Sunday, November 25, 2007

The (intangible) Wealth of Nations

If the value of all physical resources of a country is summed it is generally inadequate to account for or explain the country's current level of income. The unaccounted for income derives from the country's intangible wealth. This includes things like trust among the people, an efficient and fair judicial system, clear property rights and effective government. Typically more than half the wealth of a country is of this intangible type.

A World Bank study begins by defining natural capital as the sum of nonrenewable resources (including oil, natural gas, coal, and mineral resources), cropland, pastureland, forested areas, and protected areas. Produced capital is what many of us think of when we think of capital. It is the sum of machinery, equipment, and structures (including infrastructure) and urban land. The Bank then identifies intangible capital as the difference between total wealth and all produced and natural capital. Intangible capital includes raw labor; human capital, which includes the sum of the knowledge, skills, and know-how possessed by population; as well as the level of trust in a society and the quality of its formal and informal social institutions.

About 90 percent of intangible capital is accounted for by years of schooling and the rule of law. On average, the rule of law explains 57 percent of countries' intangible capital while schooling accounts for 36 percent. An economy with a very efficient judicial system, clear property rights, and an effective government will produce higher total wealth.

To create wealth and lift people from poverty establish the rule of law and educate people.