Few political phrases have been more effective—or more misleading—than "trickle-down economics."
Opponents of capitalism use the phrase to create a powerful image. Picture a wealthy capitalist standing at the top of an economic pyramid with an enormous cup. Government cuts his taxes, protects his wealth, and allows him to accumulate more and more. Eventually his cup becomes so full that a few drops spill over the edge and "trickle down" to the workers struggling below.
What a terrible economic system that would be.
Fortunately, that isn't capitalism.
In fact, the metaphor gets capitalism almost exactly backward.
In a functioning capitalist economy, the entrepreneur generally doesn't get paid first and allow everybody else to fight over the leftovers.
The entrepreneur gets paid last.
And even when an entrepreneur becomes spectacularly wealthy, the aggregate value delivered to everybody else can dwarf the personal benefit enjoyed by the person who created the business.
Capitalism isn't a trickle.
It's an avalanche.
The Capitalist Gets Paid Last
Consider what must happen before a business owner earns a single dollar of profit.
First, somebody has to provide the capital.
An entrepreneur may invest his own savings, borrow money, or convince outside investors that his idea has enough merit to justify risking their money. Investors don't simply hand over capital because someone calls himself an entrepreneur. They have to be persuaded that the opportunity justifies the risk.
Then the entrepreneur needs workers.
Those employees expect to be paid.
Importantly, they get paid whether the business ultimately succeeds or fails.
An employee doesn't normally return six months of wages because the company lost money. The business owner bears that risk.
Then there are suppliers.
A restaurant needs food, equipment, furniture, electricity and countless other goods and services. A manufacturer needs raw materials, machinery and transportation. A technology company needs computers, software, office space, servers and professional services.
Those suppliers expect payment too.
Then there is government.
The business must comply with applicable regulations, obtain required licenses and permits, maintain records, collect and pay taxes, and satisfy whatever other legal obligations apply to its industry.
And then comes the most important participant of all:
The customer.
After satisfying investors, employees, suppliers, lenders, landlords, regulators and numerous other participants, the entrepreneur still hasn't earned a profit unless he can persuade somebody voluntarily to buy what he produced.
The customer has the final say.
The entrepreneur may believe his product is brilliant.
It doesn't matter.
The customer may disagree.
And if enough customers disagree, the entrepreneur loses his investment and perhaps his business.
Only after creating something customers value enough to purchase—and after paying the expenses required to create and deliver it—does the capitalist get what remains.
We have a word for that remainder.
Profit.
That doesn't sound much like wealth trickling downward from the capitalist.
It sounds more like wealth flowing toward everyone else before reaching him.
The Billionaire With an iPhone
But there is a second—and even more important—reason the "trickle-down" metaphor gets capitalism backward.
Consider Steve Jobs.
Jobs became extraordinarily wealthy through Apple.
A critic of capitalism can look at his fortune and say: Nobody needs that much money.
But that's the wrong measurement.
The more interesting question is:
How much value did everybody else receive?
Steve Jobs could own one iPhone.
He could own ten.
He could fill an entire house with iPhones if he wanted.
But there was a limit to how much personal benefit Steve Jobs could derive from the product he helped create.
The rest went to us.
Billions of people have benefited from the smartphone revolution. Smartphones placed communication, photography, navigation, banking, entertainment, commerce, news, education and enormous portions of humanity's accumulated knowledge into an ordinary person's pocket.
An individual carrying a modern smartphone possesses capabilities that some of the wealthiest people on Earth couldn't have purchased at any price a few generations ago.
Steve Jobs became enormously wealthy.
But society received the iPhone.
Which side of that exchange received the greater aggregate benefit?
Elon Musk Can't Drive a Billion Teslas
Consider Elon Musk and Tesla.
Musk can own multiple Teslas.
He can drive a different one every day of the week.
But he cannot personally consume the overwhelming majority of the vehicles his company produces.
Those go to everybody else.
Consumers receive the transportation. Employees receive wages. Suppliers receive orders. Engineers gain employment and experience. Competitors respond with innovations of their own. New investment flows into batteries, charging infrastructure, manufacturing and related technologies.
And consumers who never purchase a Tesla can still benefit when competition pressures other automobile manufacturers to improve their products.
Again, the capitalist may become extraordinarily wealthy.
But the products go outward.
The benefits disperse throughout society.
This Happens Everywhere
Jobs and Musk are unusually visible examples, but the same principle operates throughout a capitalist economy.
Think about medicine.
A pharmaceutical entrepreneur or medical-device manufacturer might become wealthy developing a successful treatment. But the entrepreneur can consume only so much medicine himself. The enormous social value appears when millions of other people live longer, suffer less, or recover from diseases that once killed them.
Think about agriculture.
The inventor of better farm machinery can eat only a few meals each day. The real benefit appears when farmers produce vastly more food with less human labor and consumers encounter supermarkets overflowing with inexpensive choices.
Think about transportation.
The people who built airlines, automobiles and transportation networks could personally take only so many trips. The greater benefit came when ordinary people gained mobility that previous generations associated with extraordinary wealth.
Think about education.
Computers, inexpensive books, digital publishing and online educational platforms have given ordinary people access to information and instruction that once required proximity to elite universities or enormous libraries.
Think about entertainment and leisure.
Previous generations spent enormous portions of their lives performing physical labor simply to obtain life's necessities. Rising productivity has helped make possible shorter workweeks, paid vacations, inexpensive entertainment, restaurants, hobbies, professional sports and leisure activities on a scale previous civilizations couldn't have imagined.
Capitalism repeatedly performs the same remarkable trick:
It turns luxuries into ordinary products.
Yesterday's status symbol becomes today's household appliance.
Yesterday's technological miracle becomes today's inconvenience when the Wi-Fi takes five seconds too long.
The Real Direction of the Flow
This is why the phrase "trickle-down" gets the direction of capitalism wrong.
The capitalist doesn't first consume an enormous quantity of goods and eventually allow the leftovers to reach everyone else.
Quite the opposite.
The entrepreneur generally becomes wealthy only by producing something that flows outward to other people.
Bill Gates couldn't personally use millions of copies of Windows.
Henry Ford couldn't drive millions of Model Ts.
The founders of Google couldn't personally perform trillions of searches.
A pharmaceutical inventor can't personally consume a billion doses of medicine.
A hotel entrepreneur can't personally sleep in thousands of hotel rooms every night.
An airline founder can't occupy every seat on every airplane.
The capitalist's fortune can become enormous precisely because the product's usefulness has spread enormously.
That is a fundamentally different picture from the "trickle-down" caricature.
Look at What Happened to Ordinary Human Beings
We don't have to rely entirely on theory.
Look at what has happened to human living standards.
Using the World Bank's current international extreme-poverty threshold, approximately 43% of humanity lived in extreme poverty in 1990.
Today the figure is roughly 10%.
More than 1.5 billion fewer people live in extreme poverty today than in 1990.
That is not a trickle.
Look at health.
Global life expectancy was approximately 46 years in 1950.
Today it is above 70.
That is not a trickle.
Consider what those extra decades actually represent: millions upon millions of additional birthdays, graduations, marriages, careers, friendships and grandchildren.
That is human wealth in perhaps its most meaningful form.
Then consider education, transportation, communication and leisure.
Literacy and access to education have expanded enormously over the long run. Commercial aviation transformed international travel from something available primarily to the wealthy into something ordinary working families can experience. Computers and the Internet placed libraries of information into homes. Smartphones placed them into pockets.
Air conditioning transformed where people could comfortably live and work.
Washing machines, refrigerators, dishwashers and countless other appliances reduced hours of household labor.
Automobiles expanded where ordinary people could live and work.
Modern agriculture made food dramatically more abundant.
Mass production put clothing, furniture, electronics and household goods within reach of people who could never have afforded comparable luxuries in previous centuries.
Medicine transformed once-fatal diseases into treatable conditions.
And competitive markets continue trying to make all of these things cheaper, faster and better.
Wealth Is More Than Money
One reason we misunderstand capitalism is that we measure the capitalist's reward in dollars while overlooking much of the consumer's reward because it arrives as utility rather than cash.
Suppose an entrepreneur invents something that saves one hour per week for 100 million people.
The entrepreneur might become a billionaire.
Critics see the billion dollars because it appears on a balance sheet.
But what about the approximately 5.2 billion hours of human life saved every year?
Where does that appear on the entrepreneur's net-worth statement?
It doesn't.
Yet the benefit is real.
The same applies when a product saves lives, makes transportation safer, allows families to communicate across continents, reduces the cost of food, makes information instantly accessible, or simply makes an unpleasant task easier.
The entrepreneur captures only a portion of the value created by a successful innovation.
Much of the rest belongs to us.
Capitalism's Greatest Achievement Is Abundance
None of this means every businessman is virtuous.
Businesses can commit fraud. Executives can behave dishonestly. Companies can mistreat customers or employees. Markets require property rights, enforceable contracts, competition and laws against coercion and fraud.
Nor can every historical improvement in human welfare be attributed exclusively to capitalism. Scientific discovery, governments, charities, families, religious institutions and countless other institutions have contributed enormously to human progress.
But capitalism supplies something extraordinarily powerful:
A decentralized mechanism that rewards people for figuring out how to satisfy other human beings.
Want to become rich?
Create something people want.
Want to become extremely rich?
Create something millions of people want.
Want to become one of the richest people on Earth?
You will probably need to create or build something useful to hundreds of millions—or even billions—of people.
That isn't a system in which society waits beneath the billionaire's table hoping for crumbs.
It's almost the reverse.
The billionaire sits atop an economic structure because an enormous number of people voluntarily decided that what his enterprise provided was worth having.
It's Not a Trickle. It's a Deluge.
Capitalism's critics focus intensely on how much wealth successful entrepreneurs accumulate.
I think they are looking at the wrong side of the transaction.
Don't merely ask how much Steve Jobs received.
Ask what humanity received.
Don't merely ask how wealthy an automobile manufacturer became.
Count the vehicles.
Don't merely count the pharmaceutical company's profits.
Count the lives extended.
Don't merely count the technology company's market capitalization.
Count the hours saved, businesses created, information transmitted, people connected and capabilities placed into ordinary people's hands.
Then zoom out further.
Look at extreme poverty.
Look at life expectancy.
Look at food production.
Look at transportation.
Look at communication.
Look at medicine.
Look at education.
Look at leisure.
Look at the ordinary American home and compare its contents with the possessions of the wealthiest person alive two centuries ago.
The capitalist may become wealthy.
But the capitalist's customers receive the civilization his wealth was created by serving.
That isn't wealth "trickling down" from the top.
It's value exploding outward in every direction.
It's an avalanche.
It's a tsunami.
It's a deluge of human prosperity.