Inequality and Risk

Wednesday, August 31st, 2005

Paul Graham summarizes the link between Inequality and Risk:

Decreasing economic inequality means taking money from the rich. Since risk and reward are equivalent, decreasing potential rewards automatically decreases people’s appetite for risk. Startups are intrinsically risky. Without the prospect of rewards proportionate to the risk, founders will not invest their time in a startup. Founders are irreplaceable. So eliminating economic inequality means eliminating startups.

Economic inequality is not just a consequence of startups. It’s the engine that drives them, in the same way a fall of water drives a water mill. People start startups in the hope of becoming much richer than they were before. And if your society tries to prevent anyone from being much richer than anyone else, it will also prevent one person from being much richer at t2 than t1.

When you reduce inequality, you reduce risk, and that reduces growth:

Ok, so we get slower growth. Is that so bad? Well, one reason it’s bad in practice is that other countries might not agree to slow down with us. If you’re content to develop new technologies at a slower rate than the rest of the world, what happens is that you don’t invent anything at all. Anything you might discover has already been invented elsewhere. And the only thing you can offer in return is raw materials and cheap labor. Once you sink that low, other countries can do whatever they like with you: install puppet governments, siphon off your best workers, use your women as prostitutes, dump their toxic waste on your territory — all the things we do to poor countries now. The only defense is to isolate yourself, as communist countries did in the twentieth century. But the problem then is, you have to become a police state to enforce it.

Of course, no one’s goal is to stop high-risk startups:

The problem here is not wealth, but corruption. So why not go after corruption?

We don’t need to prevent people from being rich if we can prevent wealth from translating into power. And there has been progress on that front. Before he died of drink in 1925, Commodore Vanderbilt’s wastrel grandson Reggie ran down pedestrians on five separate occasions, killing two of them. By 1969, when Ted Kennedy drove off the bridge at Chappaquiddick, the limit seemed to be down to one. Today it may well be zero. But what’s changed is not variation in wealth. What’s changed is the ability to translate wealth into power.

How do you break the connection between wealth and power? Demand transparency. Watch closely how power is exercised, and demand an account of how decisions are made. Why aren’t all police interrogations videotaped? Why did 36% of Princeton’s class of 2007 come from prep schools, when only 1.7% of American kids attend them? Why did the US really invade Iraq? Why don’t government officials disclose more about their finances, and why only during their term of office?

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