From individuals and businesses to whole countries investing other individuals, businesses and countries, these kinds of transfers have become quite normal today. For example, remittances to Mexican citizens totaled $23 billion in 2011, received by about a fifth of its population from the United States. In Lebanon, it is about 22% of its GDP. And of course, when there is more violent circumstances that result in the takeover of one population by another, there are transfers of wealth from the loser to the victors. But let’s take a look at the more peaceful kinds of international investments, first.

International Investments

While some may believe that the moral ideal would be that rich countries invest in poor countries, in the real world rich countries more often than not invest in other rich countries. This is because, in terms of capital, most investment is done with the expectation of getting that money back. Poorer countries tend to be less stable and more corrupt, and thus a deterrent for outside investment. Additionally, the inflow of capital is often less efficient in poor countries, because of various laws within them that allow their governments more control over the economy. In fact, any time a country loosens its governmental controls over the economy (e.g. India, Hong Kong, etc.), investments begin to pour in.

There’s a wrench to be thrown however, when looking at international trade with the perspective of accounting. Since accounting ascribes categories to different goods and services, whether it sees a trade balance or not often depends on what counts as international trade. Oftentimes, exports and imports are goods focused, and disregard services. Thus, when the media reports on the effects of international trade on the US, it’s often at a deficit, despite lots of American know-how and services being used and paid for by other nations. This happens across many sectors, including technology and software.

So should we be talking about “balance of payment”, rather than “balance of trade”, since a deficit in trade of goods can be made up for elsewhere in services? There are issues with this as well. For example, nations with a good balance of payment (e.g. Nigeria presently, Germany and the United States at times, etc.) are not necessarily prospering.

Back to the main thing: when people invest, they want to invest knowing that their money is secure, and in a place where they are more likely to earn a good return. Thus, people often put their money in the United States rather than even their own countries, which means that once again, rich countries tend to be invested in. But when this happens, the debt that the United States owes to foreigners increases. So even though a deficit is happening, said country may actually be prospering.

There is a lot of talk about “creditor nations” and “debtor nations”, though neither are intrinsically good or bad. The term “debt” is thrown around a lot to evoke a certain idea, but the term doesn’t actually add much meaning to the conversation. When you deposit money in a bank, that banker becomes a debtor, because it owes you that money. Thus, such a bank would go more and more into debt the more customers it has. The same thing happens with credit (though in the other direction), and the same thing happens with debtor and creditor nations.

The United States has almost always been a debtor nation, but has almost always had the highest standard of living in the world. Those foreign to its soil have more frequently owned more assets in the US than Americans owned abroad. In such terms, this is also the case with other countries such as Australia and Argentina. While some fear that international investment means that foreigners will carry away the wealth of the country they invest in, the story of the United States and that of these other nations shows us that this is never the case. Economic transactions are not zero-sum, they create wealth.

A much more dangerous kind of debt is when a poor nation borrows money from other countries in order to cover the difference when their own exports do not cover their imports (basically, they’re spending more money than they are making). But these are illustrations of poor financial management rather than a blanket explanation for deficit and debt.

Since economic transactions are about the creation of wealth, this stifles the idea that large multinational corporations profit primarily through the exploitation of third world country workers. Firstly, as said before, the vast majority of international business investments are in more prosperous nations. Secondly, such employment is not often given to the poorest countries where they are needed most. And third, as discussed previously, attempting to artificially drive up wages in such impoverished countries would actually decrease investments into them, as the rise in wages do not reflect an increase in efficiency, which is what generally happens in countries with higher wages.

Remittances and Human Capital

While investments are essential to international economics today, the sending of money from countries to support families in others still plays a key part in it all. In fact, in 2009, they outpaced the value of foreign aid by more than two times. In these cases, as given before, the ‘foreigners’ are actually creating industry in the land, despite sending money home to family, and when politics force them to leave, it is more often than not that the economy declines afterwards.

What we need to realize is that people themselves are a large source of wealth. An interesting fact is that ethnic and immigrant groups are often responsible for creating and dominating entire industries (e.g. Germans and beer, Huguenots and watches, etc.). The reception of immigrants has often been the source of economic gains in various countries. In the same way, the emigration of people, especially educated ones, have resulted in economic losses.

Of course, there are negative patterns as well, including bringing disease, crime, and terrorism. Interestingly, as Russia and Nigeria are ranked among the most corrupt nations in the world, such emigrants from these areas often result in a rise in criminal activities in the United States. So we need to know what kind of immigrants we’re actually talking about.

Like immigration, imperialism is actually a tricky subject to touch in terms of international economics. While many decry the stripping of economic resources of the conquered nations, there are also ways in which the conquerors also lose economically on net balance. For example, even when the British Empire was at its peak, it invested more money in the United States than any of its colonies in Asia and Africa. This is, again, a reflection of the fact that rich countries want to invest in rich ones for economic gain, rather than exploiting poor ones. Thus, in terms of economics, imperialism is not much of a source of real transfers of wealth internationally.

Because of these principles, foreign aid also often fails to do what it says it’s supposed to do. Since they are transfers of wealth between governmental agencies, rather than private investments and enterprises, the financial aid often goes into the creation of things that look impressive to foreigners, but fail to produce things which raise the material standard of living in the same country.

There’s another problem as well. Since foreign aid is often given by an industrial country to a rural one, the money pouring in incentivizes the locals to abandon previous economic activities (such as fishing and farming) for the new economy being hoisted on them. Without the locals having built their own surviving economy, it is doubtful that such would become self-sufficient again, once the foreign aid stops. In this way, it actually slows economic development, rather than helping it.

One of the main problems (outside of corruption) is that these poorer countries typically have the natural resources to create wealth, but much of it is either undeveloped or not legally recognized as physical wealth by bankers, lenders, and other investors. This lack of ability to create property rights around such natural resources becomes a bottleneck that prevents them from turning them from small enterprises into larger businesses, and thus adding into the nation’s economy.

We must remember that, even in the United States, most large corporations began as small enterprises, and grew from an individual’s own small savings into the large, expansive conglomerates we see today. This was able to happen because the ability to have property rights allowed individuals to make wealth out of what they could legally own. Such a thing doesn’t exist in most Third World countries.

In the United States, a large percentage of actual transfers of wealth happens, not through foreign aid, but private philanthropic donations, private business investments, and remittances. While it’s difficult to measure the impact of all of these, in addition to official foreign aid, from what we have seen, it is the private doings of people and businesses that have helped raise the standard of living more than official government aid.

The International Monetary System

Stability in the monetary system is an important factor in international trade, as the vast majority of transfers are in fiat form, rather than goods and services. When currencies fluctuate wildly, they cause everyone to become speculators, since anyone that holds fluctuating currencies are betting something on its value relative to real goods and services.

In general, where national economies used a gold standard (where currency could be exchanged for a set amount of gold), there was not only stability in the nation, but the stability encouraged investment as well. In this way, “currencies were just names for particular weights of gold” (Robert Mundell).

When the gold standard ended, there was a variety of effects. Some nations (like those in Europe) banded together to create an international currency. Others, like the Japanese yen, became a widely accepted in international financial transactions due to their stability. Still others, due mostly to governmental corruption, began inflating their currency to the point of instability and suffering for their people.

In these times, the idea of strong and weak currencies became a normal talking about for economics. Strong typically refers to an increasing value, while weak refers to a decreasing value (almost always in reference to the United States Dollar).

However, a strong currency does NOT mean a strong economy. Sometimes it means the opposite, as the prices of imports rise, and thus fewer people are buying. On the other hand, a weakening currency can give domestic businesses a boost. But such is not always the case, since a stronger currency can also help when buying within other nations using the stronger currency. And of course, any currency can rise and fall at the same time, since there are multiple currencies to measure up against.

My Thoughts

To address the very first part of this post, the idea of ‘transfers of wealth’ has become quite the nomenclature for the Robinhood-esque idea that, with the rise of technology and current geopolitical landscape, there will somehow be a movement of wealth from where it’s typically or publicly been seen to others. Some believe this will happen from current wealthy classes to either the less fortunate (a la Bitcoin or the like) or to their own specific side they are advocating for.

As I read this chapter, I started to realize that these much more popular ideas may be a bit misguided. As Sowell explains above, transfers of wealth are happening all the time, and the vast majority of what is done effectively is not through foreign aid or a singular big dump, but rather transfers and remittances through private individuals and businesses.

As explained above, the vast majority of investments go from rich countries to rich countries. This isn’t a moral or immoral happenstance, but rather a rational reality. Those who invest want to know that their money is going to make a good return for themselves, as well as create a better economic situation for them to invest again in the future. On the moral side, perhaps there is desire to do philanthropic good as well, but in the grand scheme of things, these moral quandaries don’t really factor in.

And so to believe that some technology like Bitcoin is going to suddenly make poor people rich is quite a misnomer. Yes, perhaps those who got in early into Bitcoin are going to become part of the wealth class in the next decade, but such early adopters are rarely part of the poor working class. As much as I would want more stories where families are able to sustain a desired lifestyle through Bitcoin, this is more often a nice individual anecdote rather than a statistical trend. Instead, transfers of wealth most often happen between people who are doing well, to benefit each other.

There is another key idea he mentions that I want to explore, something that cryptocurrency may actually be able to address.

Poor countries are not poor because they are exploited. Rather, such countries are often unable, for a variety of reasons, to exploit their own often vast natural resources for their own economic gain. This is something that I think is so rarely talked about, but is perhaps the actual problem rather than things like foreign oppression or imperialism.

Let’s take a look at the opposite factor: countries like Japan, the United Kingdom, and Singapore have very few natural resources. At times, I wonder if this is a positive factor. These nations with poor natural resources are forced to work with the outside world, and thus have transfers of wealth going into their own country.

Of course, that can’t be the only factor, as that would mean that all countries with little natural resource would be rich. Instead, again, as Sowell explains, these countries with little natural resource but are also prospering economically are typically free market societies. In other words, the government doesn’t attempt to control the economy in these places, but rather allows free enterprise to do so. Perhaps, it is because there are few natural resources to exploit that the governments in these places are forced to rely on businesses.

And thus, when we look at places like Venezuela and Russia, where the natural resources are in abundance, but the society is poor, we see that centralized control has actually delayed and prevented economic activity from happening. The entities of the government take the natural resources it has access to in abundance, and uses it for its own gain rather than for and by the people it presides over.

How does cryptocurrency factor into all of this?

Of course, the first thing to recognize is that governments need to be favorable towards cryptocurrency in order for it to work.

Secondly, as demonstrated in the case of MakerDAO and DAI, the value of certain items can be soft-pegged. This means we can have decentralized digital representations of elements like metals (i.e. gold). Such things can then be bought and sold on decentralized exchanges.

Imagine if a country, rich in copper but perhaps poor otherwise, is able to take the copper it has mined and digitally trade it around the world without needing to rely on bankers and financial institutions controlled by larger nations. This would allow a smaller country to exploit its own natural resources for gain. Of course, to do so would require its governments to desist from trying to control it all, which as we now know, will only lead to extreme inefficiencies and more poverty. Instead, they’ll need to let private individuals and companies with property rights become the better experts required to produce and distribute such things.

And thus, real transfers of wealth that benefit both poor and rich countries can exist.