60% of the world's wealth can't be explained.

I recently attended the Freebairn Public Lecture in Melbourne. The topic was “what has really driven the growth of wealth and material wellbeing since the Industrial Revolution?” And the answer wasn’t simple.

Wealth is not just a matter of plant, equipment and infrastructure used to produce goods and services. These are just a matter of, well, matter. They are fixed in the universe. So the continual expansion of these forms of capital will only ever deliver diminishing returns. Specifically, only 15-20% of global wealth can be accounted for by these forms of capital – 40% once we include varying levels of human skill. Which leaves 60% of our world’s wealth unexplained. Where does it come from?

Well, as Francis Bacon said:

“People do not create material things, only ideas.”

“Knowledge is the only truly original factor of production” and therefore is the only factor that can drive a continual growth in output per worker. And the speaker at this event, Professor Beth Webster, provided three examples of exactly how knowledge drives wealth.

First, investor confidence – the notion that no brilliant idea can really take off unless someone is willing to finance it. Once upon a time, if a business needed finance, they generally had to be in the same industry with which their own banks were familiar. Banks didn’t generally become familiar with other country’s industrial specialties, so they generally didn’t invest in them at home. Today though, thanks to instantaneous communications and global finance, an Australian chemical manufacturer can obtain finance from a German bank, a German robotics manufacturer can obtain finance from a Japanese bank, and a Japanese miner can obtain finance from an Australian bank. Domestic specialties are no longer a limitation on good ideas.

Second, knowing about knowing – essentially a cultural openness to learning new ideas and guarding against your core competencies becoming your core rigidities. Examples here include Nokia failing to keep up with the smartphone, and Kodak inventing the digital camera but not capitalising on it because it would cannibalise their traditional camera division. These companies couldn’t distinguish between transient fashions and discontinuities.

But the really interesting factor that drives growth in the world was the notion of complementary inputs – that certain ideas, as revolutionary as they may have been, were not able to progress because a key input didn’t exist yet.

For example, the wheel. As revolutionary as it was, wooden wheels fell apart quite easily. It wasn’t until the invention of metallurgy that the wheel really came into its own.

Another example, in the mid-19^th century, Charles Babbage originated the concept of a digital programmable computer! But it wasn’t able to really take off because the invention of ‘standardised electricity’ hadn’t occurred yet. The same applied to the invention of the vacuum cleaner, dishwasher and washing machine, which also required yet-to-be-invented standardised electricity and a reliable water supply.

And penicillin was invented in 1928 but wasn’t rolled out at an industrial scale until after WWII, thanks to the contributions of 30 different pharmaceutical companies in the US.

But the best example was Erasmus Darwin, Charles Darwin’s grandfather, who was actually remarkably close to discovering the theory of evolution for himself. Unfortunately, Frederick William Herschel hadn’t yet theorised that the universe was billions of years old, and Thomas Robert Malthus hadn’t yet theorised that the population of a species can temporarily outstrip its food supply. Thus, Erasmus didn’t have access to two of the most important factors behind evolution – life old enough, and a species able to survive hardship long enough, for evolution to take place.

As it was, his grandson was the one to discover it. Imagine the implications if it had been discovered two generations sooner! For one, I doubt we’d still be teaching Creationism in schools.