Making the Case FOR Income Inequality

In a recent essay, writer and venture capitalist Paul Graham, laid out an interesting argument in favor of a certain type economic inequality. Since that is not a common position these days, it’s worth a moment to consider his point of view, which I believe is serious and valid.

Graham’s argument has four basic points:

  • Economic inequality comes in two forms: that created by wealth creation and that created by wealth transfer (e.g., rent seeking, theft, monopolies, etc.)
  • The former is good and the latter is bad
  • Society cannot and should not eliminate the former
  • Society can and should eliminate the latter

The foundation of Graham’s argument is his position that economic inequality has two forms, each with opposite moral and social consequences. As he notes:

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.

Graham’s point is a good one. Google’s founders did not directly make anyone poorer by inventing Google. It was the market that rewarded them from their invention and, in the end, punished traditional information providers for their lack of innovation. The same is true for the thousands of entrepreneurs who take personal and financial risks to start a company in the hope that their new ideas will make them rich. Graham bolsters his argument for a distinction within income inequality with a thought experiment: ask yourself, he suggests, what some famous entrepreneur would have done had they not started their companies:

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.

This is a subtle but important point and worth understanding. Graham is saying that one way to tell which kind of inequality a society has is to look at the alternative path of those getting rich. If a very rich person would have been rich anyway without taking risks or being innovative, society has the bad kind of income inequality, i.e., in the case of hereditary wealth. However, if a very rich person ends of that way primarily through effort, innovation (and no doubt luck), then this type of economic inequality is not only aceptable it is desirable. Indeed, in Graham’s view, entrepreneurship, with its occasionally amazing rewards, is a necessary and desirable social mechanisms that provide the best and brightest an outlet for their talents:

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.

In the end, for Graham, income inequality that arises from places like and Silicon Valley is nothing new and to fight it is to fight history itself:

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.

Concluding, Graham makes the case that what people should really focus on is not income inequality, especially since so few researchers seem to care about his distinction, but poverty. In other words, society should worry more about raising the floor, so to speak, than lowering the ceiling:

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.

After finishing Graham’s essay, I thought back to Thomas Piketty’s Capital in the Twenty-First Century,which famously made the case for rising income inequality and, in the end, proposed extensive global tax redistribution to address the problem. I don’t think Graham’s essay necessarily negates what I took away as Piketty’s central thesis, since the French economist’s concern is primarily with the “bad” kind of income inequality, which, he argued, has arisen because of three core reasons:

  • Real capital concentration in the hands of too few people.
  • An unjustified explosion in the pay of the top members of the managerial class.
  • The inability or unwillingness to tax wealth in addition to income and  inheritance.

In Piketty view, these forces have allowed great fortunes to accumulate and to become self-perpetuating, which may be what Graham is referring to when he writes about the dark side of income inequality. In other words, there is nothing wrong with Bill Gates amassing a great fortune (Graham’s argument), but there is something very wrong with his heirs inheriting that fortunate and increasing it unfairly to the detriment of society (Picketty’s argument).

Of course, even if one can, prima facie, reconcile their two views, Graham’s argument needs further refinement. For example, while he says poverty should be decreased, he does not really describe how this should be done. Also, he does not in any way address the social and financial benefits that his beloved entrepreneurs gain from wider societal investments such as schools, roads, public safety, etc. In other words, he does not address what role, if any, that “social debt,” should play in discussions about income inequality.

In the end, though, I hope Graham’s provocative essay will trigger a deeper economic analysis of his position. He makes an important point amid all the noise about income inequality, and it deserves to be studied and addressed in future analyses of this critical topic.

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