January 2016Since the 1970s, economic inequality in the US has increaseddramatically. And in particular, the rich have gotten a lot richer.Nearly everyone who writes about the topic says that economic inequalityshould be decreased.I'm interested in this question because I was one of the founders ofa company called Y Combinator that helps people start startups.Almost by definition, if a startup succeeds, its founders becomerich. Which means by helping startup founders I've been helping toincrease economic inequality. If economic inequality should be decreased, I shouldn't be helping founders. No one shouldbe.But that doesn't sound right. What's going on here? What's goingon is that while economic inequality is a single measure (or moreprecisely, two: variation in income, and variation in wealth), ithas multiple causes. Many of these causes are bad, like tax loopholesand drug addiction. But some are good, like Larry Page andSergey Brin starting the company you use to find things online.If you want to understand economic inequality — and more importantly,if you actually want to fix the bad aspects of it — you have totease apart the components. And yet the trend in nearly everythingwritten about the subject is to do the opposite: to squash togetherall the aspects of economic inequality as if it were a singlephenomenon.Sometimes this is done for ideological reasons. Sometimes it'sbecause the writer only has very high-level data and so drawsconclusions from that, like the proverbial drunk who looks for hiskeys under the lamppost, instead of where he dropped them, because thelight is better there. Sometimes it's because the writer doesn'tunderstand critical aspects of inequality, like the role of technologyin wealth creation. Much of the time, perhaps most of the time,writing about economic inequality combines all three.The most common mistake people make about economic inequality isto treat it as a single phenomenon. The most naive version of whichis the one based on the pie fallacy: that the rich get rich bytaking money from the poor.Usually this is an assumption people start from rather than aconclusion they arrive at by examining the evidence. Sometimes thepie fallacy is stated explicitly: ...those at the top are grabbing an increasing fraction of the nation's income — so much of a larger share that what's left over for the rest is diminished....[1]Other times it's more unconscious. But the unconscious form is verywidespread. I think because we grow up in a world where the piefallacy is actually true. To kids, wealth is a fixed piethat's shared out, and if one person gets more, it's at the expenseof another. It takes a conscious effort to remind oneself that thereal world doesn't work that way.In the real world you can create wealth as well as taking it fromothers. A woodworker creates wealth. He makes a chair, and youwillingly give him money in return for it. A high-frequency traderdoes not. He makes a dollar only when someone on the other end ofa trade loses a dollar.If the rich people in a society got that way by taking wealth fromthe poor, then you have the degenerate case of economic inequality,where the cause of poverty is the same as the cause of wealth. Butinstances of inequality don't have to be instances of the degeneratecase. If one woodworker makes 5 chairs and another makes none, thesecond woodworker will have less money, but not because anyone tookanything from him.Even people sophisticated enough to know about the pie fallacy areled toward it by the custom of describing economic inequality as aratio of one quantile's income or wealth to another's. It's soeasy to slip from talking about income shifting from one quantileto another, as a figure of speech, into believing that is literallywhat's happening.Except in the degenerate case, economic inequality can't be describedby a ratio or even a curve. In the general case it consists ofmultiple ways people become poor, and multiple ways people becomerich. Which means to understand economic inequality in a country,you have to go find individual people who are poor or rich andfigure out why.[2]If you want to understand change in economic inequality, youshould ask what those people would have done when it was different.This is one way I know the rich aren't all getting richer simplyfrom some new system for transferring wealth to them fromeveryone else. When you use the would-have method with startupfounders, you find what most would have done back in 1960, wheneconomic inequality was lower, was to join big companies or becomeprofessors. Before Mark Zuckerberg started Facebook, his defaultexpectation was that he'd end up working at Microsoft. The reasonhe and most other startup founders are richer than they would havebeen in the mid 20th century is not because of some right turn thecountry took during the Reagan administration, but because progressin technology has made it much easier to start a new company thatgrows fast.Traditional economists seem strangely averse to studying individualhumans. It seems to be a rule with them that everything has to startwith statistics. So they give you very precise numbers aboutvariation in wealth and income, then follow it with the most naivespeculation about the underlying causes.But while there are a lot of people who get rich through rent-seekingof various forms, and a lot who get rich by playing zero-sum games, there are also a significant numberwho get rich by creating wealth. And creating wealth, as a sourceof economic inequality, is different from taking it — not justmorally, but also practically, in the sense that it is harder toeradicate. One reason is that variation in productivity isaccelerating. The rate at which individuals can create wealthdepends on the technology available to them, and that growsexponentially. The other reason creating wealth is such a tenacioussource of inequality is that it can expand to accommodate a lot ofpeople.I'm all for shutting down the crooked ways to get rich. But thatwon't eliminate great variations in wealth, because as long as you leaveopen the option of getting rich by creating wealth, people who wantto get rich will do that instead.Most people who get rich tend to be fairly driven. Whatever theirother flaws, laziness is usually not one of them. Suppose newpolicies make it hard to make a fortune in finance. Does it seemplausible that the people who currently go into finance to maketheir fortunes will continue to do so, but be content to work forordinary salaries? The reason they go into finance is not becausethey love finance but because they want to get rich. If the onlyway left to get rich is to start startups, they'll start startups.They'll do well at it too, because determination is the main factorin the success of a startup. [3]And while it would probably bea good thing for the world if people who wanted to get rich switchedfrom playing zero-sum games to creating wealth, that would not onlynot eliminate great variations in wealth, but might even exacerbate them.In a zero-sum game there is at least a limit to the upside. Plusa lot of the new startups would create new technology that furtheraccelerated variation in productivity.Variation in productivity is far from the only source of economicinequality, but it is the irreducible core of it, in the sense thatyou'll have that left when you eliminate all other sources. And ifyou do, that core will be big, because it will have expanded toinclude the efforts of all the refugees. Plus it will have a largeBaumol penumbra around it: anyone who could get rich by creatingwealth on their own account will have to be paid enough to preventthem from doing it.You can't prevent great variations in wealth without preventing peoplefrom getting rich, and you can't do that without preventing themfrom starting startups.So let's be clear about that. Eliminating great variations in wealth wouldmean eliminating startups. And that doesn't seem a wise move.Especially since it would only mean you eliminatedstartups in your own country. Ambitious people already move halfwayaround the world to further their careers, and startups can operatefrom anywhere nowadays. So if you made it impossible to get richby creating wealth in your country, people who wanted to do thatwould just leave and do it somewhere else. Which wouldcertainly get you a lower Gini coefficient, along with a lesson inbeing careful what you ask for. [4]I think rising economic inequality is the inevitable fate of countriesthat don't choose something worse. We had a 40 year stretch in themiddle of the 20th century that convinced some people otherwise.But as I explained in The Refragmentation,that was an anomaly — aunique combination of circumstances that compressed American societynot just economically but culturally too.[5]And while some of the growth in economic inequality we've seen sincethen has been due to bad behavior of various kinds, there hassimultaneously been a huge increase in individuals' ability tocreate wealth. Startups are almost entirely a product of thisperiod. And even within the startup world, there has been a qualitativechange in the last 10 years. Technology has decreased the cost ofstarting a startup so much that founders now have the upper handover investors. Founders get less diluted, and it is now commonfor them to retain board control as well. Both further increaseeconomic inequality, the former because founders own more stock,and the latter because, as investors have learned, founders tendto be better at running their companies than investors.While the surface manifestations change, the underlying forces arevery, very old. The acceleration of productivity we see in SiliconValley has been happening for thousands of years. If you look atthe history of stone tools, technology was already accelerating inthe Mesolithic. The acceleration would have been too slow toperceive in one lifetime. Such is the nature of the leftmost partof an exponential curve. But it was the same curve.You do not want to design your society in a way that's incompatiblewith this curve. The evolution of technology is one of the mostpowerful forces in history.Louis Brandeis said "We may have democracy, or we may have wealthconcentrated in the hands of a few, but we can't have both." Thatsounds plausible. But if I have to choose between ignoring him andignoring an exponential curve that has been operating for thousandsof years, I'll bet on the curve. Ignoring any trend that has beenoperating for thousands of years is dangerous. But exponentialgrowth, especially, tends to bite you.___If accelerating variation in productivity is always going to producesome baseline growth in economic inequality, it would be a goodidea to spend some time thinking about that future. Can you havea healthy society with great variation in wealth? What would itlook like?Notice how novel it feels to think about that. The public conversationso far has been exclusively about the need to decrease economicinequality. We've barely given a thought to how to live with it.I'm hopeful we'll be able to. Brandeis was a product of the GildedAge, and things have changed since then. It's harder to hidewrongdoing now. And to get rich now you don't have to buy politiciansthe way railroad or oil magnates did. [6]The great concentrationsof wealth I see around me in Silicon Valley don't seem to bedestroying democracy.There are lots of things wrong with the US that have economicinequality as a symptom. We should fix those things. In the processwe may decrease economic inequality. But we can't start from thesymptom and hope to fix the underlying causes.[7]The most obvious is poverty. I'm sure most of those who want todecrease economic inequality want to do it mainly to help the poor,not to hurt the rich. [8]Indeed, a good number are merely beingsloppy by speaking of decreasing economic inequality when what theymean is decreasing poverty. But this is a situation where it wouldbe good to be precise about what we want. Poverty and economicinequality are not identical. When the city is turning off yourwaterbecause you can't pay the bill, it doesn't make any differencewhat Larry Page's net worth is compared to yours. He might onlybe a few times richer than you, and it would still be just as muchof a problem that your water was getting turned off.Closely related to poverty is lack of social mobility. I've seenthis myself: you don't have to grow up rich or even upper middleclass to get rich as a startup founder, but few successful foundersgrew up desperately poor. But again, the problem here is not simplyeconomic inequality. There is an enormous difference in wealthbetween the household Larry Page grew up in and that of a successfulstartup founder, but that didn't prevent him from joining theirranks. It's not economic inequality per se that's blocking socialmobility, but some specific combination of things that go wrongwhen kids grow up sufficiently poor.One of the most important principles in Silicon Valley is that "youmake what you measure." It means that if you pick some number tofocus on, it will tend to improve, but that you have to choose theright number, because only the one you choose will improve; anotherthat seems conceptually adjacent might not. For example, if you'rea university president and you decide to focus on graduation rates,then you'll improve graduation rates. But only graduation rates,not how much students learn. Students could learn less, if toimprove graduation rates you made classes easier.Economic inequality is sufficiently far from identical with thevarious problems that have it as a symptom that we'll probably onlyhit whichever of the two we aim at. If we aim at economic inequality,we won't fix these problems. So I say let's aim at the problems.For example, let's attack poverty, and if necessary damage wealthin the process. That's much more likely to work than attackingwealth in the hope that you will thereby fix poverty.[9]And ifthere are people getting rich by tricking consumers or lobbying thegovernment for anti-competitive regulations or tax loopholes, thenlet's stop them. Not because it's causing economic inequality, butbecause it's stealing.[10]If all you have is statistics, it seems like that's what you needto fix. But behind a broad statistical measure like economicinequality there are some things that are good and some that arebad, some that are historical trends with immense momentum andothers that are random accidents. If we want to fix the worldbehind the statistics, we have to understand it, and focus ourefforts where they'll do the most good.Notes[1]Stiglitz, Joseph. The Price of Inequality. Norton, 2012. p.32.[2]Particularly since economic inequality is a matter of outliers,and outliers are disproportionately likely to have gotten wherethey are by ways that have little do with the sort of thingseconomists usually think about, like wages and productivity, butrather by, say, ending up on the wrong side of the "War on Drugs."[3]Determination is the most important factor in deciding betweensuccess and failure, which in startups tend to be sharply differentiated.But it takes more than determination to create one of the hugelysuccessful startups. Though most founders start out excited aboutthe idea of getting rich, purely mercenary founders will usuallytake one of the big acquisition offers most successful startups geton the way up. The founders who go on to the next stage tend tobe driven by a sense of mission. They have the same attachment totheir companies that an artist or writer has to their work. Butit is very hard to predict at the outset which founders will dothat. It's not simply a function of their initial attitude. Startinga company changes people.[4]After reading a draft of this essay, Richard Florida told mehow he had once talked to a group of Europeans "who said they wanted to make Europe more entrepreneurial and more like Silicon Valley. I said by definition this will give you more inequality. They thought I was insane — they could not process it."[5]Economic inequality has been decreasing globally. But thisis mainly due to the erosion of the kleptocracies that formerlydominated all the poorer countries. Once the playing field isleveler politically, we'll see economic inequality start to riseagain. The US is the bellwether. The situation we face here, therest of the world will sooner or later.[6]Some people still get rich by buying politicians. My point is thatit's no longer a precondition.[7]As well as problems that have economic inequality as a symptom,there are those that have it as a cause. But in most if not all,economic inequality is not the primary cause. There is usuallysome injustice that is allowing economic inequality to turn intoother forms of inequality, and that injustice is what we need tofix. For example, the police in the US treat the poor worse thanthe rich. But the solution is not to make people richer. It's tomake the police treat people more equitably. Otherwise they'llcontinue to maltreat people who are weak in other ways.[8]Some who read this essay will say that I'm clueless or evenbeing deliberately misleading by focusing so much on the richer endof economic inequality — that economic inequality is really aboutpoverty. But that is exactly the point I'm making, though sloppierlanguage than I'd use to make it. The real problem is poverty, noteconomic inequality. And if you conflate them you're aiming at thewrong target.Others will say I'm clueless or being misleading by focusing onpeople who get rich by creating wealth — that startups aren't theproblem, but corrupt practices in finance, healthcare, and so on.Once again, that is exactly my point. The problem is not economicinequality, but those specific abuses.It's a strange task to write an essay about why something isn't theproblem, but that's the situation you find yourself in when so manypeople mistakenly think it is.[9]Particularly since many causes of poverty are only partiallydriven by people trying to make money from them. For example,America's abnormally high incarceration rate is a major cause ofpoverty. But although for-profit prison companies and prison guard unions both spend a lot lobbying for harsh sentencing laws, theyare not the original source of them.[10]Incidentally, tax loopholes are definitely not a productof some power shift due to recent increases in economic inequality.The golden age of economic equality in the mid 20th century wasalso the golden age of tax avoidance. Indeed, it was so widespreadand so effective that I'm skeptical whether economic inequality wasreally so low then as we think. In a period when people are tryingto hide wealth from the government, it will tend to be hidden fromstatistics too. One sign of the potential magnitude of the problemis the discrepancy between government receipts as a percentage ofGDP, which have remained more or less constant during the entireperiod from the end of World War II to the present, and tax rates,which have varied dramatically.Thanks to Sam Altman, Tiffani Ashley Bell, Patrick Collison, RonConway, Richard Florida, Ben Horowitz, Jessica Livingston, RobertMorris, Tim O'Reilly, Max Roser, and Alexia Tsotsis for readingdrafts of this.Note: This is a new version from which Iremoved a pair of metaphors that made a lot of people mad, essentially by macroexpanding them. If anyone wants to see the old version, I put it here.Related:
