Our Intangible Riches

World Bank economist Kirk Hamilton on the planet's real wealth.

Ronald Bailey from the August/September 2007 issue

Oil, soil, copper, and forests are forms of wealth. So are factories, houses, and roads. But according to a 2005 study by the World Bank, such solid goods amount to only about 20 percent of the wealth of rich nations and 40 percent of the wealth of poor countries.

So what accounts for the majority? World Bank environmental economist Kirk Hamilton and his team in the bank's environment department have found that most of humanity's wealth isn't made of physical stuff. It is intangible. In their extraordinary but vastly underappreciated report, Where Is The Wealth Of Nations?: Measuring Capital for the 21st Century, Hamilton's team found that "human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries."

The World Bank study defines natural capital as the sum of cropland, pastureland, forested areas, protected areas, and nonrenewable resources (including oil, natural gas, coal, and minerals). Produced capital is what most of us think of when we think of capital: machinery, equipment, structures (including infrastructure), and urban land. But that still left a lot of wealth to explain. "As soon as you say the issue is the wealth of nations and how wealth is managed, then you realize that if you were only talking about a portfolio of natural assets, if you were only talking about produced capital and natural assets, you're missing a big chunk of the story," Hamilton explains.

The rest of the story is intangible capital. That encompasses raw labor; human capital, which includes the sum of a population's knowledge and skills; and the level of trust in a society and the quality of its formal and informal institutions. Worldwide, the study finds, "natural capital accounts for 5 percent of total wealth, produced capital for 18 percent, and intangible capital 77 percent."

Social institutions are most crucial. The World Bank has devised a rule of law index that measures the extent to which people have confidence in and abide by the rules of their society. An economy with a very efficient judicial system, clear and enforceable property rights, and an effective and uncorrupt government will produce higher total wealth. For example, Switzerland scores 99.5 out of 100 on the rule of law index and the U.S. hits 91.8. By contrast, Nigeria gets a score of just 5.8, while the war-torn Democratic Republic of the Congo obtains a miserable 1 out of 100. The members of the Organisation for Economic Co-operation and Development-30 wealthy developed countries- have an average score of 90, while sub-Saharan Africa's is 28. "Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity," the study concludes. According to Hamilton's figures, the rule of law explains 57 percent of countries' intangible capital. Education accounts for 36 percent.

The rule of law index was created using several hundred individual variables measuring perceptions of governance, drawn from 25 separate data sources constructed by 18 different organizations. The latter include civil society groups, political and business risk-rating agencies, and think tanks.

This new focus on the importance of social and political institutions marks a dramatic shift away from the World Bank's infatuation with financing mega-projects in poor countries. Examples include the $2.5 billion Lesotho Highlands Water Development Project and the $3.7 billion Chad-Cameroon oil pipeline project. Most such projects are failures. The World Bank's own self-audited evaluations found that the projects it financed failed 55 to 60 percent of the time. In its 1997 World Development Report, the bank recognized the failure of such top-down technocratic aid interventions: "Governments embarked on fanciful schemes. Private investors, lacking confidence in public policies or in the steadfastness of leaders, held back. Powerful rulers acted arbitrarily. Corruption became endemic. Development faltered, and poverty endured." Evidently, the World Bank is coming to realize that the late economist Peter Bauer was right when he wrote in his brilliant 1972 book Dissent on Development: "If all conditions for development other than capital are present, capital will soon be generated locally or will be available...from abroad....If, however, the conditions for development are not present, then aid...will be necessarily unproductive and therefore ineffective. Thus, if the mainsprings of development are present, material progress will occur even without foreign aid. If they are absent, it will not occur even with aid."

Where is the Wealth of Nations? convincingly shows what countries need to do to create wealth and lift billions of people out of abject poverty: Establish the rule of law and educate their people. That's a lot harder to do than building giant dams or aluminum factories, but it would be a lot more effective in reducing poverty.

Science Correspondent Ronald Bailey interviewed Hamilton at his office in the World Bank's gleaming headquarters in downtown Washington, D.C. Where Is The Wealth of Nations? can be downloaded from worldbank.org.

Reason: What do you mean by intangible capital?

Kirk Hamilton: Intangible capital is capital that has an economic value but is not something you can drop on your foot.

It's the preponderant form of wealth. When we look at the shares of intangible capital across income classes, you see it goes from about 60 percent in low-income countries to 80 percent in high-income countries. That accords very much with that notion that what really makes countries wealthy is not the bits and pieces, it's the brainpower and the institutions that harness that brainpower. It's the skills more than the rocks and minerals.

Reason: What sorts of institutions help countries become rich?

Hamilton: I tend to think of them as social structures that allow societies to achieve certain outcomes. An institution could be a village-level committee that deals with how common property is used. It could be something as abstract as the legal system.

Comments

|8.3.07 @ 4:26PM|#

The subtitle is from a previous article by accident.

|8.3.07 @ 4:49PM|#

Dan: Very astute. It's fixed. Enjoy the article.

anon|8.3.07 @ 5:18PM|#

"We do have some examples in recent history in developing countries-South Korea, India, Thailand -where some sort of crisis or impetus came and institutional change occurred very quickly and had a major impact."

In the U.S., we have to take care that the same scale and speed of change does not happen _in reverse_ here.

|8.3.07 @ 5:28PM|#

And here we have the flaw in Georgist reasoning. It may have been true once that unimproved land and minerals were the source of wealth, but not so much now. Just look at the S&P and figure out to what extent command of land wealth is the basis of corporate value. The Dow is a goofy measure of the market as a whole not only because of its small number of components, but because it is by definition the Industrial Average.

Guys like Chavez are able to sell a lot of snake oil based on the common misunderstanding of the basis of wealth. All over Latin America you hear critics spin "they steal our wealth!" as a criticism of open international markets. The idea is baked in that wealth = oil or copper or whatever you are standing on top of. You are doomed to be poor if you don't figure out that wealth is primarily generated elsewhere.

|8.3.07 @ 5:45PM|#

In the U.S., we have to take care that the same scale and speed of change does not happen _in reverse_ here.

Indeed. You have to wonder what the future for America holds when it seems that so few people find rewarding jobs in the civil service. I think we're still living off the fumes of a bye-gone era when, for example, the best lawyers became judges instead of high paid litigators...

Time for a drink =)

Mike Laursen|8.3.07 @ 8:51PM|#

Fascinating. Social and financial stability are products that have a market value just like real estate and washing machines.

|8.3.07 @ 9:05PM|#

Nice article.

|8.3.07 @ 9:09PM|#

So why didn't Ron Bailey ask the relevant questions on most of our minds here: "Would moving to a more libertarian society increase our wealth, and how? Is the drift to authoritarian socialism and bigger government going to drive us into decline?"

The answers, according to our resident statist commenters (you know who you are), would be "no" and "yes".

|8.3.07 @ 9:37PM|#

I really hope that there are some powerful people out there reading this report. I remember being in a enviromentalism class in college, when my professor brought out that quote that goes something like 'human beings are the most valuable natural resource'. Most of the class, himself included, laughed. Why is this so hard for people, especially fairly bright ones, to understand? Some aspects of the environmentalist movement certainly have a religious overtone, and so I suppose that explains much of their beliefs/actions. But the sane remainder would do well to read this report. Things are complicated - but people need to be shown, concretely and convincingly, that just a small amount of natural resources, in the hands of the right minds and institutions, can go along way to improving things for humans, and can even do much to advance the more worthy goals of environmentalists. The only limit to the value of an arbitrary amount of matter is the cleverness of its curator.

|8.4.07 @ 2:04AM|#

Leif-

Just think back to the cro-magnon days, when there was more of every natural resource on the planet. People were much wealthier back then, and had a far higher standard of living. Then all the rest of us came along and ruined it all.

|8.4.07 @ 2:53AM|#

concretely and convincingly, that just a small amount of natural resources, in the hands of the right minds and institutions, can go along way to improving things for humans, and can even do much to advance the more worthy goals of environmentalists.

Not sure who you are trying to educate with this. Seems like the basic message of environmentalism...

|8.4.07 @ 3:34AM|#

My point was that standard environmentalism doesn't seem to fully grasp that improvements to institutions/technology steadily increase the efficiency of resource use. Thats why conservationists assume that we're going to need the same amount resources to output the same amount of consumables in, say, 50 years. This obviously isn't true; for example one tree today ouputs many more sheets of paper than it did 50 years ago.

When I said that 'a little can go a long way' I meant that the conversion from raw materials to consumables does not have the simplistic effects that standard enviro. assumes. The other night Stephen Colbert made some joke about how the 'overbreeding' of goats in china was guaranteeing him cheap cashmere - the punchline was supposed to show that the only thing people are getting in return for the nasty pollution is some cheap sweaters. This is the kind of trap that environmentalism falls into again and again - that mass production and 'consumerism' can be simplified into: nat. resources => pollution + product. The diamond mine example from the interview pretty much refutes this.

In short, to increase efficiency in the long run, we sometimes have to increase consumption in the short run. This is antithetical to 'basic environmentalism'.

|8.4.07 @ 10:36AM|#

That accords very much with that notion that what really makes countries wealthy is not the bits and pieces, it's the brainpower and the institutions that harness that brainpower. It's the skills more than the rocks and minerals.

IOW, the report is an obscurant version of Lynn's "IQ and the Wealth of Nations."

|8.4.07 @ 12:40PM|#

Mr. FLeM,

Not really.

|8.4.07 @ 1:05PM|#

IOW, the report is an obscurant version of Lynn's "IQ and the Wealth of Nations."

Here we go again with the IQ Fetishists.

|8.4.07 @ 2:23PM|#

Leif

You make a good point, but I think a common misconception occurs on the other end of the stick... many people think that when environmentalists say we need to reduce our consumption of natural resources they must mean that we need to reduce our consumption of products.

Given even your toy formula Nat. R => product + pollution... there is no reason that reduction in Nat. R. consumption can't result from reduction in the Pollution in that formula. In other words, environmentalists are arguing for the use of human and institution capital to increase efficiency.

atrevete|8.4.07 @ 4:45PM|#

What this article really answers is the charge that "Something is wrong when there are billionaires with more money than they can spend and 1.5 billion people are living on less than $1 a day".

That "something" is that those 1.5 billion are living in god-awful political systems with no education, not that Donald Trump is cheating them out of the money they'd use to buy another bowl of rice and building Trump Palace.

|8.5.07 @ 12:38AM|#

Where Is The Wealth of Nations? isn't downloadable from the worldbank.org site, it's buyable for $25.00. Or have I missed a link?
http://publications.worldbank.org/ecommerce/catalog/product?item_id=4980649

|8.5.07 @ 3:32PM|#

Too Cheap to Pay,

You can get it free here...

http://go.worldbank.org/7M49XI1HT0

Ventifact|8.6.07 @ 6:15PM|#

The World Bank seems to have realized that it's not omnipotent, not even close enough to wave their magic wands and develop countries at will. Now, frustrated at the corruption that they should have seen as an obvious and insurmountable (at least by sheer weight of investment) problem all along, they are accruing data to empirically prove that they do not bear the blame for this lack of development.

Good for them. It looks like they've been working at it for a few years now. One obvious next step which they seem to have wanted to take for a little while but have been unable to is to take a firm stand against continuing to contribute money to heavily corrupt states, using these and similar findings to justify firmer policies.

Mark Plus|8.8.07 @ 11:44AM|#

Just think back to the cro-magnon days, when there was more of every natural resource on the planet. People were much wealthier back then, and had a far higher standard of living. Then all the rest of us came along and ruined it all.

But our hunter-gatherer ancestors lived in state-free societies and didn't have to work. States and work didn't come along until the advent of agriculture and metallurgy. The upper classes have always shown the truth about our leisured pre-agrarian past by hunting for recreation.