THE BLOG
04/21/2015 07:57 am ET Updated Jun 21, 2015

Our Children and Grandchildren Will Be Richer Than Us, but There Is a Problem

Writing in 1830, the British historian Thomas Babington Macaulay said "If we were to prophesy that in the year 1930 a population (in Britain) of 50 million, better fed, clad and lodged than the English of our time, will cover these islands, that Sussex and Huntingdonshire will be wealthier than the wealthiest parts of (England) today ... that machines constructed on principles yet undiscovered will be in every house ... many people would think us insane."

When 1930 came along and had vindicated Macaulay, the great economist John Maynard Keynes pushed the parlor game forward to 2030. "I would predict," he wrote, "that the standard of life in the progressive countries one hundred years hence will be between four and eight times as high as it is today ... the economic problem is not - if we look into the future - the permanent problem of the human race."

Keynes, too, erred on the cautious side. In the year 2000, people in North America and Europe were not 4 to 8 times better off than in 1900, but roughly 10 times better off, and, barring catastrophe, the comparison of 2030 to 1930 looks set to be similar or better for the rich countries, and even better for the developing nations.

And yet, you probably often hear it said - I certainly do - that today's young people won't experience the benign economic weather which has blessed most of their parents. Are there good reasons for what people say, or are they being perversely pessimistic?

The Very Long Historical View

I find it helps to take a very long perspective. If you were to draw a chart of the growth in world wealth each century from 2000 BC to 2000 AD, it would be flat as a pancake for the first 3,500 centuries, pottering along at essentially zero. I find this an amazing fact. All those ancient civilizations - the Phoenicians, the Babylonians, the ancient Egyptians and Greeks, the Romans, the Chinese and Indians - all leaving those marvelous monuments, machines, and literature, building great cities - all those civilizations could not produce any measurable growth in total wealth or wealth per capita. Nor was there any marked increase in the earth's population. Economic history, essentially, begins around the year 1500, probably not coincidentally the time that the Renaissance got into full swing, and just before the Protestant Reformation, and the Scientific Revolution of the seventeenth century.

This should not just be of interest to historians and economists, but to everyone who values their life and what it can bring today. In the year 1000, world life expectancy was around 24 years, and a third of all infants would die in their first year. In Europe in 1700, life expectancy was scarcely higher than it had been in Rome, around fourteen hundred years earlier. You see, nature was in charge of humankind and not the other way round, and whatever today's green politicians tell you, dame nature was not a very nice woman.

And then the miracle. The line of wealth creation perks up notably after 1500, then flattens and wobbles around a bit until 1800, after which it suddenly changes direction, shooting up almost vertically to 2000.

Why has wealth soared?

I think there are three main reasons:

First, the Industrial Revolution and the triumph of global markets. From around 1760, with a steam engine that finally worked and a number of innovations in the British clothing industry, machines substituted for human- and horse-power. The British, because they had a technological lead, realized that they would benefit from treating the world as a single economic entity, and unilaterally instituted free trade. Specialization by country, region, and company, and continual technological progress, did the rest. The great age of globalization was probably 1870 to 1914, when goods, capital, and people all moved about the world in quite unprecedented fashion. An incredible 10% of the world's population emigrated during this period - it's well known that around 60 million people emigrated from European countries, mainly to the U.S., but about the same huge number left their homes in different Asian countries (mainly China and India) to go to more prosperous Asian destinations such as Ceylon, Burma, Siam, the Philippines, and Vietnam. Emigration nearly always accelerates world economic growth and wealth creation.

One of the great events of our lifetimes was the fall of the Berlin Wall. This took hundreds of millions of people out of a communist tyranny and into the global economy, and led to large-scale immigration to wealthier countries. Since then, the Chinese communists have taken their people into the capitalist world too, though, alas, without the freedom to elect a new government or leave the country.

Second, and accelerating hugely as we come to recent decades, is the breakthrough in weightless technology. During the last century, the economy went on a huge diet. Total wealth increased about twenty times in the U.S. and Europe, and yet the weight of output staying roughly the same. What this means is that:

• Products became lighter, as for example when plastics substitute for metal in a car or just about any product

• Services substituted for products - more restaurant meals, more expensive haircuts, more healthcare, more consulting and professional services of all kinds

• A whole new intangible sector emerged - mind over matter - valuable products that have almost no weight, such as software. The internet is currently the biggest manifestation of this trend, but there will be other developments of the same ilk, but with even more importance, in the next 30 years.

These developments have very attractive economic implications:

• Growth can happen more sustainably, using fewer finite resources (though this needs to go a lot further, especially in the developing world)

• Knowledge-based products and services exhibit increasing returns, meaning that the return on capital is very high and gets higher the more people join in the game. For example, the first iPod cost a fortune to produce, but every new one costs relatively little to make. This means that successful knowledge-based companies can have happy customers and incredible cash flow. Look at Apple as a prime example.

• Knowledge-based products are also essentially digital, which means they lend themselves to international trade, which in turn increases wealth.

My third and final reason for increasing prosperity is the near-global entrepreneurial revolution. When I was at business school in Philadelphia in the mid-1970s, Wharton was viewed as eccentric in having courses in entrepreneurship. What was significant, however, was that nobody I knew took them. A very few of my classmates went into the then-incipient and exotic field of Venture Capital - and about half of those few became billionaires. One or two started new businesses themselves, or said they wanted to later. The rest of us opted for what was then glamorous - consulting, investment banking, and yes, amazing to recall, big business corporations. The contrast with today could scarcely be so stark.

The Romans were just as great inventors as the British of the eighteenth century. The great economist Roger Bootle tells us that "In 100 AD Rome had better water supply, sewage disposal, paved streets, and fire protection than the capitals of Europe enjoyed in 1800." Hero of Alexander in the late first century invented a steam engine that could open temple doors. But the Romans didn't have the entrepreneurial urge. Most inventors were slaves. Conquest, glory, and civic virtue were Roman ideals, and their obsession was sex - not making money or better products. To create wealth, people must want to use technology for commercial purposes. This is the big mental barrier that we have only leapt over in the past three hundred years. It has made all the difference.

Look down the Forbes list of the world's richest people. Most of them are entrepreneurs. A few are inventors. And both groups got to be rich by endowing the world with wonderful new products and services, which have accelerated economic growth by making everyone want them. It is happening everywhere and the most hopeful sign is that people of all ages are joining in.

For these three reasons, the tide of increasing wealth may ebb and flow, as always, with the economic cycle, but over the long haul wealth goes up markedly as a result of these trends. It seems impossible that the increasing sway of knowledge products and services will diminish, and very unlikely that the trends towards lighter products, intangible goods, and increased international trade will go into reverse. I conclude, therefore, that wealth will go on increasing at rates that will surprise us, but should not.

So What's the Problem?

You might guess that I am building up to saying - there is no problem. Wealth will continue to proliferate. Yes, but there is a problem. It is a problem of social mobility rather than wealth creation. Particularly in the U.S., the gains in wealth over the past 30 years have gone disproportionately to the top one percent. The reason for this is easy to understand. The 80/20 principle demonstrates, both in theory and in practice, that when markets are left to work their magic, wealth accumulates. What we have seen is that Microsoft, Apple, Google, eBay, and about fifty other companies around the world, have cornered most of the new wealth creation. They are natural monopolies, at least until anyone invents a better alternative. And being entrepreneurial firms, even if they are quoted on the stock market, the lion's share of the gains goes to the founders and early employees, not to ordinary shareholders.

We are also seeing the growth, everywhere around the world, of a hereditary meritocracy. The children of the super-rich have a huge genetic advantage to start with, which is then reinforced by superior education, contacts, and early financial backing. They are having the time of their lives. And public education lags behind, as more and more of the best teachers and professors go to the elite schools.

I went to a grammar school in England. It was free and it was a great education. It enabled me to win a place at Oxford University, where we then had free tuition. I won a scholarship which paid some of my living expenses, and a few years later won a generous Thouron scholarship to go to Wharton - it paid all my expense and living costs. Without this help up the ladder, I would never have made it.

Today's under-privileged and middle class kids have it tougher. Not everywhere, but in most places. In the UK, the grammar schools were mainly abolished, by a Labour government, that subsequent Conservative governments, even under Mrs Thatcher, did not have the courage to reverse.

Something must be done.

There are two solutions I can think of.

One is a massive improvement in free public education for everyone, and in selective scholarships for the most able kids. This is not divisive. It is society giving every kid a fair chance and also giving society the ability to make use of the brains of all its people. This is common sense, but it is not happening. In the current UK General Election, the fuss is all about the National Health Service, which paradoxically has never been in better shape. Politicians of all parties are lining up to throw money at the NHS and bribe the electorate with their own money. There is almost no focus on education, despite some promising reforms introduced by the Coalition Government, which need to be rolled out on a hugely greater scale. If we get a Labour government, social mobility will fall further, as the reforms made will be phased out or reversed.

The other solution is a huge expansion in entrepreneurship for less privileged young people. I will return to this in a future blog. We need more entrepreneurs, and we especially need more from those towards the bottom of the heap today. Otherwise, the pressures on social cohesion and the resurgence of class envy may take us backward a generation or two, despite the magnificent and apparently unstoppable whirring of the modern wealth machine.