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14 Jul

The First Principles of Wealth — Part 1: Information and Knowledge

Imagine a Ferrari speeding along a highway — sleek, powerful, a marvel of engineering.Now picture a cave dweller's first wheel — crude, basic, but transformative for its time.

Both are feats of human ingenuity, the result of countless hours of trial, error, and incremental improvement. Each, in its own way, embodies an immense amount of information — the sum total of human knowledge up to a certain point in history.

This brings us to a fundamental insight:

Products are physical instantiations of knowledge.

But before we delve deeper into how products are physical instantiations of knowledge, let me take a step back and clarify what I mean by 'information' and 'knowledge', as these two terms, though often used interchangeably, have nuanced differences that are important to our understanding.

In the simplest terms, information is data with a potential for relevance and purpose. It's raw material: a collection of facts, figures, or details that by itself doesn't tell us much.

For instance, the number 2 is a piece of information. By itself, it's not particularly meaningful. However, when we combine it with other information, like “2 apples”, it starts to make more sense. But it still is just factual information devoid of context or use. It doesn't help us really understand anything much or make use of that understanding.

Knowledge, on the other hand, is information that has been processed, organized, or structured in some way. It's information we've understood and learned from. If information is the raw data, knowledge is the understanding and insight we derive from this data.

If I know that “2 apples can supply an average human's daily requirement of insoluble fiber because Apples have skins which are a rich source of insoluble fiber,” I now have knowledge; I now have a piece of understanding, an explanation that I can use to help people.

But the knowledge we are most interested in is the kind that can be embodied in physical objects — or 'crystallized' into products. This is the knowledge that we've gleaned from centuries of human discovery and innovation, knowledge about the laws of physics, about how materials can be combined and manipulated, about what people need and want.

It's this kind of knowledge that allows us to transform raw materials into something valuable — be it a wheel, a smartphone, or a space station.

This transformative process is perhaps best exemplified in the tech industry. Consider a company like Apple. It starts with information — design principles, customer preferences, technical specifications.Through a process of research, experimentation, and refinement, this information is transformed into knowledge: an understanding of how to create products that people will find useful and desirable.

This knowledge is then crystallized into a physical product — the latest iPhone.

The key takeaway is this:

When we create a product, we're not just assembling physical materials. We're also embedding knowledge into these materials. This is why products have value and why they're more than the sum of their physical parts.

It's also why wealth — real wealth — is about more than just money. It's about knowledge and our ability to share and expand upon it.

Let me dive into this a bit deeper.

You see, every aspect of a product's design and function reflects a specific piece of information, a solution to a problem, or a response to a need.

A wheel allows heavy objects to be moved more easily. A Ferrari not only serves the same purpose but does so with greater efficiency and style. It also provides comfort, speed, and status — addressing a broader and more complex set of human desires.

At the heart of this transformation from the rudimentary wheel to the high-tech Ferrari is the accumulation of knowledge and complexity.

As our understanding of the world has expanded, so has our ability to create more sophisticated products. This accumulation of knowledge, and its application in the creation of goods and services, is what we refer to as 'wealth'.

Wealth, in this sense, is not just about money or material possessions. It's about the capacity to solve problems, to fulfill desires, to improve our quality of life.

And the key to this capacity, fundamentally, is knowledge — the understanding of how things work and how to make them work better.

The idea of wealth as embodied knowledge can be traced back to various thinkers, but two of them stand out in providing frameworks that fundamentally align with this view: Cesar Hidalgo and Paul Romer.

In his seminal work Why Information Grows, Cesar Hidalgo approaches the economy from a physicist's perspective. He postulates that information is not merely something stored in books or hard drives but is tangibly encoded in everything around us — in the physical objects we use every day, from simple hand tools to the complex systems that power our cities.

According to Hidalgo, economies become more prosperous not simply because of factors such as capital accumulation or technological innovation (though these are undoubtedly important), but primarily because of their capacity to accumulate what he calls “crystallized imagination”, or the tangible products of human ingenuity that embed practical knowledge.

Every product we see is a physical manifestation of accumulated knowledge and ingenuity. They're the result of generations of iterative knowledge, both explicit (like objective scientific principles) and tacit know-how (like knowing how to balance while riding a bike or how to chop wood or use a lathe machine).

This growing complexity of goods and services, embodying more and more information, drives economic development by creating new avenues for human needs and wants to be met.

Paul Romer, a Nobel laureate in Economics, offers another influential perspective that aligns with this idea.

In his theory of 'endogenous growth', Romer contends that the key to sustained economic growth is the continual generation and application of knowledge. His approach contrasts with traditional economic theories that see growth as a result of the accumulation of physical capital and labor.Romer's focus is on 'non-rival goods' — goods that can be used by multiple people simultaneously without losing their value.

Knowledge is the quintessential non-rival good.

When knowledge is used to create a better product or improve a production process, it doesn't get used up. Instead, it spreads and multiplies, leading to economies of scale and cascading benefits that drive economic growth.

So, for Romer, the generation of new ideas, protected by patents and copyrights (also forms of information encoding), is what fuels economic growth. Companies that innovate create new technologies, which in turn lead to better products, improved productivity, and ultimately, increased wealth.

When humans began creating tools, we started embodying our information and knowledge into physical forms. Every artifact that we create is a physical manifestation of the knowledge and information we have accumulated. It is an external, durable form of wealth that can be shared, distributed, improved upon, and even traded.

This ability has significantly increased the scope and pace of our wealth creation.

For example, when an individual crafts an object, say a chair, they are not just creating a physical object but are also embodying their knowledge and skills into that chair. When others use the chair, they benefit from the embodied knowledge without needing to acquire all the knowledge and skills needed to build a chair themselves.

Or consider the development of a software tool like Microsoft Excel. Once the developers created it, they could distribute it to millions of users worldwide at a relatively low cost. Excel does not diminish in value the more it's used. On the contrary, its value increases as more people use it, learn from it, and potentially improve upon it.

The act of creating physical instantiations of our ideas leads to a positive feedback loop of knowledge creation. As we interact with our creations, we gain new insights, learn from our mistakes, and come up with new ideas, all of which contribute to the further expansion of our knowledge.

Moreover, our ability to encode information outside our bodies allows for the cumulative progress of knowledge and wealth over generations. Every generation doesn't have to start from scratch; instead, they can build upon the knowledge and wealth accumulated by previous generations. This principle of cumulative growth is one of the fundamental drivers of the incredible progress and wealth creation we have witnessed in human history.

The essence of Romer's argument is this:

When knowledge is embodied in a product or service, it creates value not just once, but many times over. It can be used by multiple people, in multiple places, at the same time, without ever being depleted. This continual multiplication of value is a key driver of economic growth and wealth creation.

When we talk about creating wealth, we're really talking about creating new knowledge and know-how.

In both Hidalgo's and Romer's perspectives, wealth is the product of the complex interplay of knowledge creation, its embodiment in goods and services, and its propagation through markets and societies. They both place information — and the capacity to generate and harness it — at the heart of wealth creation.

Wealth creation is knowledge creation; it's about understanding the world more deeply, solving problems more effectively, and applying this knowledge to create goods and services that improve our lives.

This is a fundamental principle that underpins our economy, our society, and our progress as a species. Wrapping your head around this is crucial, because it helps you think about your own place in the economy.

It poses an important question:

What new knowledge or know-how are you creating and/or leveraging as a part of your work?

It is that knowledge that essentially dictates your value in the market.




This is going to be a 10-part series, if everything works out well. In the next part of this series, I'll help you understand another fundamental principle — energy — and explore how it fuels the processes of wealth creation and can be a big part of creating wealth itself.

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