I’m going to start laying out longer sequences, and so I begin with a comparison between value creation and value extraction. This will form the foundation for future work and discussion on the nature and morality of wealth and the wealthy.
What It Means To Create Value
In my mind, creating value involves adding something to the world that it did not have before. What you add could be almost anything—an idea, a work of art, a methodology, an accomplishment, a story, a discovery, etc. The concept to grasp is that you added it to the world. You produced it.
This can be a subtle concept, with plenty of edge cases, so let’s use a metaphor to illustrate the point.
The Metaphor: Building a Bridge
Imagine there are two towns that wish to trade with each other, but trade is difficult because the two towns are separated by a mighty river. The current is fast and the waters treacherous, so while navigating the river by boat is doable, it involves time and effort and risk. Boats are not free, and they are dangerous to sail after dark when the rapids cannot be seen.
An engineer comes along—maybe she’s a builder or an architect or a polymath if the word “engineer” isn’t widespread in these towns, but we’ll call her an engineer. The engineer sees an opportunity in these two towns and this river, because this engineer happens to know how to build bridges.
So the engineer gathers whatever is required—manpower, capital, raw material, and so on—and constructs a bridge across the river between the two towns. The final stone is placed, the bridge is inaugurated, and people and goods can now flow between the two towns much more easily, without risking the treacherous and fast-flowing waters.
A nice-looking bridge, perfect for economics metaphors.
The bridge does not require a schedule, as boat arrivals and departures do—it is open every hour of the day and night.
It does not require a skilled captain to cross, because there are no rapids or currents on the smooth stone walkway.
It does not require the wind to blow favorably to fill sails, nor does it require the sweat of rowers or the steam of engines to push against the current.
Trade flourishes between these cities, as does diplomacy and culture and all of the things that happen when people are free to intermingle.
Value Produced
So we say—so I claim—that the engineer has created value[1], and the value that she has created is found in all the trade and intermingling that happens and can happen because of the bridge she built, over and above what had previously been possible with only boats to cross the river.
In a simple equation:
Value Created = (Trade After Bridge—Trade Before Bridge) + Network Effects
Where “Network Effects” are all the incalculable and difficult-to-calculate pieces of value generated from people being better able to travel and communicate and, well, network with each other.
Who Benefits?
While the engineer may benefit from being compensated for creating the bridge, the people who benefit from its creation are those whose trade benefits from its existence. Anyone who buys or sells goods or services across the river will find that their cost of doing business has decreased—it’s less expensive to ship goods and move people from one town to the other via bridge than it is via ship.
Put (very) simply, if
Net Income = Profits—Expenses
where Expenses includes “shipping expenses,” then as shipping becomes cheaper, expenses fall, raising the net income of the businesses involved in the trade.
Of course, in a healthy market, these businesses are still competing with each other; they have to pass a large percentage of this cost savings on to their customers in order to keep their prices competitive.
So while businesses benefit from falling costs, the consumers of the goods and services benefit from the decrease in prices.
Since producers (businesses) and consumers (customers) make up most of the two towns, the overall benefit of the bridge to the people in both is large.
What It Means To Extract Value
In my mind, extracting value involves monopolizing something you did not create in order to be the only entity that benefits from it. Much like producing value, there is subtlety at work here.
While the technical definition of a monopoly (no, not the board game) is to be the only seller of a given commodity (read: thing), I prefer to think of a monopoly as the ability to deny everyone else access to something. A monopoly on the board game Monopoly means that you can deny anyone access to said board game (by refusing to sell it to them).[2] By monopolizing something, especially something you did not create, you are denying the value it generates to anyone but yourself.
The Metaphor: Trolling a Bridge
In modern parlance, “trolling” refers to being an asshole on the internet.
But trolls have a long history of being nuisances that began well before the internet allowed them to act anonymously. The kind of troll our metaphor will focus on is the Bridge Troll—a troll that lives under bridges (like the kind our engineer made, above) and blocks passage across to all those unwilling (or unable) to meet their demands.
Some bridge trolls demand a feat be performed or a riddle answered, but we’ll be focusing on a more enterprising kind of bridge troll: the kind that demands payment for crossing the bridge.
Let’s say that a few years after the engineer has constructed her bridge, a troll by the name of Rob takes up residence underneath it. Rob is a large troll, with a big club, and Rob has decided that he’s going to make his fortune by extorting anyone who wishes to cross the bridge.
The Cave Troll from the Lord of the Rings, also known as Rob’s cousin.
Whenever anyone wants to cross the bridge, they find a large and threatening Rob in their path, big club held in a big fist, and Rob gives these people three options:
Pay Rob for safe passage
Go back the way they came
Get squished
While paying Rob is unpleasant, it’s less unpleasant than getting squished. Moreover, the price Rob sets is such that crossing the bridge is still cheaper than hiring a boat, if only by a small amount. And the bridge is still the safest way to cross, not to mention that it’s still open night and day for traffic.
Our two towns have little in the way of a militia, so in the absence of a wandering hero to slay poor Rob, they have to adjust to the new economic reality: their bridge now costs more to use.
Value Extracted
Here, the bridge troll is extracting value from the bridge.
I’d like to emphasize this: Rob did not create the bridge; he didn’t participate in its design or construction, nor did he finance the endeavor in any way. Rob stumbled across a resource that was providing value to people and, through the threat of violence (getting squished), monopolized that resource.
Rob, while in no way responsible for the existence of the bridge, is excluding anyone from using it, unless they pay his toll.
Furthermore, Rob is not spending his ill-gotten gains on the upkeep of the bridge, nor is he using the income to improve the existing bridge or build another. Rob has added nothing to the bridge, has produced zero additional value.
Who Benefits?
Rob. Obviously.
Does anyone else benefit? Perhaps there are boat captains who find themselves employed somewhat more often on the margin when people are willing to pay not to be threatened by a troll. There might be some kind of benefit to those who only rely on goods and services from their own town (as opposed to those who have suppliers and customers in both towns), as trade between the two towns has become more expensive.
But in general, Rob is the only real beneficiary. Rob is the one that extracted the value, and so it is to Rob that the value goes. Importantly, any other benefits anyone sees are likely at someone else’s expense: trade within towns might be bolstered, but only because trade between the towns has become less viable.
This stands in stark contrast to the creation of the bridge, where the value produced benefited a vast majority of the population of both towns (sorry, boat captains).
Capturing Value vs. Extracting Value
There is a clear distinction to be made between capturing value and extracting value.
Both involve taking a portion of the value created by something for oneself; the difference between the two as I use the terms is that one can only capture value that one has already created; when one seeks to monopolize value they didn’t create, they’re extracting it.
While I intend to dive deeper into this in a future post, a brief summary here should serve to further specify the connotations I associate with value extraction.
Value Captured
Those that create value are morally entitled to a portion of it.
I believe the above, both as a matter of economic sense and of general morality:
Economic Sense: an economy (and a society) benefit when people create value, therefore people should be incentivized to create value, and having people collect a portion of the value they create is a good incentive
General Morality: people are entitled to the fruits of their own labor—if you did the work, you should get the reward
When the people who create value take the piece of it to which they are entitled, I call it capturing the value. The value-creator has captured a portion of the value they created, and the rest becomes, in economic jargon, producer or consumer surplus.
In our metaphor, the engineer has created value by building this bridge, and so she is entitled to a portion of the value created. This can take many forms: a small fee merchants pay the engineer to use the bridge, or a lump sum reward for building the bridge, or perhaps further contracts to build new infrastructure for the two towns and the associated income they provide.
While capturing value can absolutely be taken too far, when done reasonably it is a natural and just way of recompensing the efforts of those who have worked to produce said value.
Extracting Value is Morally Bad
Extracting value, as opposed to capturing it, can only be done by those who did not create the value in the first place. Rob, in our metaphor, is a purely negative influence upon the towns, enriching himself without having contributed or produced anything. What Rob does is bad, and he should feel bad.
In economics jargon, what Rob is doing is called rent seeking,[3] and I know of no instance where doing so is morally or economically justifiable. Granted, it happens all the time in real life, but we’ll get to that in a later post.
It’s difficult to visualize “value”, even when defined in monetary terms. When something creates “value”, what should we be picturing? A stream of dollar bills flying by? A font of liquid gold springing from the earth to enrich the people around it?
We can’t directly see the value generated by the bridge our engineer created when looking at the bridge; we can only discern it through careful analysis of trade statistics and other economic variables.
But our engineer and the bridge she built are already in the land of metaphor, and in the land of metaphor the one-eyed metaphor is king. Or something like that.
So if you want to picture the value as a garden hose dispensing sapphires or a fountain of twenty dollar bills, be my guest. The key is that it is continuously produced over time, and that it accrues to the towns in general unless someone collects a portion of it deliberately.
Note that having a monopoly does not mean that you do or will deny your asset to paying customers, only that you have the ability to do so, should you choose.
A somewhat confusing term, because someone seeking rent money from a lodger is not necessarily engaged in rent seeking, and rent seeking does not always involve rent.
Value Created vs. Value Extracted
Link post
I’m going to start laying out longer sequences, and so I begin with a comparison between value creation and value extraction. This will form the foundation for future work and discussion on the nature and morality of wealth and the wealthy.
What It Means To Create Value
In my mind, creating value involves adding something to the world that it did not have before. What you add could be almost anything—an idea, a work of art, a methodology, an accomplishment, a story, a discovery, etc. The concept to grasp is that you added it to the world. You produced it.
This can be a subtle concept, with plenty of edge cases, so let’s use a metaphor to illustrate the point.
The Metaphor: Building a Bridge
Imagine there are two towns that wish to trade with each other, but trade is difficult because the two towns are separated by a mighty river. The current is fast and the waters treacherous, so while navigating the river by boat is doable, it involves time and effort and risk. Boats are not free, and they are dangerous to sail after dark when the rapids cannot be seen.
An engineer comes along—maybe she’s a builder or an architect or a polymath if the word “engineer” isn’t widespread in these towns, but we’ll call her an engineer. The engineer sees an opportunity in these two towns and this river, because this engineer happens to know how to build bridges.
So the engineer gathers whatever is required—manpower, capital, raw material, and so on—and constructs a bridge across the river between the two towns. The final stone is placed, the bridge is inaugurated, and people and goods can now flow between the two towns much more easily, without risking the treacherous and fast-flowing waters.
The bridge does not require a schedule, as boat arrivals and departures do—it is open every hour of the day and night.
It does not require a skilled captain to cross, because there are no rapids or currents on the smooth stone walkway.
It does not require the wind to blow favorably to fill sails, nor does it require the sweat of rowers or the steam of engines to push against the current.
Trade flourishes between these cities, as does diplomacy and culture and all of the things that happen when people are free to intermingle.
Value Produced
So we say—so I claim—that the engineer has created value[1], and the value that she has created is found in all the trade and intermingling that happens and can happen because of the bridge she built, over and above what had previously been possible with only boats to cross the river.
In a simple equation:
Value Created = (Trade After Bridge—Trade Before Bridge) + Network Effects
Where “Network Effects” are all the incalculable and difficult-to-calculate pieces of value generated from people being better able to travel and communicate and, well, network with each other.
Who Benefits?
While the engineer may benefit from being compensated for creating the bridge, the people who benefit from its creation are those whose trade benefits from its existence. Anyone who buys or sells goods or services across the river will find that their cost of doing business has decreased—it’s less expensive to ship goods and move people from one town to the other via bridge than it is via ship.
Put (very) simply, if
Net Income = Profits—Expenses
where Expenses includes “shipping expenses,” then as shipping becomes cheaper, expenses fall, raising the net income of the businesses involved in the trade.
Of course, in a healthy market, these businesses are still competing with each other; they have to pass a large percentage of this cost savings on to their customers in order to keep their prices competitive.
So while businesses benefit from falling costs, the consumers of the goods and services benefit from the decrease in prices.
Since producers (businesses) and consumers (customers) make up most of the two towns, the overall benefit of the bridge to the people in both is large.
What It Means To Extract Value
In my mind, extracting value involves monopolizing something you did not create in order to be the only entity that benefits from it. Much like producing value, there is subtlety at work here.
While the technical definition of a monopoly (no, not the board game) is to be the only seller of a given commodity (read: thing), I prefer to think of a monopoly as the ability to deny everyone else access to something. A monopoly on the board game Monopoly means that you can deny anyone access to said board game (by refusing to sell it to them).[2] By monopolizing something, especially something you did not create, you are denying the value it generates to anyone but yourself.
The Metaphor: Trolling a Bridge
In modern parlance, “trolling” refers to being an asshole on the internet.
But trolls have a long history of being nuisances that began well before the internet allowed them to act anonymously. The kind of troll our metaphor will focus on is the Bridge Troll—a troll that lives under bridges (like the kind our engineer made, above) and blocks passage across to all those unwilling (or unable) to meet their demands.
Some bridge trolls demand a feat be performed or a riddle answered, but we’ll be focusing on a more enterprising kind of bridge troll: the kind that demands payment for crossing the bridge.
Let’s say that a few years after the engineer has constructed her bridge, a troll by the name of Rob takes up residence underneath it. Rob is a large troll, with a big club, and Rob has decided that he’s going to make his fortune by extorting anyone who wishes to cross the bridge.
Whenever anyone wants to cross the bridge, they find a large and threatening Rob in their path, big club held in a big fist, and Rob gives these people three options:
Pay Rob for safe passage
Go back the way they came
Get squished
While paying Rob is unpleasant, it’s less unpleasant than getting squished. Moreover, the price Rob sets is such that crossing the bridge is still cheaper than hiring a boat, if only by a small amount. And the bridge is still the safest way to cross, not to mention that it’s still open night and day for traffic.
Our two towns have little in the way of a militia, so in the absence of a wandering hero to slay poor Rob, they have to adjust to the new economic reality: their bridge now costs more to use.
Value Extracted
Here, the bridge troll is extracting value from the bridge.
I’d like to emphasize this: Rob did not create the bridge; he didn’t participate in its design or construction, nor did he finance the endeavor in any way. Rob stumbled across a resource that was providing value to people and, through the threat of violence (getting squished), monopolized that resource.
Rob, while in no way responsible for the existence of the bridge, is excluding anyone from using it, unless they pay his toll.
Furthermore, Rob is not spending his ill-gotten gains on the upkeep of the bridge, nor is he using the income to improve the existing bridge or build another. Rob has added nothing to the bridge, has produced zero additional value.
Who Benefits?
Rob. Obviously.
Does anyone else benefit? Perhaps there are boat captains who find themselves employed somewhat more often on the margin when people are willing to pay not to be threatened by a troll. There might be some kind of benefit to those who only rely on goods and services from their own town (as opposed to those who have suppliers and customers in both towns), as trade between the two towns has become more expensive.
But in general, Rob is the only real beneficiary. Rob is the one that extracted the value, and so it is to Rob that the value goes. Importantly, any other benefits anyone sees are likely at someone else’s expense: trade within towns might be bolstered, but only because trade between the towns has become less viable.
This stands in stark contrast to the creation of the bridge, where the value produced benefited a vast majority of the population of both towns (sorry, boat captains).
Capturing Value vs. Extracting Value
There is a clear distinction to be made between capturing value and extracting value.
Both involve taking a portion of the value created by something for oneself; the difference between the two as I use the terms is that one can only capture value that one has already created; when one seeks to monopolize value they didn’t create, they’re extracting it.
While I intend to dive deeper into this in a future post, a brief summary here should serve to further specify the connotations I associate with value extraction.
Value Captured
Those that create value are morally entitled to a portion of it.
I believe the above, both as a matter of economic sense and of general morality:
Economic Sense: an economy (and a society) benefit when people create value, therefore people should be incentivized to create value, and having people collect a portion of the value they create is a good incentive
General Morality: people are entitled to the fruits of their own labor—if you did the work, you should get the reward
When the people who create value take the piece of it to which they are entitled, I call it capturing the value. The value-creator has captured a portion of the value they created, and the rest becomes, in economic jargon, producer or consumer surplus.
In our metaphor, the engineer has created value by building this bridge, and so she is entitled to a portion of the value created. This can take many forms: a small fee merchants pay the engineer to use the bridge, or a lump sum reward for building the bridge, or perhaps further contracts to build new infrastructure for the two towns and the associated income they provide.
While capturing value can absolutely be taken too far, when done reasonably it is a natural and just way of recompensing the efforts of those who have worked to produce said value.
Extracting Value is Morally Bad
Extracting value, as opposed to capturing it, can only be done by those who did not create the value in the first place. Rob, in our metaphor, is a purely negative influence upon the towns, enriching himself without having contributed or produced anything. What Rob does is bad, and he should feel bad.
In economics jargon, what Rob is doing is called rent seeking,[3] and I know of no instance where doing so is morally or economically justifiable. Granted, it happens all the time in real life, but we’ll get to that in a later post.
It’s difficult to visualize “value”, even when defined in monetary terms. When something creates “value”, what should we be picturing? A stream of dollar bills flying by? A font of liquid gold springing from the earth to enrich the people around it?
We can’t directly see the value generated by the bridge our engineer created when looking at the bridge; we can only discern it through careful analysis of trade statistics and other economic variables.
But our engineer and the bridge she built are already in the land of metaphor, and in the land of metaphor the one-eyed metaphor is king. Or something like that.
So if you want to picture the value as a garden hose dispensing sapphires or a fountain of twenty dollar bills, be my guest. The key is that it is continuously produced over time, and that it accrues to the towns in general unless someone collects a portion of it deliberately.
Note that having a monopoly does not mean that you do or will deny your asset to paying customers, only that you have the ability to do so, should you choose.
A somewhat confusing term, because someone seeking rent money from a lodger is not necessarily engaged in rent seeking, and rent seeking does not always involve rent.