Involuntary Transactions Destroy Wealth

I hope we have established that voluntary transactions in a fair market increase the wealth of all traders. My question: What do involuntary transactions do to wealth?

First, let us define "involuntary transaction." Stealing, of course.  Taxes, too.  Maybe even regulations and laws that make your property less productive and useful.  But in general I mean any transaction that one participant does not wish to enter into, but is required to by some external force.  What happens to the total quantum of wealth in such transactions?


Well, you might say, nothing.  If a thief takes a $1,000 diamond ring from me, I have lost wealth of $1,000, but the thief has gained $1,000, so the total net change in wealth (my $1,000 loss plus his $1,000 gain) is $0, right? Wrong. Why? First, I earned the $1,000 to buy that ring, and it means more to me, wealth-wise, than its $1,000 price tag. This is not only because I value something I worked to get, but also because I valued it more than I paid for it, or else I wouldn't have bought it. On the other hand, a $1,000 ring isn't worth nearly that much to a thief who didn't work to get it. Its value to him is whatever he can get for it, and fences and pawn shops are notoriously cheap. He'll take $250, $100, maybe less. So here's the equation: I'm down by over $1,000 (let's say $1,100); the thief is up by $250; so the net loss of wealth due to that transaction is -$850.  The ring is still floating around somewhere, still worth $1,000, but the total quantum of wealth in our economy just sank by a good chunk.  Involuntary transfers destroy wealth.

What if we change the facts a little, and say that the thief can't just take the ring, because I have it well guarded, but he threatens to make my life miserable unless I sell it to him for $900, and feeling forced to sell I do. Because the thief didn't steal the ring, he can sell it legitimately, for its market value, and pockets the $100 difference.  But I had to sell it for less than market value, and much less than I valued it, so the transaction still results in a net loss of wealth.  (I'm down by $200; he's up by $100; net loss $100).  Moreover, I would say the $100 in the thief's hands is worth less to him than $100 (of the $200) I lost.  The thief didn't earn $100, and it is not worth as much in his hands as it is to someone who did earn it.  So the net loss of the transaction is even greater than the $100 in value that just vanishes.

Let us change the facts a bit further.  Now, instead of a thief, we have a government that is convinced that the only reason some people have more wealth and others have less is due to an unjust "distribution," and so it requires that I pay $1,000 to the government so that it may "redistribute" that wealth to someone else. Being forced to, I write a check to the government, and the government writes a check to a deserving recipient.  (Let us further assume, contrary to all reason and experience, that the government is able to accomplish this transfer, with its bureaucrats, managers, auditors, inspectors, regulations, buildings and machinery, at $0 transaction cost and with no waste.)  Just as in the above examples, the total quantum of wealth is less after the transaction than before.  I'm down by more than the value of $1,000 I had to part with, which I valued because I earned it.  Conversely, the recipient does not value $1,000 deposited into his hands by government largesse as much as I who earned it. Where I would be careful in how I spent that money, investing it, paying for my kid's education, or even just adding wealth to the general economy through prudent purchasing, the recipient is much more likely to treat it as found money and put it to unproductive uses. Even if we assume that the recipient does not completely squander the redistributed wealth in a fling of high-spending (champagne, fancy dinners, a trip to Atlantic City), whatever he spends it on will be worth less to him than what he pays -- it's not his money he's spending, after all.  Because he pays more for things than they are worth to him, every purchase he makes with that money results in wealth destruction. Even though he gets $1,000 in a check, what he buys is worth less than that to him, so he doesn't end up with more than (or at least) $1,000 in wealth; rather he ends up with less. Thus, I lose more than $1,000 in wealth; the recipient gets less than $1,000 in wealth; and society loses total wealth as a consequence.  Add in the cost of the huge bureaucracy needed to effectuate the transfer, and the waste that goes along with it, and the net loss is that much bigger.

The observation that involuntary transactions destroy wealth necessarily leads to a few conclusions.  Next post.