Supporting sustainable economic development
and direct trade in Guatemala

Creating wealth

Creating wealth.  This is a dry economics lesson.  It is intended for those serious about microfinance and developing communities, those with too much time, and those who can’t sleep.

Creating wealth

Our economies have become complex mechanisms for moving money around, and sometimes we confuse moving money with making money.  We hope to become wealthy without thinking about generating wealth.  As long as there is a little folding money in our pockets, we don’t think much about generating wealth, yet it’s worth thinking about.

Creating wealth is much different from getting rich.  I can inherit a million dollars, and I’d be rich, but I didn’t create any wealth.  I can convince my government that I’m a good candidate for a research fellowship, and I can get wealthy regardless of what I create.  I can steal from my neighbor and make myself wealthy without making wealth.  I can exploit natural resources and pull trees out of the jungle and generate income, though most of the wealth was actually generated by Mother Nature.

The economy breaks down into a few big categories.  There is the manufacturing sector, which takes steel and glass and copper and raw materials and turns them into cars and bicycles.  There is the service industry, which makes sure you get your pizza in 30 minutes or helps you buy a house.  There is the government sector, that can encompass just about anything from schools to guns to policemen to keep the guns out of school to gun purchase payments later used to pay Charleton Heston to tell you why those kids have the right to bear arms in school.  We have agriculture, growing corn and wheat, or feeding cows that grain to make meat.  There is technology, creating the ideas, processes, and inventions used by the other sectors.  There is mining and forestry, exploiting Mother Nature.  These names lead to confusion—what if you’re the guy coming up with new ways to process gold ore?  Are you in mining, technology, or manufacturing?  Let’s simplify it chronologically.

Step 1, Primary economies.

This is the production or extraction of raw materials.  Agriculture, forestry, mining, fishing—where Mother Nature did most of the work and folks are collecting her products.  Sure, there’s work, someone had to plant the corn, chop down the tree, pull the coal out of the ground or catch the fish in the net, but Momma Nature did the research and development, genetic engineering, chemical conversion of CO2 to pine trees and later those pine trees to coal, etc.

Step 2, Secondary economies

This is manufacturing and processing.  We turn that corn into corn flakes; those pine trees into 2X4’s, houses and furniture; that coal into electricity; and those fish into cans of tuna.  People are responsible for virtually all the value added. The products are very different from their raw materials.  Something with no value to the producer (you didn’t want a lump of coal or dried corn) is now valuable (you’ll pay for electricity and corn flakes.)

Step 3, Tertiary economies

This is retail, distribution, and service.  The grocery store that sells you the corn flakes, the trucking company that brings the corn flakes to the grocery store, and the company that designed the logo on the corn flakes box are all tertiary economies.  Note that they provided a useful service, like making the corn flakes easier to purchase, but they were always corn flakes.  The product didn’t really change, and didn’t have any value added, other than being brought closer to the consumer.

Step 4, Quaternary economies

This is research and development, creating ideas and inventions that can later be used by folks in other sections to make a new or better product.  Certainly an idea has value, like the idea for a light bulb or the story of Cinderella.  But, unless you are a rare individual or able to capitalize on an idea, you want to purchase the actual light bulb or buy the book and those were made in the manufacturing sector.

What does all this mean?

Wealth is principally generated in manufacturing.  In Primary economies, we utilize wealth from Mother Nature.  In Secondary economies, we manufacture wealth.  In Tertiary economies, we move wealth around.  In Quaternary economies, we prepare the manufacturing section to make more wealth.  Wealth is principally generated in manufacturing.

If you are going to create wealth (which should not be confused with making someone wealthy) you must manufacture.  The more value added steps in the manufacturing, the more wealth you create.

Let’s look at the common microfinance business models.  They sound good, setting up a businesswoman selling firewood, bringing soap to market, selling water filters, selling efficient light bulbs, etc.  They have a fatal flaw.

Firewood is certainly needed, but a firewood business doesn’t generate wealth.  Mother Nature did most of the work.  The added value was chopping and distribution.  That’s a fairly minor manufacturing step that adds little value.  While the wood chopper got paid for his labor, the community is no wealthier and doesn’t have anything they didn’t have they day before.  What’s more, if the business doesn’t integrate the agro-forestry section, the business fails completely when there are no more trees.

Retail sales are similarly flawed.  Someone can buy soap wholesale from the manufacturer at Village A and retail it in Village B.  Village A now has cash from the wholesale sale, and has generated wealth.  Village B, however, is unchanged.  The transactions were Tertiary, or retail distribution.  Wealth moved around and money left the consumer in exchange for soap, but there was no net change in the community.  The soap seller has a few more coins in her pocket, much of which will wind up back at Village A.  Little is different in Village B.

Retail sales of water filters have the same fatal flaw as soap, with two very important distinctions.  At first glance, it is again the village where the filters are manufactured who make the wealth, while the village that retails them simply moves wealth around.  However, the village that purchases the filters gains a certain degree of wealth in the form of not being sick from water-borne illnesses, and though difficult to quantify, is certainly an increase in wealth.  However, that is only made possible if the consumers perceive this value.  That is to say that the economic transaction will only happen if the consumers are at a level of education or sophistication that they understand the difference between clear water with germs and clear water without germs.  If this level of education is not there, the entire business model fails.

Enough about problems.  What actually works to generate wealth?

If a community is going to have a net increase in wealth, they must control the manufacturing of the product.  If they are going to increase their wealth significantly, they must control the steps that the customer perceives to be value added.  If they are going to maximize their wealth, they must control as many of the four economic levels as are relevant, and as many steps within each level as possible.

A carpenter by definition is a manufacturer.  He is already controlling the most important part of his business to create wealth, but it hasn’t been maximized for the community.  If he buys lumber from the local saw mill, that value added from another manufacturer stays in the community.  If the log is purchased by a local forester, then the Primary stage, the agro-forestry stage, has been vertically integrated and the community is wealthier still.

If the carpenter sells his furniture out his front door, he becomes the de facto retailer and distributor, again gaining the value of the Tertiary economy for himself and his community.

If the carpenter invents and builds his own lathe, he then controls the Quaternary economy.

If he then purchases Jacaranda wood from a local forester, to turn on his newly invented lathe, to make containers to be distributed out his front door, he now controls all economic sectors and 100% of the wealth was generated and retained by his community.

I just described one of our business models, Roberto Barrera’s frasco business.

This same approach to business is why our coffee model really works.

A coffee farmer controls the agricultural side, working alongside Mother Nature to create a raw material in the form of coffee fruit.

He controls the manufacturing and processing side, moving from fruit, to sorted fruit, to fruit graded by density, to pulped beans, fermented beans, sorted fermented beans, washed beans, dried pergamino, green coffee, graded green coffee, sorted green coffee, roasted beans, ground coffee, and packaged ground coffee.  He added thirteen value-added steps.  That’s a lot of stages that bring wealth to the community.

He was also aware of customer perception.  Though the roasting stage is one of the simplest and easiest steps of the coffee preparation, it is where the consumer perceives the value to be added.  Perception is reality, so he must control the stage the consumer is willing to pay for.

As a retailer, he controls the Tertiary economy.  Though he must generally subcontract those services, he maintains control of them, and therefore the control of most of the wealth generated.

As an inventor of processing equipment and agricultural techniques, he enters the Quaternary economy, becomes completely vertically integrated, generates wealth, and controls the distribution of that generated wealth.  That wealth stays within the community for the benefit of the community.

Any approach to finance and business that doesn’t incorporate this understanding will simply move money around.  While it is possible to make an individual wealthy without this understanding, a community will not generate wealth and the individual can only be wealthy at the expense of the community.