Sunday, January 25, 2015

Zero Sum Games

The zero sum game fallacy is one of the more annoying erroneous beliefs that discourage people from reaching financial freedom. They believe that there is a fixed amount of resources (including money) in the world. Therefore in any exchange of value, one person’s gain is exactly equal to another person’s loss with no net change in total wealth. Following this logic to its conclusion, these people mistakenly surmise that all the wealth in the world will end up in fewer and fewer hands. Since other players with more money and resources have a head start, they conclude that they have no possibility of reaching financial freedom, so why try.

Monopoly, the board game we played as children is a zero sum game. Money and property change hands with each move until all the players except one exit the game in bankruptcy. The winner is left with all the properties and all the money.

The economy is not a zero sum game. In medieval Europe the basis of wealth was control of land by warlords. If the leader could obtain enough plunder to feed his troops, he could enslave the peasants living within a certain geographic area, ensuring the stability of his reign and (if he was very lucky) his ensuing dynasty. Even this unfortunate state of affairs was not a static zero sum game. Although the residents of cities were taxed by the local nobility and their mercenary troops, they were creating new wealth beyond that contained on the then existing monopoly board based on land.

Merchants were moving goods that came from as far away as China. Goldsmiths and other artisans were plying their trades, turning raw materials into far more valuable commodities. Eventually, this newly created wealth that was not based on the control of land, exceeded the value of the assets found on the old game board. The new game, called the Renaissance, was played on the land board, the banking board, the manufacturing board, and the world trade board.

Then the industrial revolution added steam engines, railroads, coal mining, steamships, mechanized looms, and whole host of new game boards. Winners and losers came and went over the centuries as the value of the entire game continued to grow. Austrian economics calls this process, creative destruction. The end of buggy whips and carriage makers, heralds the rise of an automotive industry based on the assembly line. Radios in cars gradually replace newspapers read in trains. Television leads to the decline of both radio and print media. Then cable TV minimizes the power of the three major networks and PBS.

Just in the last 40 years, men like Bill Gates of Microsoft and Steve Jobs of Apple have created new Monopoly boards that didn’t exist when I first graduated from college. Billions of dollars in entirely new businesses have been created out of nothing.

Today the Internet is changing everything; Amazon is replacing brick and mortar stores; the cost of premium digital content (movies, television programming, and music) is asymptotically approaching zero as predicted by Kevin Kelly in his seminal book, New Rules for The New Economy.

As you produce goods and services that are deemed as valuable by your neighbors, you too are creating new wealth. It doesn’t require a genius IQ or a huge amount of money to start. If you take Aunt Martha’ china hutch out of storage, repair forty years worth of dings and bangs and refinish it, you can create wealth by selling the product of your imagination and labor on eBay. A piece of junk costing you money to store is now a prized possession in a home you will never visit.

All it takes is your ingenuity and hard work.

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