Monday , May 17 2021

More inequality

Paul Graham adds interesting thoughts on inequality, looking at the Forbes 100. Maybe we don't have enough inequality, and maybe the rise in inequality (especially of wealth) since the 1970s represents too little inequality then, not too much now. Contra the usual in politics, a change is not always a problem, but sometimes for the ...

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Paul Graham adds interesting thoughts on inequality, looking at the Forbes 100. Maybe we don't have enough inequality, and maybe the rise in inequality (especially of wealth) since the 1970s represents too little inequality then, not too much now. Contra the usual in politics, a change is not always a problem, but sometimes for the better. How? Read on. 

Contra the mantra of inherited wealth, the super-rich in America today largely earned their way there from middle class, by starting new companies. They did not inherit wealth. The rich did not get richer. They were superseded by the (fabulously) nouveau-riche. 

In 1982 the most common source of wealth was inheritance. Of the 100 richest people, 60 inherited from an ancestor. There were 10 du Pont heirs alone. By 2020 the number of heirs had been cut in half, accounting for only 27 of the biggest 100 fortunes.

Why would the percentage of heirs decrease? Not because inheritance taxes increased. In fact, they decreased significantly during this period. The reason the percentage of heirs has decreased is not that fewer people are inheriting great fortunes, but that more people are making them.

How are people making these new fortunes? Roughly 3/4 by starting companies and 1/4 by investing. Of the 73 new fortunes in 2020, 56 derive from founders' or early employees' equity (52 founders, 2 early employees, and 2 wives of founders), and 17 from managing investment funds.


 the main source of new fortunes now is starting companies, and when you look at the data, you see big changes there too. ....

 In 1982, there were two dominant sources of new wealth: oil and real estate. Of the 40 new fortunes in 1982, at least 24 were due primarily to oil or real estate. Now only a small number are: of the 73 new fortunes in 2020, 4 were due to real estate and only 2 to oil.

By 2020 the biggest source of new wealth was what are sometimes called "tech" companies. Of the 73 new fortunes, about 30 derive from such companies. These are particularly common among the richest of the rich: 8 of the top 10 fortunes in 2020 were new fortunes of this type.


The tech companies behind the top 100 fortunes also form a well-differentiated group... these are mostly companies that win by having better technology, rather than just a CEO who's really driven and good at making deals.

... the rise of the tech companies represents a qualitative change. The oil and real estate magnates of the 1982 Forbes 400 didn't win by making better technology. They won by being really driven and good at making deals... And indeed, that way of getting rich is so old that it predates the Industrial Revolution. The courtiers who got rich in the (nominal) service of European royal houses in the 16th and 17th centuries were also, as a rule, really driven and good at making deals.

People who don't look any deeper than the Gini coefficient look back on the world of 1982 as the good old days, because those who got rich then didn't get as rich. But if you dig into how they got rich, the old days don't look so good. In 1982, 84% of the richest 100 people got rich by inheritance, extracting natural resources, or doing real estate deals. Is that really better than a world in which the richest people get rich by starting tech companies?

The lower (badly measured, reported) inequality of the 1950-1970 period, and the less-well remembered predominance of inherited wealth in that halcyon era (not)  is actually a historical aberration, 

In 1892, the New York Herald Tribune compiled a list of all the millionaires in America. They found 4047 of them. How many had inherited their wealth then? Only about 20% — less than the proportion of heirs today. And when you investigate the sources of the new fortunes, 1892 looks even more like today. Hugh Rockoff found that "many of the richest ... gained their initial edge from the new technology of mass production." 

So it's not 2020 that's the anomaly here, but 1982...

By the end of World War II, as Michael Lind writes, "the major sectors of the economy were either organized as government-backed cartels or dominated by a few oligopolistic corporations." 

In 1960, most of the people who start startups today would have gone to work for one of them. You could get rich from starting your own company in 1890 and in 2020, but in 1960 it was not really a viable option. You couldn't break through the oligopolies to get at the markets. So the prestigious route in 1960 was not to start your own company, but to work your way up the corporate ladder at an existing one. 

I hope the wonderful days of joyous equality in 1980 are starting not to look so great. The post goes on, which I encourage you to read. Bottom line, tech broke through the big-3 style oligopoly, needs less capital, financing is easier to get, and companies can grow a lot faster. 

BM, founded in 1896, took 45 years to reach a billion 2020 dollars in revenue. Hewlett-Packard, founded in 1939, took 25 years. Microsoft, founded in 1975, took 13 years. Now the norm for fast-growing companies is 7 or 8 years.

His bottom line

It's easier now to start and grow a company than it has ever been. That means more people start them, that those who do get better terms from investors, and that the resulting companies become more valuable. Once you understand how these mechanisms work, and that startups were suppressed for most of the 20th century, you don't have to resort to some vague right turn the country took under Reagan to explain why America's Gini coefficient is increasing. Of course the Gini coefficient is increasing. With more people starting more valuable companies, how could it not be?


Thoughts. We should not think about more or less inequality, we should think about the right amount of inequality, or productive vs. rent-seeking sources of inequality. Take Paul's picture of the US economy at face value. What's a better economy and society? One in which a few oligopolies big companies, deeply involved with government, run everything -- think GM, Ford, IBM, AT&T, defense contractors -- and it's hard to start new innovative fast growing companies? Or the world in which the Bill Gates and Steve Jobs of the world can start new companies, deliver fabulous products and get insanely rich in the process? 

Let us acknowledge the counterargument. Russia has a lot of inequality, if you measure oligarchic wealth stashed abroad. Likewise Cuba. There's a French fable about inequality coming from centuries old inherited wealth that grows faster than labor income, so the descendants of 1700s aristocrats own everything today. Perhaps the contemporary American fable might be the notion that descendants of southern plantation owners have all the wealth today. One might complain that inequality, never a problem per se, nonetheless is a symptom of problems if this were the case. 

But a look at just who is fabulously wealthy in the US and how they got there simply says these are fables. 

It frustrates me that to the left the answer, as in so many issues, is always "less" inequality and "more" redistribution. What is enough inequality and when do we know when we have gotten there? Surely not zero. On income inequality, just the fact that people earn more as they get older, and then retire and earn little means there will be wage inequality. And surely there must be some reward for those who take risks, start new companies, and serve the rest of us well. Their other goals are similarly frustratingly unquantified and unmeasured. It's always more. 

More inequality
Meanwhile, courtesy Alec Stapp on  twitter, here is how people respond (at least in 2014) to the survey question "Most people are better off in a free market economy, even though some people are rich and some are poor." 

I am gratified it still polls 70/25 in the US. It is interesting that Vietnam (96/3) China (76/16) and Nigeria (74/17) beat us on this question! Now, they are not asking about democracy, just about free markets. Still, gratifying that the lessons of history are resistant to ideology.  



John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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