How Paul Graham gets it wrong in “Economic Inequality”

Paul Graham (PG) is one of my favorite writers. His Essays are just about all well worth the time to read (and sometimes re-read). It’s not often that I disagree with PG’s reasoned, thoughtful arguments, not to mention disagree vehemently. His recent essay on Economic Inequality, however, feels very off the mark.

In the essay, his overarching point seems to be that an ever-increasing level of economic inequality is a necessary function of living in a healthy society where wealth is created for the benefit of all and innovation flourishes. Further, he argues that attempts to limit such inequality would mean “ending startups.” Neither argument stands up to scrutiny.

There are many studies that demonstrate negative effects of economic inequality[1]. Bill Gates gave an excellent summary of the argument against unchecked levels of economic inequality[2]:

• High levels of inequality are a problem — messing up economic incentives, tilting democracies in favor of powerful interests, and undercutting the ideal that all people are created equal.
• Capitalism does not self-correct toward greater equality — that is, excess wealth concentration can have a snowball effect if left unchecked.
• Governments can play a constructive role in offsetting the snowballing tendencies if and when they choose to do so.

Before diving into the substantive arguments, it’s necessary to call out a straw man argument PG appears to be making. He spends a good deal of time arguing against policies intended to “end economic inequality” which, he argues, can’t be done without “preventing people from getting rich.” While this is true, it’s not an argument I’ve heard anyone make. Rather, the conversation is about what level of economic inequality is desirable in a society, and how to limit inequality — not about how to end it entirely. Furthermore, it is absolutely true, as Warren Buffet said, that “the poor are most definitely not poor because the rich are rich.” But this is not the most interesting argument against income inequality by any means. PG goes on to say that when he hears “people saying that economic inequality is bad” he feels he is “overhearing a conversation between hunters.” Suffice it to say, I don’t think Bill Gates hunts.

This is perhaps the most off-the-mark argument PG makes:

“You can’t end economic inequality 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. Ending economic inequality would mean ending startups. Are you sure, hunters, that you want to shoot this particular animal?”

I’m going to be charitable here and assume that PG is not arguing against those that want to, literally, end economic inequality completely. That is, I’m assuming he wouldn’t dedicate an essay to arguing against those who would propose all people in a society should be utterly and completely economically equal — both because that wouldn’t necessitate such a long essay, and because I’ve never met anyone arguing for this.

Further, the argument that any policies meant to limit economic inequality in a society would mean ending startups in that society is empirically false (see: America).

So PG must be arguing against people who believe that the current system is too unequal, and who hence argue for policies to reduce this inequality. The question then becomes, which policies is PG arguing against specifically? Increasing the estate tax? Single-payer healthcare? A progressive system of taxation? Universal basic income? It’s not clear from his essay.

Not all policies that limit inequality are anti-startup. America already has many such policies — California more than most states — and Silicon Valley remains the startup capital of the world. I’m sure PG himself supports some policies that reduce inequality (progressive system of taxation, social security, medicare). It’s quite hard to see how some of the most popular proposed policies to reduce economic inequality would hurt startups. How would increasing the estate tax, for instance, cause any worthwhile entrepreneur to not start a business? I know quite a lot of entrepreneurs, and not a single one of their founding stories involved contemplating the estate tax.

Further, there are an abundance of studies that show that reducing economic inequality (even through redistributive means) actually boosts overall prosperity. This study by the IMF shows that countries with lower levels of economic inequality show higher levels of economic growth over the long term, while this report by the OECD found that “income inequality has a sizable and statistically significant negative impact on growth.” Why? Because when more people have a shot at economic success, there are more people who can contribute to a society’s economy, which leads to greater overall innovation and greater overall prosperity. This is why redistributive policies like public education make economic sense. By keeping the gap between the rich and poor beneath a certain level, we actually increase the size of the pie for everyone.

FOOTNOTES:

1: Many studies have shown that income inequality is bad, even controlling for other factors — too many to include in a short blog post. For example this one, which shows economic inequality is bad for health: http://www.nytimes.com/2015/03/31/upshot/income-inequality-its-also-bad-for-your-health.html

2: https://www.gatesnotes.com/Books/Why-Inequality-Matters-Capital-in-21st-Century-Review

Thanks to Jordan Lee and Ela Madej for reading drafts of this post.