Wednesday, September 20, 2023

Birth of Plenty

Every once in a while, I go down the Bogleheads rabbit hole. Usually I emerge with a refreshed conviction about my savings and investment plan, but I usually pick up some other stuff along the way. On my most recent excursion, I picked up a book: The Birth of Plenty, by William Bernstein. Bernstein is an interesting guy: he worked as a neurosurgeon for an entire career, and along the way got interested in finance. He became one of the most eloquent and passionate early advocates of the philosophy of index-fund-based investing. He started his own financial advising firm, wrote several general-audience books on investing, and then branched out to write on a broader set of topics related to economics.


"The Birth of Plenty" was the first of these books. It's a sprawling, ambitious project, but the main thing it's trying to do is answer the question: why has the world been growing more prosperous over the last 200 years? He offers a thesis that there are four pre-requisites for a nation to turn into a wealth-generating engine. Prior to those dependencies being available, things will just grind along at barely subsistence levels; once in place, they become impossible to stop, and lead to ever-increasing levels of prosperity.

He wrote this book back in 2003, and I was a little surprised to see how much of its content I recognized from "Capital in the Twenty-first Century", particularly the first 1/3 or so of that book. I think there are a lot of things that have been generally known to economists for decades, but that only more recently became widely discussed among the general public. One particularly striking area is the last 2000 years of economic history. From roughly 1AD to 1000AD, there was no per-capita growth of income on the planet: things stayed at the same level for fifteen centuries! Obviously, individual people and groups would gain wealth through conquest or exploitation of resources, but it was very much a zero-sum game. Starting around 1000, there was a very very tiny increase in the world's per-capita GDP. Barely 0.1% growth year over year; but over 800 years, this cumulatively did lead to some increase in wealth. Things really took off after 1820, though: there was a drastic shift in the developed nations (the UK, then America, then gradually more "first-world" nations) of roughly 2% annual per-capita growth. The result has dwarfed thousands of previous years of advancement.



Bernstein's thesis, which he introduces and repeats often, is that four factors must all be present to unlock the compounding advances of the modern economy.

  1. Property rights. For him this is the first and most important element. Basically, you need to be assured that you will be able to hold on to the results of your labor and your investments, and that neither the state nor private parties can take them from you without following well-established law.
  2. Scientific rationalism. Embracing an outlook that allows for dissent, looks to advance knowledge via empirical experimentation rather than deductive reasoning, shares the results of science, builds on previous results and remains willing to question and throw out previously accepted ideas that are proven false.
  3. Capital markets. To start new businesses or expand operations, entrepreneurs need to be able to access money, in sufficient quantities and at reasonable enough rates. On the other side, holders of capital need to trust that they will stand to gain by loaning out their money, rather than keeping it sewn into their socks or mattresses.
  4. Rapid communication of ideas and movement of goods. The most awkwardly-phrased of the four pillars, this mostly boils down to "the telegraph and the steam engine". The former greatly facilitates collaboration, which enables larger-scale and more efficient planning. The latter greatly expands markets, allowing goods to be sold far away from their point of manufacture, and supplies to be sourced from far away as well.

Going into these a bit more:

I've been feeling a bit down on property rights lately, and this book was a good reminder of the arguments in their favor. (More broadly, I think most of my economic readings of the last 10+ years have been arguments against economic liberalism, and I think I'm well overdue to actually read an argument in its favor.) Going back to that period from 0-1000 where there was no growth: during this time, the vast majority of Europeans were serfs living in feudal regions. Under feudalism, there really is no concept of private property or ownership: your entire self, body and labor and land and production, belongs to your liege; your liege, in turn, belongs to his superior, and so on. As a serf, your lord will come by and take almost all of your production, leaving you only enough to live and continue producing. Now, if you were a very motivated serf, you could work a lot harder and a lot smarter and maybe find a way to double your yield: but it wouldn't really matter, the lord would still take all of your additional production and still leave you with the minimum required for subsistence. So why would you want to put in all that extra effort? Multiply that decision-making by the entire population of Europe, and you have a good understanding why there was no growth.

Property rights are closely bound together with a bunch of other concepts, including civil liberties (basically a property right over yourself), the legal system, and, interestingly, separation of powers. If the executive is the judiciary, then any action that the lord takes is legal: your property rights are only as strong as your relationship with the current king. Having a separate judiciary seems like a technicality, but actually is huge: it's an entity that can say "No" to your lord, or the king, or the President or whatever. This devolves true ownership of property from the king and the state to the individual.

Property rights doesn't necessarily mean that you get to enjoy uninterrupted use of your property in perpetuity: for example, if you fail to pay someone else what you owe them, you may be forced to sell some property to make them whole. But the key is that this is a legal process, with well-defined rules that are well-known in advance.

The upshot of all this is creating an incentive to generate more wealth. If you feel secure that you will get to enjoy the fruits of increased labor or a brilliant new invention, then you'll be motivated to take those steps. And that will eventually benefit all of society: you will then be able to buy more goods and services from others, or show others a more efficient way of doing things that will then allow them to increase their own productivity and create more wealth.

Next up, science! I found myself thinking of Ryan North's "How To Invent Everything" often while reading this book. Most of our technological advances are things that seem trivial and simple in retrospect; if you already know how something works, it's very easy to recreate it. But in practice, it often took a thousand years or more for a thing to be invented after all of its pieces were available. Why did it take so long? In Bernstein's view, the main issue is the historical lack of a system for discovering new knowledge and propagating the results. More specifically, we needed to embrace an empirical system that can be experimented on and proved, rather than lofty intellectual arguments that didn't need to be based in reality.

A secondary aspect has to do with the intellectual culture that surrounds potential innovators. If you know that your discoveries may cause you to be denounced by the church and burned alive at the stake, you're extremely unlikely to pursue those discoveries, and even less likely to share what you've found. Much like how the feudal attitude towards property kept the masses of serfs from improving their land and work, feudal dogma from the medieval Catholic Church locked up potential advances in European sciences for a millennium.

There's a bit of a dovetailing between science and property in the form of patents. Patents are a creation of law that confer a temporary monopoly to the creator in exchange for a thorough explanation of how their invention works. Patents replaced the old secretive guild-based systems, in which knowledge was jealously guarded, unavailable for outside improvement, and could be lost altogether - in one of the most startling anecdotes, the Romans knew how to make concrete, but that knowledge was lost during the Dark Ages, again for nearly a thousand years. Patents also replaced the old granting of monopolies, which were typically issued by monarchs for the benefit of a favored group of merchants: these monopolies created wealth for the monarch and the clique, but at the strict detriment of everyone else, and were a net destroyer of value. In contrast, patents generate entirely new value, and open the doors to future innovations in the future.

Here, I found myself thinking a lot of "The Code of Capital" by Katarina Pistor, as I think these two books use slightly different vantage points to describe the same history and outcome. Patents were a creation of the English legal system, are friendly towards private parties, and allowed Britain and then the US to significantly grow their wealth. It's a bit of magic, how the mere "idea" of a patent didn't exist, and then did exist, and brought a whole new major source of wealth along with it.

Moving on, capital markets are the third major component Bernstein demands of modern wealth-generating economies. A tantalizing question he asks is why Leonardo's helicopters never were produced. The concept seems solid, and there were materials around to make at least a primitive version of it. I don't think Bernestein ever directly answers the question, but capital markets seem like a major explanation. To bring helicopters from sketched doodles and diagrams to real working contraptions takes a lot of effort and a lot of money: experimenting, prototyping, developing, manufacturing and selling. Leonardo himself definitely didn't have the money to fund all that, and even if he did, he would understandably have balked at risking his entire fortune. He was connected with wealthy families in Florence and Milan, but again, the costs and risks were more than a single individual could bear, and there weren't yet the widespread risk-sharing instruments available for shared investments.

Much like the scientific method, capital markets need both the technical presence of a thing, as well as a broader cultural embrace of it. It's one thing to know how science works, and another to feel safe pursuing new ideas. Likewise, it's one thing (and not a small thing!) to have banks available that take in deposits, pay interest, loan out capital and charge interest. It's another thing to have banks that are trusted enough by the citizens to entrust their hard-earned life savings with them. In countries with low levels of corruption and long histories of financial safety, a large share of a country's wealth will be placed within institutions that can put that money to use in growing the economy. In other countries, such as France in the 18th century or many developing nations today, people will be far more likely to keep their money in household safes or buried in the back yard, thus preserving their value but denying the utility of growth.

Like many other elements in this book, capital markets form a virtuous circle: as they grow more trusted, people will place more wealth in them, which will generate more wealth in the national economy, which makes more wealth available for investment, which can further grow the economy, and so on. Now that I'm writing this, I realize that it's just another way of expressing Piketty's formula about the increasing share of the national income going to the owners of capital, but told from the perspective of the investor. So long as the additional investment unlocks growth in the economy greater than the rate of return, the total growth will cause the proportionate share going to capital to shrink; but if (e.g.) a 4% rate of return on capital is matched with a 2% per-capita growth rate, then while the economy will continue to grow, it will increasingly benefit the existing holders of wealth at the expense of others.

Anyways - how does that virtuous cycle get started? Bernstein argues that it's initiated by the state through the issuance of national bonds, like England used to fund its wars. The government is the ultimately reliable backstop of value: if the government isn't in good enough shape to pay its bonds, then as a citizen you're screwed anyways.  So people with excess wealth put that money to work by funding their government, experience passive income, and become familiar with the concepts of bonds. Once this is in place, local governments and large private enterprises can likewise begin issuing bonds. Being riskier, they'll offer higher interest rates, and an increasingly informed public can begin funding them. While Bernstein doesn't draw this line, it makes me think of Alexander Hamilton's genius in nationalizing the debt from the Revolutionary War: at a time when everyone else saw the debt as a troublesome burden, he had read enough economic texts to understand that the national debt would begin establishing creditworthiness for the US, and create a sort of financial umbrella that would facilitate the creation of capital markets on this side of the Atlantic.

Finally, there's rapid communications and transportation. I kind of threw up my hands at this point: why not just have 5 things instead of 4 things where the last one has an "and" in the name? Near the end of the book he tosses in the generation of energy as well. Overall, these things are kind of the magical ingredients that lead to a critical mass of positive developments that cause a self-reinforcing process of growth to occur.

I found it more helpful to think of this last point in specifics rather than generalities. Property rights and science are all that you need to come up with a good invention that will increase productivity and generate economic growth. Capital markets will allow you to get the funds to make that thing. And... then what? Prior to the creation of the telegraph, most people were only aware of things that were happening within their town or within about a day's ride of it. And before the creation of railroads, most people were born, lived and died within a short distance: long-distance travel of people or goods was extremely hazardous. So, even if you did manage to manufacture a cool new invention, you would maybe only enrich the lives of the 5000 or so people living in your town. With the telegraph, though, you could tell everyone about it, learn which markets were demanding your product, and communicate with local agents to source materials or deliver goods to places where you'd never go. And the railroads could ship more materials to you to ramp up production, and cart away manufactured goods for sale.

Bernstein is very insistent that all four ("four") elements are required in order to make a wealth-producing economy. In England and the US, the first three of them (property rights, scientific method, and capital markets) were available early on, and once those new technologies became available, they took off. (In an interesting sidebar, he claims that the Netherlands actually got a head start on it, as their capital markets were even better developed than those of Britain; they didn't yet have the steam engine, but were blessed with a geography that was compact and had lots of navigable waterways, which for most of history were far faster than travel by horse.) Because those inventions were the catalyst for the Industrial Revolution, modern economists and policy-makers have tended to believe that the key to improving a developing economy is to introduce these inventions and improve their infrastructure. But to Bernstein, these tools are insufficient on their own. If you're a communist or absolutist dictatorship that doesn't respect private property rights, then your citizens will not voluntarily toil to improve their lot in life and grow the economy. If you're a fundamentalist tribal society that values inherited religious wisdom over the cacophonous seeking of science, then your citizens will be unwilling or unable to engage with the rising tide of technology and make their own discoveries. And if your citizens stash their savings in their socks or in overseas bank accounts because they don't trust domestic financial institutions, then any profits from enterprises will flow to foreigners instead of citizens, causing newly-generated wealth to instantly evaporate from your soil.

The end prognosis is as clear as it is grim: becoming a "modern" wealthy society is more a matter of history and culture - vibes, if you will - than following a development plan or importing a certain set of technical and legal institutions. The reason why the West is on top of the world is because it lucked out centuries ago in developing a certain set of home-grown institutions. There's nothing about those institutions that's intrinsically tied to our bodies or our soil, but they also aren't something that can be flipped on at will. It will take generations for these institutions to fully take root, in an organic, fully-embraced way. But once they do, nothing will stop those other countries from enjoying the same growth and, eventually, surpassing Europe and the US.

This book was written in 2003, and one of the most striking and infuriating aspects of it was just how clearly Bernstein knew that George W. Bush's project to export American-style democracy to Iraq and Afghanistan was doomed. And this was written during the heyday of "shock and awe", long before the insurgency started. Bernstein confidently wrote that this was going to be an expensive disaster, a hopeless experiment, that no matter how much money we poured into these countries we wouldn't be able to turn them into Western-style democracies or shift their economies from resource-exploitation to manufacturing and service jobs. Anyways, it's really depressing to see Bernstein get this so right when the vast majority of our elected officials got it wrong. Watching the fall of Kabul nearly 20 years after he wrote this is really humbling; and, in many ways, can be explained through his lens. Why didn't the Afghans fight to stay in power? Well, why would they? Without a sense of ownership and a stake in the success of their country, there was really no rational reason to risk their lives.

One of the more provocative arguments Bernstein makes is that wealth produces democracies, and not the other way around. For the last 75 years or so, the more-or-less consistent message of the First World has been to encourage developing countries to create systems of representative government, with the thinking being that this will minimize corruption, help untap free-market forces within the country, encourage development and lead to an increase in posterity. From Bernstein's view, this is backwards: historically, political power has devolved in response to economic power devolving. The Magna Carta was signed after King John needed military and financial resources from his vassals. Parliament was empowered after the merchant class became wealthy and influential. The voting franchise was expanded after the economy shifted to industrial and service jobs. And so on. That's a surprisingly Marxist view of the interplay between economic and political power! In Bernstein's explanation, again, it all comes back to property rights: there needs to be enough wealth to be worth protecting, and then that wealth needs to receive legal assurances of durability; this will produce a sizable class of citizens who are invested in the long-term success of the country and will work to protect and expand it, and eventually will have the motivation and power to demand more say in how it is governed. Bernstein feels much better about the long-term prospects for democracy in a monarchy that assures private property rights than he does in a populist democracy can redistribute property at will. Again, this is a very different perspective than most of the other books I've been reading lately! But well-argued and a good perspective to understand.

I had a kind of hard time following Bernstein's politics while reading the book. He's obviously very focused on private ownership of property, and he frequently rails against socialism and communism. And yet he equally heaps scorn upon libertarians: he absolutely sees a role for government in establishing rules and ensuring everyone plays fairly, and like Piketty he sees value in increasing national tax receipts up to a certain level. In the last few chapters of the book, he abruptly shifts into asking the (very important!) question "What does this matter?". More specifically, does increasing wealth making us happier? Following a data-driven approach, he sees only a loose correlation between happiness and wealth at the national level: residents of very wealthy countries have a general tendency to be happier than residents of poorer countries, but it's only a rule of thumb, and lots of poorer countries report better well-being than richer countries (for example, Columbians are poorer but happier than Spaniards). But, within a country a person's relative wealth has a huge impact on their happiness. The people who are at the top 1% of a country's wealth and income distribution are significantly happier than those at the bottom 10%, and the size of that gap corresponds strongly to the level of misery. In Northern European countries with small gaps between rich and poor, everyone tends to be happier than in England, the US and other countries with larger gaps. And the source of this research that Bernstein cites? None other than Thomas Piketty and Emmanuel Saez! I gasped when I saw them, much like Nick Fury showing up in the final chapter of a Marvel movie.

The end of the book was honestly a bit of a whirlwind: after spending most of the pages explicitly defending the sacralization of private property, Bernstein shifts towards arguing for high tax rates on the richest people, redistributing wealth via transfer payments to the very poor. I didn't see that twist coming! He has some opinions on how best to do this. He's rather skeptical of funding social programs, like subsidizing higher education or health care, due to the "deadweight loss" of value: the dollar price of providing e.g. health care in America is greater than the value a consumer would assign to it. He never uses the phrase "universal basic income", but I think he's advocating for something closer to that, just straight-up taking dollars from rich people and giving dollars to poor people.

He acknowledges that higher rates of taxation and transfers of wealth will have a negative impact on overall wealth creation and economic efficiency; it removes some incentive to grow wealth at the highest levels since innovators won't retain as much of their income, and may similarly remove some incentives at the lower levels if people are sufficiently comfortable without working very hard. But he still thinks it's a good idea for several reasons. First, it helps with overall happiness, which at the end of the day is more important than money. And relatedly, it also improves social cohesion: people who are desperately poor and hungry are far more likely to steal than those who have their essential needs met. You could have a highly unequal society with a few very rich people surrounded by massive slums of very poor people; but such a society would also need lots of policemen, high walls, private security, and other ongoing costs to defend that wealth. In contrast, a more egalitarian society doesn't need to spend as much of its wealth on maintaining internal security from its own citizens.

Or, to put it another way: Bernstein, like Piketty and Pistor and Elizabeth Warren and others, doesn't see unfettered capitalism leading to an eternity of inequality; rather, they see unfettered capitalism as bringing about the downfall of capitalism, when the miserable masses have finally had enough and rise up in violent revolt against a system that has treated them poorly. All of them ultimately see capitalism as a machine that hums along and creates wealth that can benefit society, but that needs to be kept in check lest it destroy itself.

Ultimately, I think Bernstein falls squarely in the category of being a Social Democrat, while being vehemently opposed to Democratic Socialism; where most of us see a gradual continuum between the two, for him there's a very sharp line dividing them. In his view, it's absolutely necessary to reward inventors, entrepreneurs and investors, so it's desirable to have a society where some people are richer than others and where risk-takers receive greater benefits. "Socialism" crosses a red line into a world without private ownership, where people are expected to labor for an amorphous promise of uplifting society rather than concrete incentives of making a better life for themselves.

Adding a bunch of random thoughts here:

Reading this book felt a lot like reading Neal Stephenson. There's an ostensible central thread - why and how we changed from a world where the vast majority of people had a subsistence standard of living, and transformed to a world where many people share in an increasing amount of wealth. But it's surrounded and often overwhelmed with a ton of fascinating digressions and side-notes. Orbital mechanics! Farming techniques in the Attican hills of Greece! Calvinism! Intrigues of the Elizabethan court! With both Bernstein and Stephenson, you get the sense that they stumbled across something so interesting that they just couldn't help sticking it into their book, whether it belongs there or no. And there's a huge amount of overlap with The Baroque Cycle and this book, dealing with the creation of reliable specie currency, creation of the scientific method, and investments in long sea-voyages.

It was actually a bit stunning in just how many ways this book connected with other stuff I've read recently. "House of Morgan" was a fantastic concrete example of the creation and application of capital markets, and Bernstein name-checks Morgan as only investing in established technologies, due to the very high failure rate in new ventures. "Freedom & Necessity" occurred during the social upheaval of post-1820 as the existing social classes adapted to the new economy, and Bernstein's extensive quotations from Engels line up with his presentation in that novel as a businessman-slash-revolutionary. And ALSO I was amazed by all the detailed ways in which this book and Europa Universalis IV lined up with and commented on one another, down to details like how granting monopolies worked, why conquest-driven expansion can produce short-term power but leads to long-term economic decline, the ways in which trade-based economies differ from production-based mercantilist ones, and so on. Reading this book made me appreciate EU4 even more, and having played EU4 gave me a deeper appreciation of this book. EU4's institution-embracing gameplay pretty exactly covers the progression out of the Dark Ages through the renaissance and development of property rights, science and trade, and ends in 1821, exactly when Bernstein's modern world kicks off. That makes me want to play Victoria even more!

As I noted before, this book also dovetails nicely with Pistor's "Code of Capital". Very briefly, Piketty notes how much additional wealth has been created in entirely new categories that didn't even exist centuries ago (copyrights, patents, financial instruments, etc.). Pistor covers how those categories were created, describing the common-law process of private-sphere contracts that endow certain intangible assets with the public protection of property rights. Bernstein more vigorously argues for why it's actually a good thing that more of our wealth is in these new categories, and does so rather persuasively. Prior to the 20th century, most wealth was in the form of agricultural land. The problem with this is that it isn't very scalable at all. Obviously, there's only a finite amount of land on the face of the planet, and all the good land is taken already. If society is going to grow, we need to bring more farmland into production; but because all the good land is taken, that will either mean enormous expense at reclaiming new land (as the Dutch did), or else bringing marginal land into production (irrigating deserts, planting in places with shorter growing seasons, etc.). Increasing investment leads to diminishing returns as worse and worse land gets brought into use.

In contrast, once we shifted to an industrial economy, we had much lower marginal costs. Building a second factory costs about as much as building the first, and may even be slightly cheaper if you already have plans and know-how. If you start with 1000 workers, and later expand to 2000 workers, you'll probably roughly double your output: the second batch of workers will likely be about as good as the first ones. And in fact, there may be some small improvements in productivity and returns: training 2000 workers costs less per worker than training 1000 workers does. So (making up numbers here), while doubling farming profits might require farming 3x or 4x as much land, doubling industrial profits just requires about double the investment, leading to a much more scalable economy that can continue to grow.

Bernstein sees even more promise for the more recent forms of capital, particularly digital copyrights and software patents. Without any physical product to manufacture or replicate, your marginal costs are zero, or close to it: it costs Larian about as much to sell 10,000 copies of Baldur's Gate 3 as it does for them to sell 10,000,000 copies of it. There are no supply shortages to be concerned with: you can produce more at will, scaling up to meet demand instantly. This has the potential to lead to even greater growth than industrial and service jobs. Not infinite exponential growth - you're still ultimately limited by the number of people on the planet and the money they have - but far faster growth and far fewer limits than in the past.

While for the most part I loved this book and found many of its arguments strong, there were certainly parts where the author's enthusiasm and belief seemed to outrun the data. For much of the first 2/3 of the book, he'll be making some argument and say "We'll cover this in more detail in [a later chapter]". In the last third of the book, he turns to a lot of contemporary research and raw data (from surveys, old national records, studies, etc.) to try and prove correlations between things. Often times this takes the form of a very noisy scatter-plot with a trendline drawn in. Beneath one he'll mention "there's a lot of variance here, so it's a weak relationship between [X and Y], just moving from 0-2% between the extremes". But the immediately preceding scatter-plot will look equally messy, and have a trend line moving from -1% to +1%, and yet have been claimed as definitive proof of a strong correlation. I look at these sorts of arguments with extreme skepticism: it's very likely that some other factor better explains the correlation, or, even more likely, that it's a complex multiplicity of factors, nay, individual histories, and there are strong limits on what sort of universal truths we can derive.

From the opposite angle, while Bernstein makes an eloquent and passionate case for the primacy of empiricism over deduction, he does periodically lapse into deductive arguments. He'll write something like, "Unfortunately we don't have good records of the size of the economy in Britain during the 15th century, but we know that it grew by about 0.1% annually, because the population of London grew by about that amount over that time." Um, no: the correlation between population density and economic development is a theory that your book is trying to argue, you can't use that same theory to infer a fact!

Overall, I found this a really impressive book. I think that 25-year-old me would have thought it was the most amazing book ever: ambitious, sprawling, persuasive, fascinating, touching on technology and science and warfare and money and politics in one heady stew. Middle-aged me is sorting this somewhere in my much-expanded mental bookshelf, shoving over some Piketty books to make room for this one, mulling whether to move it to a new shelf or rearrange my other tomes. There's a lot to nerd out on, a lot to chew on, and a lot to enjoy about this book.

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