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.

Since the 1970s, economic inequality in the US has increased dramatically, and the rich have gotten a lot richer. Nearly everyone who writes about it says it should be decreased.

I'm interested because I co-founded Y Combinator, which helps people start startups. If a startup succeeds, its founders become rich — so by helping founders I've been increasing inequality. If it should be decreased, no one should be helping founders.

But that doesn't sound right. Inequality is a single measure — really two, variation in income and in wealth — but it has multiple causes. Some are bad, like tax loopholes and drug addiction; some good, like Larry Page and Sergey Brin starting Google. To fix the bad parts you have to tease apart the components.

Yet nearly everything written does the opposite, squashing the aspects into one phenomenon: sometimes for ideology, sometimes because the writer has only high-level data, like the drunk searching under the lamppost, sometimes because he misses technology's role in wealth creation.

Inequality is a single measure with multiple causes, some bad and some good. Most writing squashes them together; to fix the bad parts you have to tease them apart.

___

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.... [1]

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. [2]

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 [blocked], 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 [blocked].

The most common mistake is treating inequality as a single phenomenon. The most naive version rests on the pie fallacy: that the rich get rich by taking from the poor — usually an assumption, not a conclusion from evidence.

More often the fallacy is unconscious, and widespread, because we grow up in a world where it's true. To kids, wealth is a fixed pie that's shared out, and if one gets more it's at another's expense. It takes effort to remember the real world doesn't work that way.

In the real world you can create wealth as well as take it. A woodworker creates wealth: he makes a chair, and you willingly give him money for it. A high-frequency trader does not; he makes a dollar only when someone on the other end of a trade loses one.

If the rich got that way by taking from the poor, you have the degenerate case, where the cause of poverty is the cause of wealth. But inequality needn't be that case. If one woodworker makes 5 chairs and another makes none, the second has less, but not because anyone took anything from him.

Even people who know the pie fallacy are led toward it by describing inequality as a ratio of one quantile to another. But except in the degenerate case, inequality is no ratio or curve. It's many ways people become poor and rich — to understand it you have to find individuals and figure out why.

To understand change, ask what those people would have done before. Most founders would have joined big companies or become professors back in 1960 [blocked]; before Facebook, Zuckerberg expected to end up at Microsoft. They're richer now not because of some right turn under Reagan, but because technology made it far easier to start a company that grows fast [blocked].

The naive version treats wealth as a fixed pie the rich take from the poor. But wealth can be created, not just taken, so inequality can't be read off a ratio — you have to study individual people.

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.

Traditional economists seem strangely averse to studying individual humans. Everything starts with statistics — precise numbers on variation in wealth and income, then the most naive speculation about the causes.

But while many get rich through rent-seeking and zero-sum games, a significant number get rich by creating wealth — different from taking it, not just morally but practically, in that it's harder to eradicate. Variation in productivity is accelerating, since the rate at which individuals create wealth tracks technology, which grows exponentially. And wealth creation can expand to accommodate a lot of people.

Economists start with statistics and skip individuals. But creating wealth differs from taking it not just morally but practically: it's harder to eradicate, because productivity accelerates and it scales to many 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. [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 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. [4]

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 can get rich creating it, people who want to get rich will do that instead.

Most people who get rich are driven. Make finance fortunes hard, and will those who went into finance to get rich keep at it for ordinary salaries? They don't love finance; they want to get rich. If the only way left is startups, they'll start startups.

They'll do well, since determination is the main factor in success. Switching from zero-sum games to creating wealth would be good for the world, but might even exacerbate variations in wealth: a zero-sum game at least has a limited upside, and the new startups would accelerate variation in productivity further.

Variation in productivity is the irreducible core of inequality — what's left when you eliminate other sources. And it will be big, having absorbed all the refugees, with a large Baumol penumbra: anyone who could get rich creating wealth on their own must be paid enough not to.

You can't prevent great variations in wealth without preventing people from getting rich, and you can't do that without preventing startups. So eliminating great variations would mean eliminating startups — and only in your own country. Block wealth creation and ambitious people will just leave and do it elsewhere, getting you a lower Gini coefficient and a lesson in being careful what you ask for.

Shut down the crooked routes to riches and driven people will just start startups instead — which won't reduce wealth variation and might widen it. You can't stop great variation in wealth without stopping startups.

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 [blocked], that was an anomaly — a unique combination of circumstances that compressed American society not just economically but culturally too. [5]

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 [blocked] 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.

Rising inequality is the inevitable fate of countries that don't choose something worse. The mid-20th-century stretch that convinced people otherwise was an anomaly — as I argue in The Refragmentation [blocked], a unique combination of circumstances that compressed American society economically and culturally.

Some recent growth is bad behavior, but there's also been a huge increase in the ability to create wealth. The last 10 years cut the cost of starting a startup so much that founders now have the upper hand over investors: less diluted, often keeping board control [blocked] — both raising inequality.

The surface manifestations change, but the underlying forces are very old. The acceleration of productivity in Silicon Valley has been happening for thousands of years; in the history of stone tools, technology was already accelerating in the Mesolithic. Too slow to perceive in one lifetime, but the same curve.

You do not want to design your society incompatibly with this curve; the evolution of technology is one of the most powerful forces in history. Brandeis said "We may have democracy, or we may have wealth concentrated in the hands of a few, but we can't have both." Plausible — but forced to choose between ignoring him and ignoring an exponential curve thousands of years old, I'll bet on the curve.

Mid-century compression was an anomaly; rising inequality is the inevitable fate of countries that don't choose worse. The acceleration of productivity is an exponential curve thousands of years old, and you shouldn't bet against it.

___

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. [6] 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. [7]

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. [8] 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. [9] 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. [10]

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.

If accelerating productivity always produces some baseline inequality, we should think about that future. Can you have a healthy society with great variation in wealth? Notice how novel that feels. The conversation so far has been exclusively about decreasing inequality, not living with it.

I'm hopeful we can. Brandeis was a product of the Gilded Age, and things have changed: it's harder to hide wrongdoing, and to get rich you no longer have to buy politicians the way railroad and oil magnates did. The wealth concentrations I see in Silicon Valley don't seem to be destroying democracy.

Lots of things wrong with the US have inequality as a symptom. We should fix those, and may decrease inequality in the process. But we can't start from the symptom and hope to fix the causes.

The most obvious is poverty. Most who want to decrease inequality want to help the poor, not hurt the rich — many are just being sloppy, saying inequality when they mean poverty. But the two aren't identical. When the city turns off your water because you can't pay, it makes no difference what Larry Page is worth.

Closely related is lack of social mobility. You don't have to grow up rich to get rich as a founder, but few successful founders grew up desperately poor. Still, the problem isn't inequality per se: the gap between Larry Page's childhood household and a founder's is enormous, yet it didn't stop him joining their ranks. What blocks mobility is some specific combination of things that go wrong when kids grow up poor enough.

A key Silicon Valley principle is "you make what you measure": pick a number and it improves, but only that number, so choose the right one. A university president who targets graduation rates improves graduation rates — not how much students learn, which could even drop if classes were made easier.

Inequality is far enough from the problems it symptomizes that we'll only hit whichever we aim at. So let's aim at the problems. Attack poverty, even if it damages wealth — likelier to work than attacking wealth hoping to fix poverty. And if people get rich tricking consumers or lobbying for loopholes, stop them — not because it causes inequality, but because it's stealing.

If all you have is statistics, that seems like what to fix. But behind a broad measure are things good and bad, trends with immense momentum and random accidents. To fix the world behind the statistics, we have to understand it and focus our efforts where they'll do the most good.

If some baseline inequality is inevitable, we should think about how to live with it instead of only how to reduce it. The real targets are poverty, social mobility, and theft — aim at those, because you only fix what you measure.

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 where they are by ways that have little do with the sort of things economists usually think about, like wages and productivity, but rather by, say, ending up on the wrong side of the "War on Drugs."

[3] Determination is the most important factor in deciding between success and failure, which in startups tend to be sharply differentiated. But it takes more than determination to create one of the hugely successful startups. Though most founders start out excited about the idea of getting rich, purely mercenary founders will usually take one of the big acquisition offers most successful startups get on the way up. The founders who go on to the next stage tend to be driven by a sense of mission. They have the same attachment to their companies that an artist or writer has to their work. But it is very hard to predict at the outset which founders will do that. It's not simply a function of their initial attitude. Starting a company changes people.

[4] After reading a draft of this essay, Richard Florida told me how 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 this is mainly due to the erosion of the kleptocracies that formerly dominated all the poorer countries. Once the playing field is leveler politically, we'll see economic inequality start to rise again. The US is the bellwether. The situation we face here, the rest of the world will sooner or later.

[6] Some people still get rich by buying politicians. My point is that it'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 usually some injustice that is allowing economic inequality to turn into other forms of inequality, and that injustice is what we need to fix. For example, the police in the US treat the poor worse than the rich. But the solution is not to make people richer. It's to make the police treat people more equitably. Otherwise they'll continue to maltreat people who are weak in other ways.

[8] Some who read this essay will say that I'm clueless or even being deliberately misleading by focusing so much on the richer end of economic inequality — that economic inequality is really about poverty. But that is exactly the point I'm making, though sloppier language than I'd use to make it. The real problem is poverty, not economic inequality. And if you conflate them you're aiming at the wrong target.

Others will say I'm clueless or being misleading by focusing on people who get rich by creating wealth — that startups aren't the problem, but corrupt practices in finance, healthcare, and so on.

Once again, that is exactly my point.

The problem is not economic inequality, but those specific abuses.

It's a strange task to write an essay about why something isn't the problem, but that's the situation you find yourself in when so many people mistakenly think it is.

[9] Particularly since many causes of poverty are only partially driven by people trying to make money from them. For example, America's abnormally high incarceration rate is a major cause of poverty. But although for-profit prison companies and prison guard unions both spend a lot lobbying for harsh sentencing laws, they are not the original source of them.

[10] Incidentally, tax loopholes are definitely not a product of some power shift due to recent increases in economic inequality. The golden age of economic equality in the mid 20th century was also the golden age of tax avoidance. Indeed, it was so widespread and so effective that I'm skeptical whether economic inequality was really so low then as we think. In a period when people are trying to hide wealth from the government, it will tend to be hidden from statistics too. One sign of the potential magnitude of the problem is the discrepancy between government receipts as a percentage of GDP, which have remained more or less constant during the entire period from the end of World War II to the present, and tax rates, which have varied dramatically.

Determination decides success or failure, but the hugely successful take more. Purely mercenary founders usually take an early acquisition offer; the ones who go on are driven by a sense of mission, attached to their companies as an artist is to their work. Starting a company changes people.

Some problems have inequality as a cause, but rarely the primary one. Usually some injustice lets inequality turn into other forms, and that's what to fix: when police treat the poor worse than the rich, the answer isn't to make people richer but to make the police more equitable.

Some will say I'm misleading by focusing on the rich end — that inequality is really about poverty. That is exactly my point: the real problem is poverty, and conflating them aims at the wrong target. Others will say the problem is corruption in finance and healthcare, not startups. Again, exactly my point. It's strange to argue something isn't the problem, but that's the situation when so many think it is.

Tax loopholes aren't a product of recent inequality: the mid-century golden age of equality was also the golden age of tax avoidance — so effective I doubt inequality was really as low as we think, since hidden wealth is hidden from statistics too.

Footnotes on what determination really predicts in startups, the symptom-versus-cause distinction, the rich-end focus, and the long history of tax avoidance.

Thanks to Sam Altman, Tiffani Ashley Bell, Patrick Collison, Ron Conway, Richard Florida, Ben Horowitz, Jessica Livingston, Robert Morris, Tim O'Reilly, Max Roser, and Alexia Tsotsis for reading drafts of this.

Note: This is a new version from which I removed 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 [blocked].

Related:

The Short Version [blocked] A Reply to Ezra Klein [blocked] A Reply to Russell Okung [blocked]

This is a new version from which I removed a pair of metaphors that made a lot of people mad. If anyone wants the old version, I put it here [blocked].

A note that this is a revised version with two inflammatory metaphors removed, plus a link to the old one.