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January 2016  
  
Since the 1970s, economic inequality in the US has increased dramatically. And
in particular, the rich have gotten a lot richer. Nearly everyone who writes
about the topic says that economic inequality should be decreased.  
  
I'm interested in this question because I was one of the founders of a company
called Y Combinator that helps people start startups. Almost by definition, if
a startup succeeds, its founders become rich. Which means by helping startup
founders I've been helping to increase economic inequality. If economic
inequality should be decreased, I shouldn't be helping founders. No one should
be.  
  
But that doesn't sound right. What's going on here? What's going on is that
while economic inequality is a single measure (or more precisely, two:
variation in income, and variation in wealth), it has multiple causes. Many of
these causes are bad, like tax loopholes and drug addiction. But some are
good, like Larry Page and Sergey 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 to tease apart the
components. And yet the trend in nearly everything written about the subject
is to do the opposite: to squash together all the aspects of economic
inequality as if it were a single phenomenon.  
  
Sometimes this is done for ideological reasons. Sometimes it's because the
writer only has very high-level data and so draws conclusions from that, like
the proverbial drunk who looks for his keys under the lamppost, instead of
where he dropped them, because the light is better there. Sometimes it's
because the writer doesn't understand critical aspects of inequality, like the
role of technology in 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 is to treat it
as a single phenomenon. The most naive version of which is the one based on
the pie fallacy: that the rich get rich by taking money from the poor.  
  
Usually this is an assumption people start from rather than a conclusion they
arrive at by examining the evidence. Sometimes the pie 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.... 

Other times it's more unconscious. But the unconscious form is very
widespread. I think because we grow up in a world where the pie fallacy is
actually true. To kids, wealth _is_ a fixed pie that's shared out, and if one
person gets more, it's at the expense of another. It takes a conscious effort
to remind oneself that the real world doesn't work that way.  
  
In the real world you can create wealth as well as taking it from others. A
woodworker creates wealth. He makes a chair, and you willingly give him money
in return for it. A high-frequency trader does not. He makes a dollar only
when someone on the other end of a trade loses a dollar.  
  
If the rich people in a society got that way by taking wealth from the poor,
then you have the degenerate case of economic inequality, where the cause of
poverty is the same as the cause of wealth. But instances of inequality don't
have to be instances of the degenerate case. If one woodworker makes 5 chairs
and another makes none, the second woodworker will have less money, but not
because anyone took anything from him.  
  
Even people sophisticated enough to know about the pie fallacy are led toward
it by the custom of describing economic inequality as a ratio of one
quantile's income or wealth to another's. It's so easy to slip from talking
about income shifting from one quantile to another, as a figure of speech,
into believing that is literally what's happening.  
  
Except in the degenerate case, economic inequality can't be described by a
ratio or even a curve. In the general case it consists of multiple ways people
become poor, and multiple ways people become rich. Which means to understand
economic inequality in a country, you have to go find individual people who
are poor or rich and figure out why.   
  
If you want to understand _change_ in economic inequality, you should ask what
those people would have done when it was different. This is one way I know the
rich aren't all getting richer simply from some new system for transferring
wealth to them from everyone else. When you use the would-have method with
startup founders, you find what most would have done _back in 1960_, when
economic inequality was lower, was to join big companies or become professors.
Before Mark Zuckerberg started Facebook, his default expectation was that he'd
end up working at Microsoft. The reason he and most other startup founders are
richer than they would have been in the mid 20th century is not because of
some right turn the country took during the Reagan administration, but because
progress in technology has made it much easier to start a new company that
_grows fast_.  
  
Traditional economists seem strangely averse to studying individual humans. It
seems to be a rule with them that everything has to start with statistics. So
they give you very precise numbers about variation in wealth and income, then
follow it with the most naive speculation about the underlying causes.  
  
But while there are a lot of people who get rich through rent-seeking of
various forms, and a lot who get rich by playing zero-sum games, there are
also a significant number who get rich by creating wealth. And creating
wealth, as a source of economic inequality, is different from taking it — not
just morally, but also practically, in the sense that it is harder to
eradicate. One reason is that variation in productivity is accelerating. The
rate at which individuals can create wealth depends on the technology
available to them, and that grows exponentially. The other reason creating
wealth is such a tenacious source of inequality is that it can expand to
accommodate a lot of people.  
  
___  
  
I'm all for shutting down the crooked ways to get rich. But that won't
eliminate great variations in wealth, because as long as you leave open the
option of getting rich by creating wealth, people who want to get rich will do
that instead.  
  
Most people who get rich tend to be fairly driven. Whatever their other flaws,
laziness is usually not one of them. Suppose new policies make it hard to make
a fortune in finance. Does it seem plausible that the people who currently go
into finance to make their fortunes will continue to do so, but be content to
work for ordinary salaries? The reason they go into finance is not because
they love finance but because they want to get rich. If the only way left to
get rich is to start startups, they'll start startups. They'll do well at it
too, because determination is the main factor in the success of a startup. 
And while it would probably be a good thing for the world if people who wanted
to get rich switched from playing zero-sum games to creating wealth, that
would not only not eliminate great variations in wealth, but might even
exacerbate them. In a zero-sum game there is at least a limit to the upside.
Plus a lot of the new startups would create new technology that further
accelerated variation in productivity.  
  
Variation in productivity is far from the only source of economic inequality,
but it is the irreducible core of it, in the sense that you'll have that left
when you eliminate all other sources. And if you do, that core will be big,
because it will have expanded to include the efforts of all the refugees. Plus
it will have a large Baumol penumbra around it: anyone who could get rich by
creating wealth on their own account will have to be paid enough to prevent
them from doing it.  
  
You can't prevent great variations in wealth without preventing people from
getting rich, and you can't do that without preventing them from starting
startups.  
  
So let's be clear about that. Eliminating great variations in wealth would
mean eliminating startups. And that doesn't seem a wise move. Especially since
it would only mean you eliminated startups in your own country. Ambitious
people already move halfway around the world to further their careers, and
startups can operate from anywhere nowadays. So if you made it impossible to
get rich by creating wealth in your country, people who wanted to do that
would just leave and do it somewhere else. Which would certainly get you a
lower Gini coefficient, along with a lesson in being careful what you ask for.
  
  
I think rising economic inequality is the inevitable fate of countries that
don't choose something worse. We had a 40 year stretch in the middle of the
20th century that convinced some people otherwise. But as I explained in _The
Refragmentation_, that was an anomaly — a unique combination of circumstances
that compressed American society not just economically but culturally too.   
  
And while some of the growth in economic inequality we've seen since then has
been due to bad behavior of various kinds, there has simultaneously been a
huge increase in individuals' ability to create wealth. Startups are almost
entirely a product of this period. And even within the startup world, there
has been a qualitative change in the last 10 years. Technology has decreased
the cost of starting a startup so much that founders now have the upper hand
over investors. Founders get less diluted, and it is now common for them to
retain _board control_ as well. Both further increase economic inequality, the
former because founders own more stock, and the latter because, as investors
have learned, founders tend to be better at running their companies than
investors.  
  
While the surface manifestations change, the underlying forces are very, very
old. The acceleration of productivity we see in Silicon Valley has been
happening for thousands of years. If you look at the history of stone tools,
technology was already accelerating in the Mesolithic. The acceleration would
have been too slow to perceive in one lifetime. Such is the nature of the
leftmost part of an exponential curve. But it was the same curve.  
  
You do not want to design your society in a way that's incompatible with this
curve. The evolution of technology is one of the most powerful forces in
history.  
  
Louis Brandeis said "We may have democracy, or we may have wealth concentrated
in the hands of a few, but we can't have both." That sounds plausible. But if
I have to choose between ignoring him and ignoring an exponential curve that
has been operating for thousands of years, I'll bet on the curve. Ignoring any
trend that has been operating for thousands of years is dangerous. But
exponential growth, especially, tends to bite you.  
  
___  
  
If accelerating variation in productivity is always going to produce some
baseline growth in economic inequality, it would be a good idea to spend some
time thinking about that future. Can you have a healthy society with great
variation in wealth? What would it look like?  
  
Notice how novel it feels to think about that. The public conversation so far
has been exclusively about the need to decrease economic inequality. 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 Gilded Age, and
things have changed since then. It's harder to hide wrongdoing now. And to get
rich now you don't have to buy politicians the way railroad or oil magnates
did.  The great concentrations of wealth I see around me in Silicon Valley
don't seem to be destroying democracy.  
  
There are lots of things wrong with the US that have economic inequality as a
symptom. We should fix those things. In the process we may decrease economic
inequality. But we can't start from the symptom and hope to fix the underlying
causes.   
  
The most obvious is poverty. I'm sure most of those who want to decrease
economic inequality want to do it mainly to help the poor, not to hurt the
rich.  Indeed, a good number are merely being sloppy by speaking of
decreasing economic inequality when what they mean is decreasing poverty. But
this is a situation where it would be good to be precise about what we want.
Poverty and economic inequality are not identical. When the city is turning
off your _water_ because you can't pay the bill, it doesn't make any
difference what Larry Page's net worth is compared to yours. He might only be
a few times richer than you, and it would still be just as much of a problem
that your water was getting turned off.  
  
Closely related to poverty is lack of social mobility. I've seen this myself:
you don't have to grow up rich or even upper middle class to get rich as a
startup founder, but few successful founders grew up desperately poor. But
again, the problem here is not simply economic inequality. There is an
enormous difference in wealth between the household Larry Page grew up in and
that of a successful startup founder, but that didn't prevent him from joining
their ranks. It's not economic inequality per se that's blocking social
mobility, but some specific combination of things that go wrong when kids grow
up sufficiently poor.  
  
One of the most important principles in Silicon Valley is that "you make what
you measure." It means that if you pick some number to focus on, it will tend
to improve, but that you have to choose the right number, because only the one
you choose will improve; another that seems conceptually adjacent might not.
For example, if you're a 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 to improve
graduation rates you made classes easier.  
  
Economic inequality is sufficiently far from identical with the various
problems that have it as a symptom that we'll probably only hit 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 wealth in the
process. That's much more likely to work than attacking wealth in the hope
that you will thereby fix poverty.  And if there are people getting rich by
tricking consumers or lobbying the government for anti-competitive regulations
or tax loopholes, then let's stop them. Not because it's causing economic
inequality, but because it's stealing.   
  
If all you have is statistics, it seems like that's what you need to fix. But
behind a broad statistical measure like economic inequality there are some
things that are good and some that are bad, some that are historical trends
with immense momentum and others that are random accidents. If we want to fix
the world behind the statistics, we have to understand it, and focus our
efforts where they'll do the most good.  
  
  
  
  
  
  
  
  
  
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