A Response to Paul Graham’s Article on Income Inequality

While perusing HackerNews today, I encountered this article and this comment thread by Paul Graham (PG for short), founder of Ycombinator. I think that a lengthy response is in order. I originally intended this response to be in my HN comment, but it was too long. If you’re not interested in debating income inequality, this response is not for you. I’ll be quoting quite liberally from PG’s essay in this response.

So, let’s get started. I think PG really missed the mark with his assessment of the impact of economic inequality and instead substituted a real world struggle against economic conditions with a rosy economic model which starts from the premise that the rich need the ability to get richer in order to have a successful society.

To quote Graham, mafioso of the startup incubators: “I’m interested in the topic because I am a manufacturer of economic inequality.”

Well, not quite. The throughput of successful startup folks is never going to be enough to make a dent in the economy’s general state of inequality. If anything, YC offers social mobility insurance; the potential for social mobility from the middle classes to the lower-upper class without the potential for a slip from the middle classes to the lower classes in the event of failure.

“I’ve also written essays encouraging people to increase economic inequality and giving them detailed instructions showing how.”

Perhaps PG misunderstand the terms here? Has he been instructing his charges to pay lower wages and fewer benefits as their profits scale upward so as to add more to their own purses? A disconnect between rising productivity and worker income is one of the largest factors for economic inequality in the US.

“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.”

Well, “taking” is a bit biased, but broadly speaking, it’s true that the poor must buy or rent what the rich are offering in order to survive. This means that the poor are economically at the whim of the rich unless they choose to grow their own food and live pastorally, which isn’t desirable. People pay rent if they’re poor, and collect rent if they’re rich. The poor sell their labor, whereas the rich buy labor in order to utilize their capital, which the poor have none of. These are traits of capitalism rather than anything to get upset about. People get upset when the rich use their oversized political influence to get laws passed to their benefit; over time, the rich make more money due to their ability to manipulate the political system.

“…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….”

Check out these charts… the data is much-discussed because they are unimpeachable. Ignoring the reality of data is a mistake economists often make, which can explain some of their more incorrect predictions.

“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.”

The woodworker works in a wood shop, not alone. The owner of the wood shop has decided that if 5 chairs are sold, it takes 2 chairs worth of money to recoup the costs of making the chair. With three chairs worth of money remaining, he takes two and three fourths chairs for himself and distributes the remaining amount to the worker who created the chair.

The woodworker created the wealth by using the owner’s capital, and so the owner of the capital gets the vast majority of the wealth generated, even though he didn’t actually make the chairs himself. Is the owner “taking” from his employee? No, the employee has merely realized that one fourth of one chair’s income is the standard amount that a woodworker can get from working in a shop owned by someone else, and happened to choose this particular shop to work in. “Taking” is the wrong word; “greed” is the proper word. The proportion of revenue derived from capital that is returned to workers selling their labor is far too low. The woodworkers can’t simultaneously pay off their woodworking school loans, apartment rent, and care for their children on the wages they’re offered.

“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.”

Actually, economists have been describing it in the terms of ratios and curves for a long time. Piketty’s account is the most current. The “ways” of becoming poor or rich misses the point entirely. Upward social mobility is very low now, and downward social mobility is quite high. Outside “becoming” rich or poor, the standard of living for the rich has risen and the standard of living for everyone else has dropped. Becoming rich is an edge case which isn’t even worth talking about when there are far more people in danger of becoming poor. We have no obligation to stop someone from “becoming rich”– but we have a strong obligation to stop someone from becoming poor.

“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 sinister 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.”

Not even close. The richest hundred people have gotten wildly richer as a result of crony capitalism in which the richest are able to bend the political system to their will via overt bribery, creating unfair advantages for their ventures and endless loopholes for their personal wealth to avoid taxation. The ventures of the very rich are given unearned integration into political life, again making them a shoe in for special treatment.

Remember how the failing banks in the financial crisis were considered too big to fail, and were accommodated at the public’s expense? This kind of behavior insures the rich’s safety with the money culled from the poor. Information technology is a gold rush, and creates rich people by forging new vehicles of capital– generating wealth. The economics of a gold rush are quite clear, but PG forgets that the vast, vast majority of the workers in the economy are not participating in the gold rush, nor could they.

“And that group presents two problems for the hunter of economic inequality. One 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 polynomially. The other problem with creating wealth, as a source of inequality, is that it can expand to accommodate a lot of people.”

Productivity has been increasing for decades, and at one point in time, wages tracked productivity. The relationship between wages and productivity fell apart. This means that the business owners were benefiting from increased worker productivity, but the workers were not benefiting… another cause of economic inequality that can be attributed directly to the owners not allowing enough money to go to their workers. If productivity is accelerating, wages should be too. Rather than understanding workers as slaves that require a dole as they are presently, they must be considered as close partners in economic production.

“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. [3] 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 economic inequality, but might even make it worse. 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.”

Once again: the current flap about economic inequality is not about people wanting to become rich, it is about people wanting to get by. Most people are not driven. Everyone wants to at least get by. You will not stop people from being driven to become rich by making it possible for everyone else to get by.

“So let’s be clear about that. Ending economic inequality would mean ending startups. Are you sure, hunters, that you want to shoot this particular animal? 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, the ambitious people in your country 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. ”

No, it wouldn’t. There is lower and higher economic inequality in many places in the world, and many of those places have startups. There is nothing special about startups, and startups persist whether or not the society is extremely unequal. There are startups in Sweden. There are startups in China. There are startups in Nigeria. There are startups in Denmark. There is absolutely no reason to be prideful in the American startup phenomenon if it requires people living in poverty– I do not believe that it does require this, though.

“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.”

Do not confuse the tech startup as a method for creating wealth that anyone can step into. Coding is a difficult skill that most people are not about to retrain into, even if it’s lucrative.

“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. [6] The great concentrations of wealth I see around me in Silicon Valley don’t seem to be destroying democracy.”

Living with economic inequality is uncomfortable for the majority of the population, but it is comfortable for the rich. The way to live with it is to defer having children, not get a graduate education, never own a home, have a shitty car, never eat out, don’t go on vacation, work two jobs, don’t ever get sick, don’t get married, never pay off student loans, never save for retirement or an emergency, and never get arrested.

Seems pretty shitty, right? Seems like something people would want to change for the better, right? I will also state that all of the above items vastly detract from a person’s free-mental and physical energy, which results in less innovation and ultimately less creation of the “startups” that income inequality is supposed to support. PG even acknowledges this, but doesn’t seem to understand the visceral impact of income inequality.

To crystallize everything, let’s hop backward to a time when there was less inequality and compare lifestyles. In yesteryear, families requires only one breadwinner, and debt beyond a mortgage was unknown. People had a car per person, and college education. If you were sick, you could pay for a doctor. People had savings. People married young, and bought starter homes… then moved into larger homes. People had children. People could care for their aging parents without moving back in. People had pensions, retirement funds, and plans to use both. All of this wealth derived directly from workers selling their labor for money. Starting new businesses happened frequently because there was a robust net to fall on in case of failure. Workers banded together to protect their share. Wages tracked productivity.

Now: none of the above, and families often consist of two breadwinners (& no children) with a hearty amount of debt, nothing owned, and few savings. The family unit itself may even be weaker because of less shared ownership. Wages haven’t tracked productivity for decades, so wages haven’t risen since the previous story was normal. We’ve lost all of that ground: not just some of it, all of it, and more. We’re back to the 1920s– wage slaves with few rights and no political ability to change things.

Is this what PG thinks is okay?

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5 thoughts on “A Response to Paul Graham’s Article on Income Inequality”

  1. “We’re back to the 1920s– wage slaves with few rights and no political ability to change things.”

    Simply because we keep voting for the Punch and Judy sock puppets, yes. The two party system has utterly destroyed American democracy, neutrality, virtue and hope. We lost WW2: The fascists won in the end.

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  2. “Who is the real target?”

    What impedes the poor from pooling what little capital they have and creating their own business? What are the impediments to forward progress? You mention political power as wielded by the rich. Specifically, how is it wielded and what changes would you make?

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  3. You make a lot of basic mistakes here. I’ll list a few of them:

    “If anything, YC offers social mobility insurance; the potential for social mobility from the middle classes to the lower-upper class…” No, a large number of the very richest people in the world today were start-up founders. I wouldn’t call billionaires like Zuckerberg and Brin “lower-upper class.”

    “Well, “taking” is a bit biased, but broadly speaking, it’s true that the poor must buy or rent what the rich are offering in order to survive. This means that the poor are economically at the whim of the rich unless they choose to grow their own food and live pastorally, which isn’t desirable.” No. “The rich” aren’t a cohesive cabal. Rather, service providers compete to offer their services. If a poor person wants a pair of shoes, they don’t have to buy them from Nike, they can buy shoes from a couple dozen different shoe manufacturers. Similarly, you don’t have to rent an apartment from any one particular landlord. Rather, thousands of landlords across the country are all competing vigorously to offer the best deal to renters.

    “The richest hundred people have gotten wildly richer as a result of crony capitalism in which the richest are able to bend the political system to their will via overt bribery, creating unfair advantages for their ventures and endless loopholes for their personal wealth to avoid taxation. ” No. A large percentage (about 40%) of the richest people in the world were unambiguously wealth-creating start up founders and engineers. People like Zuckerberg and Brin. Of the remainder, many are the children of wealth creators, while others grew large companies. And a substantial percentage have paid minimal taxes because they haven’t yet “realized” their profits by selling their equity (Brin), or they’ve donated the vast majority of their wealth (Gates, Zuckerberg).

    “Productivity has been increasing for decades, and at one point in time, wages tracked productivity. The relationship between wages and productivity fell apart. This means that the business owners were benefiting from increased worker productivity, but the workers were not benefiting… another cause of economic inequality that can be attributed directly to the owners not allowing enough money to go to their workers.” Graham did a wonderful job of explaining exactly why workers received an unusually large share of the pie mid-century. That was a large part of his essay that you seem to have ignored. Workers haven’t benefited from the increases in productivity because the market for labor has become more “fair.” Labor union monopolies have less power and we’ve escaped from the corporatist and military bureaucracies with their pay grades. You can argue this is a bad thing, but you should at least understand why it’s happened after reading Graham’s essay.

    “There is lower and higher economic inequality in many places in the world, and many of those places have startups. There is nothing special about startups, and startups persist whether or not the society is extremely unequal. There are startups in Sweden. There are startups in China. There are startups in Nigeria. There are startups in Denmark. There is absolutely no reason to be prideful in the American startup phenomenon if it requires people living in poverty– I do not believe that it does require this, though.” This paragraph makes me question if you even bothered reading Graham’s essay. First, Graham very explicitly distinguishes between poverty and income inequality and agrees with you that the latter does not necessitate the former. Second, you seem to have gotten confused and reversed the causality of the argument. Graham does not say that inequality produces startups, but rather that startups produce inequality. The inventor of facebook is likely to get very rich and therefore we get income inequality. The only way to prevent this particular income inequality is to prevent the creator of facebook from getting rich, which removes the incentive to create the startup. Countries that do not allow startup creators to get rich have few if any startups. China actually allows its startup creators to get very rich (they have plenty of new billionaires) so it’s very strange you would cite them as an example. In contrast, Cuba and North Korea do not allow start up creators to get rich, and they have very few startups.

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  4. What really matters is that * being taxed doesn’t remove the incentive to start startups or innovate in general . Because Sweden. Because Denmark, because Norway, and because basically every european country plus Canada and Australia, etc etc etc. That’s all. Debate closed for me. Sure startups, and innovation in general, is what made people better off since prehistory and we want to keep that exponential trend going. But is it true that people need to starve and be in debt so we can have startups? People need to get screwed over? No, on the contrary! GET TO THE GIST OF THE ISSUE! People arguing that we need a lot of inequality to have innovation and startups are misinformed, and/or brainwashed by the media.

    One fun fact: there’s more poor* smart kids than rich smart kids, in raw numbers (despite kids from rich households being more likely to be smart, on average). Allowing these poor smart kids to waste less time at small jobs and spend more time in school and on startups is what we want. So actually it might even help innovation to have less poors.
    Other fun fact: the computer, the internet, the web, GPS, touch screens, modern encryption, and most things we rely on today aren’t coming from startups (see TED talk on that issue). Most tech innovations were done by regular employees with no financial stakes, working for a country’s government or a university. And there’s more … I wouldn’t count an employee innovating at Google, IBM or Facebook in the “startup” category. Artificial intelligence at Google or IBM or Facebook happens mostly because people are smart and passionate. These people are often knowledgeable academics, often coming from other countries where education and health care is free. Startups are the tip of the iceberg for innovation. People don’t usually innovate just to get rich. They did it because they are smart, it was their job, and they got lucky to combine two old ideas together — they were at the right place at the right time with the right knowledge.
    Other fun fact: a strong middle class is necessary for innovation. Otherwise no one will buy smartphones and use the apps. (see excellent “banned TED talk” by venture capitalist Hanauer)

    It’s not looking good for the neo conservative ideology, the “we need inequality” and no tax for the rich idea. How can people still be convinced that we need higher inequality to have a healthy economy and get innovation? The only reason it’s still widespread is because of American media owners.

    What this means for anyone with half a brain is that socialism works, when done right, done smart, … No offense to PG, who is otherwise a smart dude, but he didn’t completely nail it in this article, on this specific issue. He is trying hard though and that’s admirable. He is a brainwashed neo-conservative, to some extend, trying to make sense of things. It’s admirable that he is trying really hard to make sense. Some of what he says almost makes sense. We can feel the neo con ideology from the early 2000s Bush Jr era still running in his neurons and preventing a fair appraisal of the problem, but he is trying. Also, he is inherently in conflict of interest, one should point out here. It’s ok PG, neo cons do seem to have a lot of strong points, mostly that the USSR and China failed with communism. Economic freedom also seemed to make sense. And it’s on TV. And most people agree. And it does feel kind of uncool to tax companies and successful people. But with a bit of reasoning and at this point in history, we can say for sure that “a lot of inequality isn’t necessary for startups”. Just a bit is sufficient. Taxing companies and personal income is fine, it’s done in most successful countries.

    The current state of technology (affordable smartphones and laptops, programming languages that are easy and affordable, and more people than ever in history with some free time and extra money on their hands, etc) is what’s allowing the startup phenomenon, today in history. It wasn’t superhuman levels of effort, that could only be triggered in an individual by the promise of millions. Kids innovate by having fun and having free time and no debt — so peace of mind. High inequality (and the neo con ideology that promotes it) isn’t necessary for startups and is even detrimental. Having lobbyists influence the government isn’t necessary for startups. Dumb, bro-ish and psychopathic wall street practices and (lack of) laws aren’t necessary for startups. Taxing the rich less than the poor isn’t necessary for startups. Spending most of the budget on wars isn’t necessary for startups. Not having free health care isn’t necessary for startups. Having a bunch of psychopaths screw people over isn’t necessary for startups. On the contrary. Guaranteed basic income has been tested and empirically didn’t remove incentive for people to work (see TED talks on basic income). Do things smart for God’s sake. The variability in innovation rates and GDP per inhabitant between countries IS NOT DUE TO SOCIALISM (contrarily to what the economic freedom index people would want you to believe). Russia is still a shithole for the most part after 25 years of capitalism, maybe even more, and it always has been and shithole anyway. It’s probable Canada or France would have fared just as fine in GDP with more or less socialism — they’d just have more poors and more stress, and less kids in school given less socialism. Nordic countries are killing it in innovation despite their small size and “despite” being very socialist. But then you have examples like West vs East Germany which do seem to indicate that socialism (or communism) can be bad for the economy in some cases. Success for a country is complicated, isn’t just defined by whether it’s socialist. Important to point out that there’s smart socialist policies and dumb socialist policies. Look at empirical evidence. Free school and free health care happen to work if done right, and exist in countries that have a lot of startups per capita. You can verify that in countries that tried it.

    The bottom line is, we want innovation, and we want less inequality. We can have both. Why are we even debating this? Because people are dumb and the neo con ideology is spread far and wide by the American media, and some of its arguments can seem to make sense (the “lazy communist worker” argument and the “economic freedom index” argument are two). People have very little time and cognitive resources to spend on this issue and are easily manipulated. Recently Hillary was declared winner of the democrat debate in the news, when every online poll indicated that Sanders won. Talk about corrupted, communist-style use of the media — media owners trying to influence the issue of elections, straight up. People better wake up. Hopefully the internet is making things better and making people more informed over time, and avoiding the biased news. Brain time is a scarce ressource.

    Now some more thoughts. Most current jobs will likely be automated in the next 20 years, including lawyers and truck drivers. Now that’s inequality right there! But is stopping exponential innovation the solution? Of course not. We want to speed it up, but benefit from it. How? Spread the risk. Like capitalists in Holland did in the 1600s investing on ships to India that had a high risk of not coming back. Like YCombinator does. This form of spreading the risk basically amounts to taxing the successful ones. Countries can invest by spreading the risk or tax successful companies on behalf of their citizens and then provide guaranteed basic income. I know it doesn’t feel cool to tax successful people. But that’s what we gotta do to deal with the concentration of wealth inherent to capitalism (see TED talk on capitalism and the concentration of wealth).

    SUMMARY: – startups and innovation happen just as much with socialism – startups and innovation might happen more with socialism – to keep the historical trend of exponential innovation going, we need to maximize quality brain time spend on startups and other intellectually challenging ventures – this can be achieved with socialism (free school for selected kids, free health care, basic income, wall street regulation, less money spent on war, no subsidies to oil companies, etc) – to benefit from the exponential tech evolution trend, we need anyway to tax companies that succeed, otherwise they will concentrate all the wealth by automating most current jobs existing today …. we’re insanely lucky to have some billionaires give their fortunes to charity, in smart ways currently, but people can’t just count on that in the future to have jobs and an income when everything is automated.

    If anyone disagrees with these, please tell me why, I’m ready to change my mind! I hope you have good points.

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