Business & 'Wealth Creation'

It is a commonly held view that entrepreneurs and businesses “make money” and are “wealth creators” but this widely held view is a fundamental misunderstanding.

If the owner of a business becomes rich it is generally assumed they have “created” their wealth out of thin air, and that they have “made” new money.

However, when a business “makes” money it only does so by depriving a competitor of the same amount. When a consumer spends money with one business it means they are spending less money elsewhere. The business is only acquiring their money by depriving their customers of the same amount.

They have not created and made money, they have merely appropriated it.

The only thing (in Britain) that truly “makes” money is the Bank of England. Banks take this money and lend it out therefore increasing the money supply, a process known as credit creation. But what happens to that money afterwards doesn’t ultimately result in further money being created, it is merely shuffled around.

Right-wing politicians often claim that cutting taxes for the rich means the rich “create” more wealth and that we should be so grateful for these marvellous people creating all this additional wealth that we otherwise wouldn’t have. This is complete nonsense. The rich have become richer over the last 30 years only because the middle classes have become poorer by the same proportion. The top 1% have not “made” new money, it is simply that the rewards of economic growth over the last 35 years have largely gone to the top 1% - and a large percentage, in fact, has gone to the top 0.1%. The economy in the last 30 years has not grown any faster than it did in the 30 years before that. If it had then we might be able to conclude that the rich have indeed created more wealth and that this had "trickled down" to everyone else. But it has not.

Over time economies grow due to higher productivity and efficiency and it is true that entrepreneurs with innovative new ideas achieve a good deal of this. This is the true sense in which they are wealth creators but this facet is the least recognised. But ordinary employees and managers going about their day to day jobs achieve productivity enhancements too. An entrepreneur may initiate a new product or service but it is just as likely that their staff contribute to efficiency enhancements thereafter.

Economics is not a "zero-sum game" in that productivity enhancements do ultimately create greater productive capacity that feeds through into economic growth. Also, there is usually room for more businesses to exist in most sectors that can exist by sucking profit margins out of other businesses in the same sector. But entreprenuers do not "create" wealth in the way that is commonly supposed.

Rich people often seem to resent the tax they have to pay. This is probably because of the misguided view that they have created new money – “if I’ve created this wealth why should I have so much of it taken away by the government”? Perhaps it should be pointed out that they have not, in fact, created new wealth as such but merely taken it from others. If they hadn’t got so much money to flow into their pockets then it would simply have gone to someone else who would be paying tax on it instead.

Capitalist economies are wealthier than planned economies and it is assumed that this is because of capitalism itself. In fact, it is specialisation and economies of scale that lead to greater productive capacity. It is not capitalism itself but that capitalism is better at stimulating the development of these two elements of wealth creation.

In a capitalist society there will always be a small number of very rich people due to the principle of economies of scale. One large business can usually produce goods cheaper than lots of smaller ones and this will mean the owner of the one business that dominates the market will be very rich. There is nothing inherently clever about most people who become financially successful because if they weren’t doing it then somebody else would. The worship of the rich by the Right in politics ignores the fact that this wealth divide is simply inevitable. The sum total of all commercial activity does create greater wealth through economic growth, but on an individual level it is simply not correct to describe an entreprenuer as a "wealth creator". Most of the time if a business person decided not to do something then somebody else would.

The Right insists that we must encourage and reward wealth “creators” with lower taxes. But given the inevitability of economies of scale is it really necessary? Whatever the tax rate there will always be a concentration of wealth in the hands of a few. Denmark is consistently among the most entrepreneurial countries despite having the highest taxes in the world on the rich.

Personally, I would endorse higher taxes on the rich generally but more support for companies with innovative ideas that might not otherwise happen. Compare, for example, the inventor James Dyson who has created innovative products that sell around the world, and a person who becomes wealthy by setting up a chain of estate agents. If Dyson, over time, decided to emigrate and establish his business abroad it would be a loss to the country. If the estate agent owner decided to sell up and emigrate to escape high taxes then it wouldn't really matter to anyone (and I'd happily tell them to get lost); if I didn't use their estate agent I'd simply go to the one next door. Some entreprenuers are more valuable than others. We need a tax system that encourages genuine innovators whilst not sucking up to anyone who merely succeeds through a propitious application of the Three B's of Business (see the end of "How Not To Run A Business). I would increase Research & Development tax credits and make Capital Expenditure more tax-deductible whilst increasing taxes on dividends and salaries. Businesses that invest would get a boost; businesses that didn't invest would pay more.

Most business people do not, in any case, become rich. The pride of setting up your enterprise and being your own boss are usually rewards enough for all the hard work. I doubt that aspiring business people starting out with a hefty bank loan and long hours ahead of them would be thinking too hard about the rate of tax they may pay in the future; they would just be grateful to one-day be in the top tax bracket at all.