This post explains why wealth is not a zero sum game and why we should celebrate each others’ financial success.
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Over the past few years, I’ve noticed some hostility in the world of personal finance and investing. Some of it’s been directed towards me, since I’m very open about my finances. (I do this to show people what is possible to attain with a good income and smart investing.)
A lot of my family’s financial growth has come as a result of real estate investing, and a lot of the hate has been directed towards this part of my overall portfolio. The ethics of real estate investing are debatable, but today I want to address the overall concept of wealth.
Wealthy people are often painted as evil or undeserving of their wealth. This is certainly true for some wealthy people, but certainly not all of them. A lot of this negativity is just good old fashioned jealousy, but I think there’s also something else going on here.
To figure out this mess, let’s talk about how new wealth is generated. Let’s discuss how our market economy really works, and the magic of business. But first, why all the hate?
I believe the origin of this hate stems from one basic misunderstanding: Many people are under the mistaken assumption that wealth is a zero sum game.
Zero Sum games
In the year 1832, senator William Marcy was criticizing American politicians and said “They see nothing wrong in the rule that to the victor belongs the spoils of victory.” This is the origin of the phrase, “To the victor go the spoils,” which applies to situations where one person or team gets all the upside when they win.
Many games are “winner take all” situations, where there is one winning and one losing team. The Superbowl, like many championship games, yields one winner with no tie possible. Similarly, in card games like poker, there’s a clear winner at the end.
A “zero sum game” is the geekified, formal term used in game theory for contests like this, where the winner’s gain is equivalent to the loser’s loss.
We can explain this economic theory with a simple example:
- John has 10 apples, and is in a room with Sandy.
- For Sandy to walk out of the room with 7 apples, they have to be taken from John.
- He only gets to walk out of the room with 3 apples after Sandy is done with him.
- For Sandy to “win” this game of apples, John must “lose.
Let’s start tying all of this together.
Wealth is not a zero sum game
When it comes to businesses, some people only see the simplistic transaction of sales and extrapolate this to the entire concept of wealth building. For example, you might think, “If I pay $10 for this Big Mac meal, McDonald’s is getting $10 dollars richer. If only they charged less for this meal, I’d have more money and McDonald’s would have less money.”
When it comes to general wealth, the simple way to perceive this is to think: “Since that girl is rich, her success is coming at my expense.” You can see how this thinking might create a lot of hostility, especially in a society where social media encourages people to show off success like never before.
But here’s the truth about business and wealth that belies this simplistic way of thinking: Business is magic. It has the power to create money and wealth out of thin air.
Below, I’ll explain how this is possible, and how this fact makes it obvious that wealth is not a zero sum game.
The magic of business
Let’s dive into human history to help explain the magic of business. Before business existed, it was only “eat what you kill.”
Quite literally in hunter-gatherer societies, you ate what you killed that day. If you didn’t kill a deer, you might go hungry. Your gain was that deer’s loss.
But as soon as human civilization got to a point where people were trading goods or working with or for each other, we gained the magical ability to defy the laws of physics. Through effort and intelligence, people could all of a sudden create situations where value could be created out of thin air.
This magic became more common after the industrial revolution, but human beings have been using this special economic power for thousands of years. The magic is in our ability to create value add businesses.
Value add businesses
Most businesses create much more value for society than meets the eye. This is why the government encourages businesses with tax incentives. It’s not just some evil plot by the government to make the rich richer. (I really believe this.) It’s to incentivize people like you and me to create business and benefit our society as a whole.
Value add businesses are the secret sauce that allows wealth creation to be a net gain for the average person, not just for privileged groups of insiders.
Let’s go back to that example above with that Big Mac meal. There are endless steps along the way that your purchase of that meal is creating value for our society via the McDonald’s business:
- Buying raw materials for the sandwich supports farmers and ranchers.
- Transporting all the materials supports truckers and the railroad industry.
- Packaging and selling the sandwich supports McDonald’s workers.
- Creating the advertising supports the advertising and media industry.
- Building the McDonald’s restaurants supports the construction industry.
- Buying the meal (instead of cooking) frees up time for you to do other things.
At each point in this chain of events, people are gaining wealth from the McDonald’s corporation. The economic activity necessary to create that Big Mac is creating tons of economic growth for the country. Those economic benefits translate into a higher quality of life for people working in the supporting industries.
Your purchase is worth much more than the $10 that comes out of your pocket. For our society, this is very much a positive sum game.
As for the magic, here it is: All of the infrastructure and systems behind modern businesses create companies with market values much greater than the sum of its parts. When Ray Croc put together the McDonald’s corporation, he created money out of thin air.
I can already hear people grabbing pitchforks, so here’s the disclaimer. Obviously this assumes a free society where people are being fairly compensated at each point along this chain of events.
Wealth can be zero sum, but why?
When it comes to money, it certainly can be zero sum. Here are a couple of examples of zero-sum games that are essentially bad businesses in disguise:
- A bully in third grade beats up your kid and takes their lunch money. The bully just got richer, and your son’s going hungry that day.
- A man with a gun walks around and accosts people, taking their money.
These are both zero sum businesses, but you could imagine that this type of business model won’t survive over the long term. In the real world, the local community will learn to avoid these unlawful “businesses”, or law enforcement (or a good vice principal) will shut them down.
This will probably never happen to McDonald’s, because it’s such a beloved company. It adds value to society by providing great benefits and entry level jobs, as well as an awesome product that delights billions of people worldwide. Employee satisfaction at McDonald’s is 73% for a reason.
What about the stock market?
A lot of people cite the United States stock market as an example of a marketplace where there are only winners and losers. This might be true at a simplistic level if you’re a stock trader. For you to make a big profit, the only way to do this is to turn your stock into cash by selling it. By doing so, you’re saying that the stock isn’t worth holding onto, and you’re looking for some chump who disagrees with you and will buy the stock.
To an certain extent, I can understand this characterization. But I think this also ignores the beauty of the free market and is too focused on the short term. One person’s gains aren’t necessarily another person’s losses over time. There’s a good chance that over time, the buyer of your stocks will make money in the long run (especially if they’re using index funds to buy the stock).
Also, when you buy a stock, you aren’t just investing in your own wealth. You’re also supporting a company by giving them the ability to raise money and use that money for financial gains for investors, expansion, or further investment. Again, it’s a value-add action.
What about taxes?
I complain about taxes a lot, especially after living in California for 12 years. As I mentioned recently, we paid over $50k of state income taxes last year. (Read more: The Amazing Power of Geoarbitrage)
But I can readily admit that taxes aren’t just some tactic of California liberals to annoy the wealthy. They play a big role in making sure the overall distribution of resources remains equitable. Taxes pay for a lot of social programs that try to blunt the negative impacts of poverty. This reduces income inequality. As you might know, countries with the highest levels of income inequality have unique problems as a result of this situation.
Wealthy people ironically play a large role in reducing income inequality by paying a lot of taxes that support social support programs.
In fact, data shows that the rich pay the majority of income tax revenue in our country. The progressive tax system ensures that the more you earn, the more you pay. There are obviously ways to get around paying income taxes. I’ve enjoyed the short term rental business tax incentive, but again this is another example of a tax incentive that exists to encourage businesses.
You don’t have to love wealthy people, but I wouldn’t automatically assume that they became wealthy at your expense. Unless we are talking about pure inherited wealth, financially successful people are likely to have contributed greatly to the economic development of our country. The contribution might have come via the magic of businesses, by supporting the stock market, or simply paying taxes.
If you’ve become wealthy, I’m here to absolve you of some of your guilt. (Use charitable giving for the rest of your guilt!)
After all, wealth is not a zero sum game.
Do you agree with me, or am I way off the mark here? Let me know in the comments below. And please subscribe to my newsletter so you don’t miss another post!