So if you’ve been reading all the comments on the blog on importance of inequality you’ve noticed a lot of brouhaha.
My argument was that there is no correlation between distribution of wealth and standard of living. There is a correlation between GDP and economic freedom and standard of living.
Most of the argument didn’t focus around this. First they complained about my use of UN data for standard of living numbers even though I despise the UN and make no attempt to hide it. I found this odd; I admitted I was playing in the opposition’s ball park. I know that if I use data from more conservative sources of course it will show the same thing, but my point wasn’t to show that numbers from the sources I trust justify my beliefs (that’s a given), it was to show that numbers from liberal sources don’t even come close to justifying liberal beliefs.
But I made this other statement about if you had a way to measure happiness in an accurate way you would not necessarily see the diminishing returns you see in the set of data I was using.
Now diminishing returns is an idea that the same incremental gain has a lower return with each new increment. One steak dinner is great. Two in a row we’re eating like kings…three okay, can we cook it another way…four, did we just slaughter a cow and need to clear out some freezer space…five in a row, can I have some chicken please…a week of steak, is this some kind of psych experiment. The first hundred year old book I bought was the coolest thing in the world at the time, and while I love my growing collection and like any English teacher find old book smell practically an aphrodisiac, each new addition never quite reaches the high of the last. Economics states the same thing; every new $100 dollars is less fulfilling than the last. And new economics stated this, as a fact…but something didn’t make sense about this. To me I see more money as creating more opportunities and not having a lessening effect with the more you get. And just last night it hit me as to why.
I was talking about money and my opponents (and most economists) were talking about wealth. What’s the difference you ask? Wealth is the acquired material things. Money can actually be a part of wealth if you acquired it just to acquire and save it. And this is where the diminishing returns come in. The first house you own is a spectacular thing. But if you buy a second it’s still cool, but not the thrill of the first. By the time you own four or five houses they’re just things without much personal or emotional value to you. This applies to all material things from a cup of yogurt to an entire company. You have a clear demonstration of diminishing returns. Why because things don’t buy happiness. A minimum level of stuff is required, but after you have comfortable shelter, sturdy clothes, and enough cash to insure medical care and a safety net through old age anything after that has a diminishing return effect.
However, while math and economics were quite clear, from both my knowledge of psychology and personal experience I knew that this wasn’t the full case when it comes to money. From the psychological viewpoint I would look to Maslow as a guide to happiness. Maslow’s hierarchy is basically a clear path of needs that once met will take you to the next level of the hierarchy. At the top is something he calls self-realization, which Aristotle and the ancient philosophers called eudaimonia, and which is usually rendered as Happiness (the capital H is intentional). If diminishing returns on wealth were a complete story about how to get to the highest level of standard of living then you would think you would need an increasing amount of money to get to each next level. But you don’t. It’s quite the opposite. To meet all your first level needs you probably need about $25,000 a year. To meet your second level needs of security you probably only need about $20,000 more. Hell you probably only see a minimal increase in the next level (I’m figuring if you get married, which is part of that level, either you’ll need about $15,000 increase to pay for two people at the same lifestyle you were at in level one). Is money really even needed for the next two levels, not really (although if you make it to those levels you’re probably good at what you do and make more, but you don’t need it).
And then there is personal experience. If you have diminishing returns with all money then the biggest high you should get is when you make your first payment on a loan, and get less and less excited with each new payment. Yet we all know it works in the reverse. As we get closer and closer to paying off a debt each check actually becomes more fulfilling. The check that pays off the car, the house, the college loan, that’s the one that you’re jumping for joy on. And when I think about my own life in general it holds…think about this for yourself. If I got a $10,000 raise, I’d be ecstatic because I’d have all my debts paid off in 10 years instead of 30. If I got a $20,000 raise I’d be even happier because now I would be even closer to the end and could really start planning about life without debt. A $30,000 raise I could start investing which is always far more fun. $40,000, hell I could start looking for a house. This keeps going with every increment up I could do more and get further out of debt sooner, take more control of my life and have less concern. So it has to get up there before I really see a diminishing return on a $10,000 increase in my yearly income.
Why? Because I’m not looking to acquire wealth. I’m not looking at money as a thing to hoard or transfer for other stuff, which it can easily be. I’m looking at it as a tool. And tools don’t have diminishing returns. The chisel and hammer don’t become less effective the longer a sculptor uses them, they become more effective with time and practice and skill. Tools are not subject to diminishing returns. And tools are designed to be used to achieve a goal. For me it goes (A) Get out of debt (B) build writing career (C) establish financial stability (D) become philanthropist. (Your goals maybe different or even better than mine…but I had to give an example.)
Most people don’t have goals. They just buy stuff. Most people when they get a raise they go out and increase their lifestyle to match their new income. They keep up with the Jones’s. They treat money as wealth. They do not have a goal; they just are concerned with things. (In case you’re wondering I may be a die-hard capitalist, but I also believe in the virtue of personal frugality). If you have goals that require some kind of financial backing (most goals do), each incremental increase brings you closer to the goal and thus heightens your happiness, your anticipation, your joy and lowers your doubts and worries. If you treat money as a tool for reaching goals and stay focused on those goals the diminishing returns don’t come into play because it’s not just something you already had and now you’re just getting more of it. When are you happiest and most energetic in a race, at the end of course when you can see the finish…same with money when treated as a tool and not just as wealth, it helps you get to your goal and thus each new amount actually brings more happiness than the last increase of the same amount.
I do not know how many times I can repeat the phrase goal oriented, but just so we’re clear if you have a goal and are working towards it then money does not have a diminishing return because it always brings you closer to your goal which make you happier. If you don’t have a goal…well what’s the point in life?
My mistake was making a logical fallacy that I often complain about others making, the “I am the world fallacy.” I was thinking about increases of money with someone goal oriented. I hate this fallacy and yet I fell victim to it, hey, I’m only human, I admit it. I forget not everyone lives the rather Spartan lifestyle I do, and not everyone is always long-term goal oriented, and that most people don’t by habit think everything through 10 years ahead. Yes I am an incredibly boring person. And I’m okay with that. And because of this I wasn’t realizing that everyone else was talking about money as wealth, which comes with absolute limitation of diminishing returns. This was my mistake for not realizing how I was putting everything on a different playing field.
Now to reference back to my above goals. Odds are I’ll never fully reach D (but I’m not one to play by the odds), but this is another reason why I don’t see more money as having diminishing returns. There are few joys as great as charity. To be able to raise it to the level of philanthropy I imagine to be just short of ecstasy (the state of being, not the drug). If it’s done right. Philanthropy like charity needs to be done at a personal level…so I guess yes once you hit this point you will find a diminishing return on money as a tool, but only because you’ve kind of lost any long term goal. The minute you have so much money that you can’t personally oversee giving it away it loses a lot of the happiness factor…it’s still fun but not as fun as doing it yourself.
So if you’re talking about money as wealth, yeah it has a diminishing return. Because money as wealth is its own goal, kind of a silly goal if you ask me, but this does seem to be the prevalent idea in the world. However if you are goal oriented then money doesn’t have to have a diminishing return (at least until you reach the super rich level)—as long as it is a tool to achieve your goals then it holds and increases value with every addition because each time you’re closer to your goal which always feels good.