economics wealth

The difference between wealth creation and wealth extraction

In George Monbiot’s book Out of the Wreckage, he describes how the word ‘investment’ can take two different forms.

Investment means two quite different things. One is the funding of productive and socially useful activities, the other is the purchase of existing assets to milk them for rent, interest, dividends and capital gains. Using the same word for different activities ‘camouflages the sources of wealth’, leading us to confuse wealth extraction with wealth creation.

The distinction between wealth creation and wealth extraction is an important one. We all want investment that makes new things happen in the world, that creates jobs and builds something out of nothing. But not all wealth is that kind of investment. Some of it is extractive – it relies on charging others for access to an existing asset, rather than creating anything new.

The difference is perhaps clearest in housing. If I build a new house, I have created something new. If I buy a house to rent out, I am extracting wealth from an existing thing. As the owner of that property, I am making money without doing any work for it. Likewise, investing in a start-up or building solar power creates something new. Buying shares or speculating on land value does not.

Monbiot is drawing on the work of Andrew Sayer here (who introduces his ideas here). He puts it this way:

Unearned income is derived from control of an already existing asset, such as land, buildings, technology, or money, that others lack but need or want, and who can therefore be charged for its use. Those who receive it are ‘rentiers’. Mere ownership or possession produces nothing, and so any return to an owner merely for access or use is something for nothing.

There is language for describing these different kinds of wealth, and the distinction between the two has been better understood in the past. Ricardo talked about rentiers and landlordism and how to rebalance the economy of his own time. Keynes talked about ‘functionless investors’. Henry George had the harshest words for the unearned income of rent, describing it as a “fresh and continuous robbery”.

If we are able to distinguish between these forms of wealth, we can treat them differently. We can lower taxes on earned income and reward those taking genuine risk. And we can raise taxes on unearned income, through measures such as a financial transaction tax or land value taxation. In shifting the tax base this way, we would reward wealth creation, and capture a greater share of wealth extraction for redistribution. We could lower the tax burden on work, winding down our reliance on income taxes and making work pay better. (In doing so, we would increase the incentive to work, and potentially reduce the benefits bill). It’s not a silver bullet for a fairer and more sustainable society, but it’s a useful step in that direction.

7 comments

  1. Oh Goodness, so much wrong.

    If by your terms an investor builds something that is ’good’ investment Eventually they will want to sell it. But someone buying it would be ‘bad’ investment became that are then controlling an existing asset. So the good investor can’t exit, quite probably stopping them from making new ‘good’ investments because their capital is tied up in their existing investment. You need buyers of assets as well as sellers.

    Buying a house for rent is bad, building one for rent is good? Improvements good or bad?

    The fact is it might seem easy to draw lines but it isn’t. That in the 19th century with is far less complex economy it seemed easier doesn’t mean it would be now. You risk making moral judgments on something you don’t seem to understand.

    1. Oh Goodness, so much patronising.

      I think you’ll find that ‘good’ and ‘bad’ are pejorative terms that I deliberately didn’t use. Don’t bring them into it and then say ‘by your terms’. And where did I say nobody would be allowed to sell on an asset?

      Adam Smith would agree with me, by the way. He called rent “a species of revenue which the owner, in many cases, enjoys without any care or attention of his own” and said it should be taxed accordingly.

      1. Both you and DevonChap have lumped land and capital together into the category “asset”. When Henry George refers to “rent”, he means economic rent of land, in the same sense as Ricardo. I have commented on this above. We all need to be more precise in our use of terms when discussing matters of political economy.

        1. I agree with you that land rent should be separated from other capital income (not that I totally agree without on the policy suggestions), I was just following Jeremy’s terms.

          Jeremy I accept you didn’t use the terms ‘good’ or ‘bad’ but did describe them in terms that can be characterised as such. But you did use pejorative terms like “As the owner of that property, I am making money WITHOUT DOING ANY WORK FOR IT.” which are fairly clearly meant to be a bad thing. Using shorthand terms like Good and Bad encapsulates the value you give them and I noticed that Henry used them too.

          Share ownership is not useless to the wider economy and is not risk free. Buying existing assets to gain an income is hardly unproductive. Otherwise how would private pensions work? Speculators in markets have a very useful function providing liquidity, narrowing spreads, taking on risk and bringing prices forward. Wealth creators need buyers to be able to realise the wealth they created.

    2. Both you and Jeremy have fallen into the same trap, which, to be fair, is very difficult to spot. The use of term like “asset” or “property” conceals the underlying reality. Both Karl Marx, Pope Leo XIII, and the authors of all subsequent Catholic Social Teaching have also missed the point here. Its usual manifestation is the conflation of land and capital, with land being wrongly considered as a subset of capital. Hence even the term “capitalism” conceals the issue.

      The builder buys a plot of land. That is, an area of the surface of the earth, not made by human hands. No wealth is created by the act of purchase. All that happens is that the title to the site is changed, for a payment, it can be a trivial amount or a small fortune, depending on the location: remember, the estate agents’ famous advice about the three things that really matter. What we think of as land ownership is a legal fiction. English law recognises no such thing, since “ownership” is vested in the Sovereign. A land title is a document issued by government giving a guarantee that the holder of the title can enjoys various rights to the site eg the right of occupation which is defended by the state, though military force and the law, what the land can be used for, what taxes, if any, must be paid, freedom of disposal, etc.

      The builder then erects the house, the bricks and mortar, which are the product of the builders’ labour. The act of construction has created real wealth which did not exist previously. The value of that house is the price of the materials and the wages of the labour at whatever is the going rate – say £1500 per square metre, in principle, the fire insurance value.

      The house can either be bought or sold. If the house is sold, the purchaser is paying for the building, plus the capitalised rental value of the site, based on its general attractiveness, local amenities and infrastructure available to the occupant. Most of this value has to be sustained by the ongoing provision of infrastructure, at taxpayers’ expense. The owner is enjoying an imputed income from this continual input of service which sustains the value; if the input should cease for any reason, such as the neglect of flood protection measures, neglect of the roads, non-enforcement of the law, then the value will drop.

      If the house is let, or bought to let, then the landlord can charge a rent which consists partly of a payment for the “good” investment, and partly a payment for the value which is created externally, ie that component of the rent which represents the land value. It is not so much that it is “bad” investment, but that the landlord is receiving a payment for a service which is provided mostly at the expense of the taxpayer, due to the presence and activities of the community.

      It is very easy to distinguish between the two. If you look at residential or commercial rents, you will find that they bottom-out in places like Sunderland, where you can rent a three-bed semi for about £500 pcm. The rent for an almost identical property in, say, Brighton will be around £2000, and nearer £3000 if it is close to a tube station in north London. The difference, £1500 and £2500 pcm, is payment for the location ie land value, the value that is created not by the landlord but by the taxpayer, who protects the title-holder’s rights and provides the infrastructure which gives the land its value.

      This is the point brought out by Henry George in “Progress and Poverty”, but it needs to be read carefully to pick it up. Henry George is a fairly easy read if you get hold of a good edition. I recommend the Hogarth Press 1953 edition, which is a shortened version of the original but maintains the style. You can pick one up on the internet for about £15. Although it is little known today, it was probably the best-selling book ever on the subject of political economy.

  2. Land value taxation at 100% of the annual value of the land is something I wholeheartedly support, for the reasons given above. Treating income from such things as interest on loans, dividends on shares or for rent of buildings more harshly than earnings, on the other hand seems to me misguided. It is not money for nothing, as your first paragraph states but compensation for foregoing the benefits of spending the money on consumables by lending or spending instead, directly or indirectly, on financing wealth creation.

    Incidentally, George’s book can be downloaded free from the Project Gutenberg site in a choice of formats.

  3. With all of the rational left brain thinking going on, which I know is important, I think we’re only looking at this idea of wealth from one point of view. Chief Seattle (and his interpreters) looked at this another way. “The earth does not belong to us,, we belong to the earth… Humans merely share the Earth. We can only protect the land, not own it… How can you buy or sell the sky, the warmth of the land? The idea is strange to us. If we do not own the freshness of the air and the sparkle of the water, how can you buy them?”

    I ask this question? How much so-called “wealth” has been created by outright exploitation,theft, death, wars and environmental destruction. Isn’t it time for humanity to recognize that our only hope for survival is to make amends with one another and with the natural world, This requires that those of us who are privileged and have more than enough, must give back of our surplus to those who don’t even have the basics of live – food, water, medicine and shelter. It also requires those of us us who use large amounts of energy and material goods, to reduce our carbon footprint.

    Am I and other climate justice activists, simply naive and moralizing? Or is it possible there is another side to the coin, and a basic truth that is missing. To all people – with minds to think and hearts to care – this is an important and critical discussion. I know is not easy.

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